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:

Question

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).

Answer 1

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Answer 2

CP 4-1. Continued

CP Solution:
Landis Corporation





b. If Landis reduces the payout ratio, the company will retain more earnings and need less external funds. A slower growth rate means that less assets will have to be financed and in this case, less external funds would be needed. A declining profit margin will lower retained earnings and force Landis Corporation to seek more external funds.


CP 4-1. Continued

c.
Balance Sheet—December 31, 2005
(Dollars in Millions)

Cash $ 5.75 Accounts Payable $17.25
Accounts Receivable 17.25 Accruals 11.50
Inventory 28.75 Notes Payable 17.551
Net Fixed Assets 46.00 Long-Term Bonds 5.00
Common Stock 10.00
_____ Retained Earnings 36.452
$97.75 $97.75
1Original notes payable plus required new funds. This is the plug figure.
22005 retained earnings (beginning of 2005) + PS2 (1-.D) or $33 mil + $3.45 mil