Self- Test Problem

(ST.1) Weatherford Industries Inc. has the following ratios A*/S0 = 0.4 ;
Profit margin =0.10 ; and dividend payout ratio =0.45 or 45 percent . Sales last AFN
formula to determine the maximum growth rate Weatherford can achieve without
having to employ nonspontaneous external fund .
(ST.2) Suppose Wearthford's financial consultants report (1) that the inverntory turnOver ratio is sales / ivverntory = 3 times versus and industry average of 4 times and
without affecting sales ; the profit margin ; or the otherasset turnover ratios . Under
these conditions . use the AFN formula to determine the amount of additional funds
wearthford would require during each of the next 2 year if sales grew at a rate of 20
percent per year .
(ST.3)
Van Auken Lumber's 2004financial statemnts are shown below .
Van Auken Lumber's : Balance Sheet as Decemver 31,2004
( Thousand of Dollars)
Cash
1.800$
Receivables
10.800
Inventories
12.600
Total current assets 25.200$
Net fixed assets
21.600
2.000
26.608
Total assets

Account payable
Notes payable
Accruals
Total current liabilities
Mortgage bonds

7.200$
3.472
2.520
13.192$
5.000

Common stock
Retained earnings
$46.800
Total liabilities and equity

$46.800

Van Auken Lumber : Income statement for December 31,2004

( Thousand of Dollars)
Sales
$36.000
Operating costs
30.783
Earning before interest and taxes
$5.217
Interest
1.017
Earning before taxes
$4.200
Taxes(40%)
1.680
Net income
$2.520
Dividends (60%)
$1.512
Addition to retained earnings
$1.008
a. Assume that the company was operating at full capacity in 2004 with regard to all
items except fixed assets in 2004 were being utilized to only
75 percent of capacity By what percentage could 2005 sales increase over 2004 sales
without the need for an in fixed assets?
b. Now suppose 2005 sales increase by 25 percent over 2004 sales.how much
additional external capital will be required ? Assume that van Aan Auken cannot
forma balance sheet and income statement as in Tables 14-2 and14-3
Percent interest rate for all debt at the beginning of the year to forecast inter-

Est expens (cash does not earn interest),and use a pro froma income state_
Ment to determine the addition to retained earnings.(Another hint :Notes
payable=$6,021.)
PROBLEMS
Carter corporations sales are expected to incredse from $5 million in 2004 to $6
million in 2005 , or by 20 percent. Its assets totaled $3 million at the end of 2004.
carter is at full capacity<so its assets must grow at same rate as proJected sales. At the end of 2004, cussent liabilities were $1 million, consisting of
$250.000 of accounts patable, $500.000of notes payable ,and $250.000 of accruals .
The after-tax profit margin is forecasted to be 5 percent . Use this information to
answer problems 14-1 , 14-2 , 14-3
(14-1) Use the AFN formula to forecast Carter's additional funds needed for the
coming year.
14-1 AFN = (A*/S0)S - (L*/S0)S - MS1(1 - d)
$3,000,000
$500,000
$1,000,000 -
$1,000,000 $5,000,000
$5,000,000

0.05($6,000,000)(1 - 0.7)
= (0.6)($1,000,000) - (0.1)($1,000,000) - ($300,000)(0.3)
= $600,000 - $100,000 - $90,000
= $410,000.
(14-2) What would be the additional funds needed if the company's year-end 2004
assets had been $4 million ? Assume that all other numbers are the same . Why is this
AFN different from the one you found in problem 14-1? Is the company's " capital
intensity " the same or different?
14-2

$4,000,000
$1,000,000 (0.1)($1,000,000) ($300,000)(0.3)
$5,000,000

AFN =

= (0.8)($1,000,000) - $100,000 - $90,000

= $800,000 - $190,000
= $610,000.
(14-3) Return to the assumption that the company had $3 million in assets at the end
of 2004, but now assume that the company pays no dividend . Under these assumption
. what would be additional funds needed for the coming year ? why is this AFN
different from the one you found in problem 14-1?
14-3 AFN = (0.6)($1,000,000) - (0.1)($1,000,000) - 0.05($6,000,000)(1 - 0)
= $600,000 - $100,000 - $300,000
= $200,000.
Under this scenario the company would have a higher level of retained
earnings which would reduce the amount of additional funds needed.

