Calculating EFN [LO2] In Problem 24, suppose the firm wishes to keep its debt–equity ratio constant. What is EFN now?
To determine: External financing needed.
Introduction:
The difference between the total assets and the total liabilities and owner’s equity is termed as external financing needed. This difference amount is the source or funds, which is required from the outside sources.
Answer to Problem 26QP
External financing needed is $55,345.
Explanation of Solution
Given information:
The firm would like to keep its debt equity ratio, constant.
A sale for the year 2015 is projected to grow by 20%.
Interest expenses, tax rate, dividend payout ratio remains constant whereas cost, other expenses, current assets, fixed assets, accounts payable vary with sales.
Formulae:
Balance sheet after increase in sales by 20%
Pro forma balance sheet | |||
Particulars |
Amount ($) |
Particulars |
Amount ($) |
Current assets | Current liabilities | ||
Cash | $29,136 | Accounts payable | $78,240 |
Accounts receivable | $44,484 | Notes payable | $16,320 |
Inventory | $100,080 | Total | $94,560 |
Total | $173,700 | ||
Fixed assets | Long-term debt | $155,000 | |
Net plant and equipment | $475,800 | Owner's equity | |
Common stock and paid in surplus | $130,000 | ||
Retained earnings | $262,837 | ||
Total equity | $392,837 | ||
Total | $649,500 | Total | $642,397 |
Compute new total debt:
Compute debt equity ratio:
Hence, debt equity ratio is 0.77616.
Hence, new debt is $304,905.
The below mentioned calculations are required to compute EFN:
Note: The external financing needed is determined from the external sources and do not increase spontaneously with sales. Therefore, the spontaneous increase from the accounts payable has to be subtracted.
Hence, new level of accounts payable is $13,040.
Thus, $13,040 shows the spontaneous increase in accounts payable and the debt that is raised externally is termed as external financing needed.
Compute EFN:
Hence, external financing needed is $55,345.
Since, an increase in debt will make balance sheet unbalanced.
The new balance sheet is shown below:
Adjusted pro forma Balance:
Total asset is $649,500
Total liabilities and owner’s equity is $697,743
The balance of $697,743 and $649,500 is $48,243 that can be transferred to excess cash account.
Compute the balance sheet after taking these adjustments into account:
Any increase in fixed assets will change the firms operation. Since, the company already has enough fixed asset, the debts and equities can be repurchased in its capital structure weights.
The company’s debt-assets and equity assets are as follows:
Consider all the debts are from long-term debt and all equities are from retained earnings:
Compute the final pro forma balance sheet:
Pro forma balance sheet | |||
Particulars |
Amount ($) |
Particulars |
Amount ($) |
Current assets | Current liabilities | ||
Cash | $29,136 | Accounts payable | $78,240 |
Accounts receivable | $44,484 | Notes payable | $16,320 |
Inventory | $100,080 | Total | $94,560 |
Total | $173,700 | ||
Fixed assets | Long-term debt | $189,264 | |
Net plant and equipment | $475,800 | Owner's equity | |
Common stock and paid in surplus | $130,000 | ||
Retained earnings | $235,676 | ||
Total equity | $365,676 | ||
Total | $649,500 | Total | $649,500 |
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Chapter 4 Solutions
FUND. OF CORPORATE FIN. 18MNTH ACCESS
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