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Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

14th Edition
Eugene F. Brigham + 1 other
ISBN: 9781285867977
Textbook Problem

ADDITIONAL FUNDS NEEDED Morrissey Technologies Inc.’s 2015 financial statements are shown here.

Morrissey Technologies Inc.: Balance Sheet as of December 31, 2015

Cash $ 180,000 Accounts payable $ 360,000
Receivables 360,000 Accrued liabilities 180,000
Inventories 720,000 Notes payable 56,000
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, 2015

Sales $3,600,000
Operating costs including depreciation 3,279,720
EBIT $ 320,280
Interest 20,280
EBT $ 300,000
Taxes (40%) 120,000
Net Income $ 180,000
Per Share Data:  
Common stock price $45.00
Earnings per share (EPS) $ 1.80
Dividends per share (DPS) $ 1.08

Suppose that in 2016, sales increase by 10% over 2015 sales. The firm currently has 100,000 shares outstanding. It expects to maintain its 2015 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 87 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 2016 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 12 5%. Assume that any common stock issuances or repurchases can be made at the firm’s current stock price of $45.

  1. a. 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?
  2. b. If the profit margin remains at 5% 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.)

a.

Summary Introduction

To prepare: The financial statement of M Incorporation for the year ended 2016.

Additional Funds Needed (AFN) Equation:

The AFN equation explains the amount of money that a company needs to fulfill the financial needs of the company. It gives the information related to the external financing, as the options available to a company to finance through external financing methods. This equation basically gives a new capital structure that includes an optimum mix of debt, preferred and common stock.

Financial Statement:

The financial statement is final accounts of the company. Financial statement of the company contains the income statement, statement of retained earnings, balance sheet and cash flow statement.

Explanation

Prepare Income statement,

Table (1)

Prepare statement of retained earnings

Table (2)

Prepare Balance sheet

Table (3)

Working Notes:

Calculation of increase in sales:

Sales=$3,600,000+($3,600,000×10%)=$3,600,000+$360,000=$3,960,000

Calculation of operating cost including depreciation

Operatingcostsincludyingdepreciation=$3,960,000×87.5%=$3,465,000

Calculation of the dividend amount:

Dividend=Dividend per share×Number of outstanding shares=$1.08×100,000=$108,000

Calculation of dividend payout ratio:

Dividend payout ratio=DividendNet Income=108,000180,000=60%

Calculation of AFN equation:

AFN=[(($2,700,000$3,600,000)×$360,000)(($596,000$3,600,000)×$360,000)((0.05×$3,960,000)×(10.60))]=$270,000$59,600$79200=$131200

Calculation of the distribution of additional funds:

Additional Funds=Notes payable + Long term bonds=AFN(30%)+AFN(70%)=$131,200(30%)+$131,200(70%)=$39,360+$91,840=$131,200

Calculation of interest on bonds:

Interest on bonds=$20,280+($91,840×12.5%)+($39,360×12

b.

Summary Introduction

To compute: The growth in sales using AFN equation.

Additional Funds Needed (AFN) Equation:

The AFN equation explains the amount of money that a company needs to fulfill the financial needs of the company. It gives the information related to the external financing, as the options available to a company to finance through external financing methods. This equation basically gives a new capital structure that includes an optimum mix of debt, preferred and common stock.

Financial Statement:

The financial statement is final accounts of the company. Financial statement of the company contains the income statement, statement of retained earnings, balance sheet and cash flow statement.

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