Question

Morrissey Technologies Inc.'s 2019 financial statements are shown here.

Morrissey Technologies Inc.: Balance Sheet as of December 31, 2019
Cash	$180,000		Accounts payable	$360,000
Receivables	360,000		Notes payable	56,000
Inventories	720,000		Accrued liabilities	180,000
Total current assets	$1,260,000		Total current liabilities	$596,000
			Long-term debt	100,000
Fixed assets	1,440,000		Common stock	1,800,000
			Retained earnings	204,000
Total assets	$2,700,000		Total liabilities and equity	$2,700,000

Morrissey Technologies Inc.: Income Statement for December 31, 2019
	Sales	$3,600,000
	Operating costs including depreciation	3,279,720
	EBIT	$320,280
	Interest	20,280
	EBT	$300,000
	Taxes (25%)	75,000
	Net Income	$225,000
	Per Share Data:
	Common stock price	$45.00
	Earnings per share (EPS)	$2.25
	Dividends per share (DPS)	$1.35

Suppose that in 2020, sales increase by 20% over 2019 sales. The firm currently has 100,000 shares outstanding. It expects to maintain its 2019 dividend payout ratio and believes that its assets should grow at the same rate as sales. The firm has no excess capacity. However, the firm would like to reduce its operating costs/sales ratio to 86.5% and increase its total liabilities-to-assets ratio to 30%. (It believes its liabilities-to-assets ratio currently is too low relative to the industry average.) The firm will raise 30% of the 2020 forecasted interest-bearing debt as notes payable, and it will issue long-term bonds for the remainder. The firm forecasts that its before-tax cost of debt (which includes both short- and long-term debt) is 13%. Assume that any common stock issuances or repurchases can be made at the firm's current stock price of $45.

1. Construct the forecasted financial statements assuming that these changes are made. What are the firm's forecasted notes payable and long-term debt balances? What is the forecasted addition to retained earnings? Do not round intermediate calculations. Round your answers to the nearest cent.
   

   Morrissey Technologies Inc. Pro Forma Income Statement December 31, 2020
   	2019		2020
   Sales	$3,600,000		$
   Operating costs (includes depreciation)	3,279,720
   EBIT	$320,280		$
   Interest expense	20,280
   EBT	$300,000		$
   Taxes (25%)	75,000
   Net Income	$225,000		$
   Dividends (60%)	$		$
   Addition to retained earnings	$		$

   Morrissey Technologies Inc. Pro Forma Balance Statement December 31, 2020
   	2019		2020
   Assets
   Cash	$180,000		$
   Accounts receivable	360,000
   Inventories	720,000
   Fixed assets	1,440,000
   Total assets	$2,700,000		$
   Liabilities and Equity
   Payables + accruals	$540,000		$
   Short-term bank loans	56,000
   Total current liabilities	$596,000		$
   Long-term bonds	100,000
   Total liabilities	$696,000		$
   Common stock	1,800,000
   Retained earnings	204,000
   Total common equity	$2,004,000		$
   Total liabilities and equity	$2,700,000		$

2. 
   
3. If the profit margin remains at 6.25% and the dividend payout ratio remains at 60%, at what growth rate in sales will the additional financing requirements be exactly zero? In other words, what is the firm's sustainable growth rate? (Hint: Set AFN equal to zero and solve for g.) Do not round intermediate calculations. Round your answer to two decimal places.
     %

Answer 1

(A)

INCOME STATEMENT for December 31, 2020

PARTICULAR	2019 $	Details	2020 $
Sales	36,00,000	inc. by 20%	43,20,000
Operating Costs (includind dep.)	32,79,720	86.5% of sales	37,36,800
EBIT	3,20,280		5,83,200
Interest (@13%)	20,280	13% of 432000	56,160
EBT	3,00,000		5,27,040
Taxes (25%)	75,000		1,42,550
Net Income	2,25,000		3,84,490

BALANCE SHEET as of December 31, 2020

PARTICULAR	2019 $	DETAILS	2020 $
ASSETS
Cash	1,80,000	inc. by 20% (like sales)	2,16,000
Receivables	3,60,000	inc. by 20% (like sales)	4,32,000
Inventories	7,20,000	inc. by 20% (like sales)	8,64,000
Fixed Assets	14,40,000	inc. by 20% (like sales)	17,28,000
TOTAL ASSETS	27,00,000	inc. by 20% (like sales)	32,40,000
EQUITY & LIABILITIES
EQUITY
Common Stock	18,00,000	no change in equity shares	18,00,000
Retained Earnings	2,04,000	residual of total liab. & equity	4,68,000
LIABILITIES
Notes Payables	56,000	30% of total int-bearing debt	1,29,600
Accrued Liabs.	1,80,000	taken as same	1,80,000
Accounts Pyable	3,60,000	taken as same	3,60,000
Long term debts	1,00,000	70% of total int-bearing debt	3,02,400
TOTAL LIAB.	6,96,000	30% of assets	9,72,000
TOTAL EQUITY & LIABILITIES	27,00,000		32,40,000

(B)

SUSTAINABLE GROWTH RATE = Retention Rate * Return on Equity

Here,    Retention rate = (Net income - dividend) / Net income

                                             = (225,000 – 135,000) / 225,000

                                             = 40%

               Return on Equity = Net income / Total equity

                                                   = 225,000 / 2,004,000

                                                    = 11.23%

Hence,

                              Sustainable GR = (40%) * (11.23%) = 4.492%