(14-5) Upton Computers makes bulk purchases of small computers , stocks them in
conveniently located warehouses , and ships them to its chain of retail stores .Upton's
balance sheet as of December 31,2004 , is shown here (million of dollars ):
Cash

$3.5

Accounts payable

$9.0

Receivables
26.0
Inventories
58.0
Total current assets
$87.5
Net fixed assets
35.0
15.0
Common stock
66.0
Retained earnings
Total assets
$122.5

Notes payable
18.0
Accruals
8.5
Total current liabilities $35.5
Mortgage loan
6.0
Total liabilities and equity 122.5

Sales of 2004 were $350.000 , while net in come for the year was $10.5 million .
Upton paid dividends of $4.2 million to common stockholders . The firm is operating
at full capacity .Assume that all ratios remain constant .
a. If sales are projected to increase by $70 million , or 20 percent , during 2005 , use
the AFN equation to determine Upton's projected external capital requirements .
b. Construct Upton's pro forma balance sheet for December 31,2005. Assume that all
external capital requirements are met by bank loans and reflected in notes payable
.Assume Upton's profit margin and dividend payout ratio remain constant
14-5 a. AFN
= (A*/S)(S) (L*/S)(S) MS1(1 d)
=
millb.

$122.5
$17.5
$10.5
($70) ($70) ($420)(0.6) = $13.44
$350
$350
$350

Upton Computers

Pro Forma Balance Sheet

December 31, 2005
(Millions of Dollars)
Forecast

Pro Forma
Basis %

after
2004 2005 Sales Additions Pro Forma Financing
Financing
Cash

$ 3.5

0.0100

$ 4.20

26.0

0.7430

31.20

58.0

0.1660

69.60

4.20
Receivables
31.20
Inventories
69.60
Total current
assets
$105.00
Net fixed assets

$ 87.5
35.0

$105.00
0.100

42.00

42.00
Total assets
$147.00
Accounts payable

$122.5
$ 9.0

$147.00
0.0257

$ 10.80

10.80
Notes payable
31.44
Accruals

18.0
8.5

18.00
0.0243

+13.44

10.20

10.20
Total current
liabilities

$ 35.5

$ 39.00

52.44
Mortgage loan
Common stock
15.00
Retained earnings

6.0
15.0

6.00

66.0

7.56*

6.00
15.00
73.56

73.56
Total liab.
and equity
$147.00
AFN =

$122.5

$133.56
$ 13.44

*PM = $10.5/$350 = 3%.

Payout = $4.2/$10.5 = 40%.
NI = $350 1.2 0.03 = $12.6.
Addition to RE = NI - DIV = $12.6 - 0.4($12.6) = 0.6($12.6) = $7.56.

(14-7) Gargling ton Technologies Inc's 2004 financial statements are shown below
Garglington Technologies Inc's:
Balance Sheet as of December 31,2004
Cash
$180.000
Accounts payable
$360.000
Receivables
360.000
Notes payable
156.000
Inventories
720.000
Accruals
180.000
Total current assets
$1.260.000
Total current liabilities $696.000
Fixed assets
1.440.000
Common stock
1.800.000
204.000
Retained earnings
Total assets
$2.700.000
Total liabilities and equity $2.700.000
Garglington Technologies Inc's : Income statement for December 31,2004
Sales
Operating costs
Earning before interest and taxes
Interest
Earning before taxes
Taxes(40%)
Net income
Dividends (45%)

$3.600.000
3.279.720
$320.280
18.280
$302.000
120.00
$181.200
$108.000

Suppose that in 2005 sales increase by 10 percent over 2004 sales and that 2005
divide's will increase to $112,000. Construct the prove forma financial statement
using the percent of sales method . Assume the firm operated at full capacity in 2004.
Use an interest rate of 13 percent on the dept plans at the beginning of the year.
Assume divide's will grow 3 percent and that the AFN will be in the form of notes
payable.
14-7 a. & b.
Garlington Technologies Inc.
Pro Forma Income Statement
December 31, 2005
Forecast
2004

Basis
2005
Sales
$3,600,000
1.10 Sales04
Operating costs 3,279,720 0.911 Sales05
EBIT
$ 320,280
Interest
18,280
0.13 Debt04
EBT
$ 302,000
Taxes (40%)
120,800
Net income
$ 181,200
Dividends:
$ 108,0001.03 2004 Dividends
Addition to RE: $ 73,200

Additions
$3,960,000
3,607,692
$ 352,308
20,280
$ 332,028
132,811
$ 199,217
$ 112,000
$ 87,217

Garlington Technologies Inc.

