Chapter 3: Financial Planning and Growth

3.1 From the relationship, S = .00001 x GNP, we can get forecast sales: S = 0.00001; GNP = 0.00001 ($2,050 trillion) = $20,500,000

Now, compute the other values: Projected Current Assets = Current Assets + Current Assets: CA = $500,000 + 0.25 ($20,500,000) = $5,625,000 Similar for rest: FA = $1,000,000 CL = $100,000

+ +

0.50 ($20,500,000) 0.10 ($20,500,000)

= $11,250,000 = $2,150,000

and: NP = 0.02 ($20,500,000)

= $410,000

Compute the new amount of retained earnings: RE = NP ( 1 - dvd payout ratio) = NP (1 - 0.34) = $410,000 (0.66) = $270,600 RE = $3,400,000 + $270,600 = $3,670,600 Compute the new amount of bonds: Debt-to-Asset Ratio = Total Debt / Total Assets = ($1,100,000 + $2,500,000) / ($3,000,000 + $6,000,000) = 0.40 Bonds = [ Total Assets x Debt/Asset ratio ] - Current Liabilities = [(CA + FA) x 0.40] - CL = ($5,625,000 + $11,250,000) (0.40) - $2,150,000 = $4,600,000 Compute the new amount of stock: Use: Total Assets Total Liabilities + Total Equity, then Stock = [(CA + FA) - (CL + Bonds + RE)] = ($5,625,000 + $11,250,000) - ($2,150,000 + 4,600,000 + 3,670,600) = $6,454,400 And now we can use the above to fill in the Balance Sheet: Balance Sheet Current Liabilities Bonds Common Stock Retained Earnings Total Liabs & CS

Current Assets Fixed Assets Total Assets

5,625,000 11,250,000 $16,875,000

$2,150,000 4,600,000 6,454,400 3,670,600 $16,875,000

B-45

3.2

First we need to find the change in Sales. Projected Sales are 110% of current sales, so current sales are: S = 330 million / 1.10 = 300 million and

S = 300 million x 10% = $30 million

a. For external funds needed (in millions) :

Current Assets Fixed Assets Short Term Debt Long Term Debt

= 25% Sales = 150% Sales = 40% Sales = 45% Sales

= = = =

.25(30) 1.50(30) .40(30) .45(30)

and using the formula from the book:

Assets Debt EFN = Sales Sales ProfitMargin ( Sales )( 1 - DvdPayout ) Sales Sales
= (25% +150%) x 30 - (40% + 45%) x 30 - (12% x 330) (1 - 40%) = $3.24 million b. Current assets = 25% x 330 / (1 + 10%) = 75 Fixed assets = 150% x 330 / (1+10%) = 450 Total assets = Current assets + Fixed assets = 75 + 450 = $525 million Short term debt = 40% x 330 / (1+10%) = 120 Long term debt = 45% x 330 / (1 + 10%) = 135 Common stock = 50 Retained earnings = 220 Total liabilities = $525 million c. Pro Forma Balance Sheet Current assets = 25% x 330 = 82.5 Fixed assets = 150% x 330 = 495 Total assets = $577.5 million Short term debt = 40% x 330 = 132 Long term debt = 45% x 330 = 148.5 Common stock = 50 Retained earnings = 243.76 Total liabilities = 574.26

Note that parts b and c agree with part a: External funds needed = 577.5 - 574.26 = $3.24 million

B-46

3.3

a.

Compute the sustainable growth using the formula from the text.

S P(1 d )(1 + L) 0.05(0.5)(2) = = = 0.0526 = 5.26% S T P (1 d )(1 + L) 1 0.05(0.5)(2)

b.

Yes, it is possible for the actual growth to differ from the sustainable growth. If any of the actual parameters (P, T, L or d) differ from those used to compute the sustainable growth rate, the actual growth rate will deviate from the sustainable growth rate. Stieben Company can increase its growth rate by doing any of the following. i. Sell new stock ii. Increase its debt-to-equity ratio by either selling more debt or repurchasing stock iii. Increase its net profit margin iv. Decrease its total assets to sales ratio v. Reduce its dividend payout

c.

3.4

a.

Using the formula from the book: Assets Debt EFN = Sales Sales ProfitMargin ( Sales )( 1 - DvdPayout ) Sales Sales = 1(6,400,000) - .4375(6,400,000) - .0625(38,400,000(1-.7) = 2,880,000

b.
Pro Forma Balance Sheet Optimal Scam Company Current assets $19,200,000 Fixed assets 19,200,000 Total assets $38,400,000 Current liabilities $12,000,000 Long-term debt 4,800,000 Total liabilities $16,800,000 Common stock $16,880,000 Accumulated retained earnings 4,720,000 Total equity $21,600,000 Total liabilities and equity $38,400,000

B-47

c.

Sustainable growth =

S P (1 d )(1 + L) = S T P (1 d )(1 + L) 0.0625(.3)(1.7778) = = 0.0345 = 3.45% 1 0.0625(0.3)(1.7778)

d.

Optimal Scam is far below its growth rate objective. Cutting the dividend to zero will not be enough. It could only attain a 12.5% growth rate by eliminating the dividend. Optimal Scam must increase its asset utilization and/or its profit margin substantially to be able to achieve its objective growth rate. Optimal could also increase its debt load; this action will increase ROE.

B-48