I need some help with an assignment that I am working on for Introduction to Finance class. Here is the questions:
The Landis Corporation had 2008 sales of $100 million. The balance sheet items that
vary directly with sales and the profit margin are as follows:
Percent
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
Accounts receivable. . . . . . . . . . . . . . . . . . . . . . 15
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Net fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . 40
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . 15
Accruals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Profit margin after taxes . . . . . . . . . . . . . . . . . . 6%
The dividend payout rate is 50 percent of earnings, and the balance in retained earnings at the end of 2008 was $33 million. Common stock and the company’s long-term bonds are constant at $10 million and $5 million, respectively. Notes payable are currently $12 million.
a. How much additional external capital will be required for next year if sales increase 15 percent? (Assume that the company is already operating at full capacity.)
b. What will happen to external fund requirements if Landis Corporation reduces the payout ratio, grows at a slower rate, or suffers a decline in its profit margin? Discuss each of these separately.
c. Prepare a pro forma balance sheet for 2009 assuming that any external funds being acquired will be in the form of notes payable. Disregard the information in part b in answering this question (that is, use the original information and part a in constructing your pro forma balance sheet).
Here is what I have so far but I am not sure if I am doing it right. Now I have to do the pro forma balance sheet and am totally lost. Please help!!
a. How much additional external capital will be required for next year if sales increase 15 percent? (Assume that the company is already operating at full capacity.)
1. 100,000,000 x 15% = 100 million x .15 = 15,000,000 in increased sales.
2. 85%(15,000,000) – 25%(15,000,000) – 6%(115,000,000) x (1 – 50%) =
.85(15,000,000) - .25(15,000,000) - .06(115,000,000) x .50 =
12,750,000 – 3,750,000 – [6,900,000(.50)] =
12,750,000 – 3,750,000 – 3,450,000 = $5,550,000
Therefore, $5,500,000 is the outside funding required.
b. What will happen to external fund requirements if Landis Corporation reduces the payout ratio, grows at a slower rate, or suffers a decline in its profit margin? Discuss each of these separately.
1. If the dividend ratio is decreased to 25% instead of 50%, then the required amount of outside funding is decreased as shown below. The amount of outside funding required is decreased due to the increase in the amount of revenue retained in the company to reinvest in the company.
85%(15,000,000) – 25%(15,000,000) – 6%(115,000,000) x (1 – 25%)
.85(15,000,000) - .25(15,000,000) - .06(115,000,000) x .75
12,750,000 – 3,750,000 – [6,900,000(.75)]
12,750,000 – 3,750,000 – 5,175,000 = 3,825,000
2. If the company’s growth is slowed to 10% rather than 15%, there is a decrease in required funding. Since the company is growing at a slower rate, less capital is needed to fund the slower growth. An example is shown below.
a. 100,000,000 x .10 = 10,000,000
b. .85(10,000,000) - .25(10,000,000) - .06(110,000,000) x .50 =
8,500,000 – 2,500,000 – [6,600,000(.50)] =
12,750,000 – 3,750,000 – 3,300,000 = $2,700,000
3. A decline in the profit margin will result in an increase in the required outside funding. This is due to the decrease in profits that are used to reinvest in the company. An example is shown below.
85%(15,000,000) – 25%(15,000,000) – 3%(115,000,000) x (1 – 50%) =
.85(15,000,000) - .25(15,000,000) - .03(115,000,000) x .50 =
12,750,000 – 3,750,000 – [3,450,000(.50)] =
12,750,000 – 3,750,000 – 1,725,000 = $7,275,000
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