Pro Forma Balance Statement
December 31, 2005
Forecast
Basis %

AFN

With AFN
2004
2005
Cash

2005 Sales

Additions

2005

$ 180,000

0.05

$ 198,000

360,000
396,000
720,000

0.10

396,000

0.20

792,000

Effects

$ 198,000
Receivables
Inventories
792,000
Total current
assets
$1,260,000

$1,386,000

$1,386,000
Fixed assets

1,440,000

0.40

1,584,000

1,584,000
Total assets $2,700,000

$2,970,000

$2,970,000
Accounts payable$ 360,000

0.10

$ 396,000

$ 396,000
Notes payable

156,000

Accruals

180,000

156,000+128,783

284,783
0.05

198,000

198,000
Total current
liabilities
$ 696,000

$ 750,000

878,783
Common stock 1,800,000
1,800,000
Retained earnings204,000
291,217
Total liab.
and equity
$2,700,000

1,800,000
87,217*

291,217
$2,841,217

$2,970,000
AFN =

Cumulative AFN =

128,783
128,783
*See income statement.

(14-8) At year end 2004 , total assets for Bertin Inc. were $1.2 million and accounts
by payable were $375.000 sales , which in 2004 were $2.5 million , are expected to
increase by 25 percent in 2005. Total assets and accounts payable are propor tional to
sales and that relationship will be maintained. Bertin typically uses no current
liabilities other than accounts payable. Common stock amounted to $425.000 in 2004,
and retained earnings were $295.000 Bertin plans to sell new common stock in the
amount of $75.000 The firm's profit margin on sells is 6 percent; 40 percent of
earning will be paid out as dividends.
a. what was Bertin's total dept in 2004 ?
b. how mush new , long term dept financing will be needed in 2005? (Hint :AFN New
stock = New long term dept.) Do not consider any financed feedback effects.
Cash
Accounts receivable
Inventories
Net fixed assets
100
250
Total assets

$100
200
200
500

Accounts payable
Notes payable
Accruals
Long term debt

$50
150
50
400

Common stock
Retained earnings
$1.000
Total liabilities and equity $1.000

Booth's fixed assets were used to only 50 percent of capacity during 2004, but is
current assets were at their ropor levels . All assets except fixed assets increase at the
same rate as sales , and fixed assets would also increase at the same rate if the current
excess capacity did not exist. Booth after tax profit margin is forecasted to be 5
percent, and its payout ratio will be 60 percent . what is Booth's additional fund's
needed (AFN) for the coming year ?

14-8

a.

Total liabilities Accounts Long - term Common Retained

=
+
+
+
.
and equity
Payable
debt
stock
earnings

$1,200,000 = $375,000 + Long-term debt + $425,000 + $295,000

Long-term debt = $105,000.
Total debt = Accounts payable + Long-term debt
= $375,000 + $105,000 = $480,000.
Alternatively,
Total

Total debt = liabilities - Common stock - Retained earnings

and equity

= $1,200,000 - $425,000 - $295,000 = $480,000.

b. Assets/Sales (A*/S) = $1,200,000/$2,500,000 = 48%.
L*/Sales = $375,000/$2,500,000 = 15%.
2002 Sales = (1.25)($2,500,000) = $3,125,000.
AFN = (A*/S)(S) - (L*/S)(S) - MS1(1 - d) - New common stock
= (0.48)($625,000) - (0.15)($625,000) - (0.06)($3,125,000)(0.6) - $75,000
= $300,000 - $93,750 - $112,500 - $75,000 = $18,750.
Alternatively, using the percentage of sales method:
Forecast
Basis %
Financing, R/E)
Pro Forma
Total assets
Current liabilities

$1,200,000
$1,500,000
$ 375,000

Additions (New
2004 2005 Sales
0.48
0.15

468,750
Long-term debt

105,000
105,000
$ 480,000

Total debt

573,750
Common stock

425,000
500,000
295,000

Retained earnings

75,000*
112,500**

407,500
Total common equity

$ 720,000

907,500
Total liabilities
and equity

$1,200,000
$1,481,250

AFN = Long-term debt =

18,750
*Given in problem that firm will sell new common stock = $75,000.

**PM = 6%; Payout = 40%; NI2005 = $2,500,000 x 1.25 x 0.06 = $187,500.

Addition to RE = NI x (1 - Payout) = $187,500 x 0.6 = $112,500.