Question

13. External Funds Needed The Optical Scam Company has forecast a sales growth rate of 15 percent for next year. The current financial statements are shown here: Income Statement Sales $25,380,000 Costs 21,635,000 $3,745,000 Taxable income Taxes 1,498,000 Net income $2247,000 Dividends $786,450 Addition to retained earnings 1,460,550 Balance Sheet Liabilities and Owners' Equity Assets $ 5,200,000 Current assets $7,200,000 Short-term debt 6,000,000 Long-term debt Fixed assets 17.600,000 $3,200,000 Common stock 10,400,000 Accumulated retained earnings Total equity $13,600,000 Total assets $24,800,000 Total liabilities and equity $24,800,000 a. Using the equation from the chapter, calculate the external funds needed for next year b. Construct the firm's pro forma balance sheet for next year and confirm the external funds needed that you calculated in part (a) c. Calculate the sustainable growth rate for the company d. Can the company eliminate the need for external funds by changing its dividend policy? What other options are available to the company to meet its growth objectives?

Answer 1

a)	External funds required = [(Assets / Sales) x Δ sales] - [(Spontaneous liabilities / Sales) x Δ sales] - [(Projected sales x Profit margin) x (1-Dividend payout ratio)]
	EFN = (24800000/25380000)*25380000*15%-(5200000/25380000)*25380000*15%-25380000*115%*8.8534%*(1-35%) =	$      12,60,373
	Workings:
	Net profit margin = 2247000/25380000 =	8.8534%
	Dividend payout ratio = 786450/2247000 =	35.00%
b)			Next Year
		Current Year	Basis for projections	Projections before raising AFN
	INCOME STATEMENT
	Sales	$ 2,53,80,000	+15%	$     2,91,87,000
	Less: Costs	$ 2,16,35,000	85.24% of sales	$     2,48,80,250
	Taxable income	$      37,45,000		$         43,06,750
	Taxes at 40%	$      14,98,000		$         17,22,700
	Net income	$      22,47,000		$         25,84,050
	Dividends (35%)	$        7,86,450		$           9,04,418
	Addition to retained earnings	$      14,60,550		$         16,79,633
	BALANCE SHEET
	Current assets	$      72,00,000		$         82,80,000
	Fixed assets-Net	$ 1,76,00,000		$     2,02,40,000
	Total assets	$ 2,48,00,000		$     2,85,20,000
	Short term debt	$      52,00,000		$         59,80,000
	Long term debt	$      60,00,000		$         60,00,000
	Common stock	$      32,00,000		$         32,00,000
	Retained earnings	$ 1,04,00,000	+1679633	$     1,20,79,633
	Total	$ 2,48,00,000		$     2,72,59,633
			EFN	$         12,60,368
	Marginal difference between [a] and [b] due to approximation in [a]
c)	SGR = ROE*b/(1-ROE*b).
	ROE = 2247000/13600000 =	16.52%
	SGR = 0.1652*0.65/(1-0.1652*0.65) =	12.03%
d)	Yes. By changing the dividend policy the firm can completely eliminate the need for external funds.
	The projected retained earnings is $1679633, which is more than the EFN of $1260368.
	Measures to meet growth objectives:
	*Restrict dividend
	*Increase profit margins
	*Use assets more efficiently
	*Use more debt