Chapter 3, Problem 4QP

Summary Introduction

To determine: The external financing needed.

Explanation of Solution

Compute the increase in percentage of sales:

$\begin{array}{c}\text{Increase in percentage of sales}=\frac{\text{Projected sales}-\text{Current sales}}{\text{Current sales}}\\ =\frac{\$50,310-\$43,000}{\begin{array}{l}\$43,000\end{array}}\times 100\\ =17\%\end{array}$

Hence, the increase in percentage of sales is 17%.

Compute the changes in the values of income statement by 17%:

$\begin{array}{c}\text{Increase in sales}=\left(\text{Current sales}\times \text{Percentage of increase in sales}\right)+\text{Current sales}\\ =\left(\$43,000\times \frac{17}{100}\right)+\$43,000\\ =\$7,310+\$43,000\\ =\$50,310\end{array}$

Hence, the increase in sales is $50,310.

Compute the increase in cost:

$\begin{array}{c}\text{Increase in cost}=\left(\text{Current cost}\times \text{Percentage of increase in sales}\right)+\text{Current cost}\\ =\left(\text{\$30,200}\times \frac{17}{100}\right)+\$30,200\\ =\$5,134+\$30,200\\ =\$35,334\end{array}$

Hence, the increase in cost is $35,334.

Calculate the increase in the value of taxes:

$\begin{array}{c}\text{Increase in value of taxes}=\left(\text{Current taxes}\times \text{Percentage of increase in sales}\right)+\text{Current taxes}\\ =\left(\$4,352\times \frac{17}{100}\right)+\$4,352\\ =\$739.84+\$4,352\\ =\$5,091.84\end{array}$

Hence, the increase in value of taxes is $5,091.84.

Pro forma income statement

Hence, the net income is $9,884.16.

Compute the changes in the values of balance sheet by 17%:

$\begin{array}{c}\text{Increase in assets}=\left(\text{Existing assets}\times \text{Percentage of increase in sales}\right)+\text{Existing}\text{assets}\\ =\left(\text{\$104,500}\times \frac{17}{100}\right)+\$104,500\\ =\$17,765+\$104,500\\ =\$122,265\end{array}$

Hence, the increase in assets is $122,265.

Compute the dividend and additional retained earnings:

Since the company wish to maintain a constant payout ratio, the dividend can be determined as follows:

$\begin{array}{c}\text{Dividend}=\frac{\text{Current year's dividend}}{\text{Net income}}\times \text{Projected net income}\\ =\left(\frac{\text{\$2,600}}{\$8,448}\right)\times \$9,884.16\\ =\$3,042\end{array}$

Hence, the dividend is $3,042.

$\begin{array}{c}\text{Additional retained earnings}=\text{Net income}-\text{Dividend}\\ =\text{\$9,884}\text{.16}-\text{\$3,042}\\ =\$6,842.16\end{array}$

Hence, the additional earnings are $6,842.16.

Compute the total equity:

$\begin{array}{c}\text{Total equity}=\text{Current equity}+\text{Additional equity}\\ =\$76,300+\$6,842.16\\ =\$83,142.16\end{array}$

Hence, the total equity is $83,142.16.

Prepare the Pro forma balance sheet:

Compute the external financing needed:

$\begin{array}{c}\text{External financing needed}=\text{Total assets}-\text{Total liabilities and Owner's equity}\\ =\$122,265-\$111,342.16\\ =\$10,922.84\end{array}$

Hence, the external financing needed is $10,922.84.