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CHAPTER 4 Problems 4-1. Philip Morris is very excited because a sale for his clothing company was expected to double from $500,000 to $1,000,000 next year. Philip notes that net assets (asset – liabilities) will remain at 50 percent of sales. His clothing firm will enjoy a 9 percent return on total sales. He will start the year with $100,000 in the bank and is bragging about the two Mercedes he will buy and the European vacation he will take. Does his optimistic outlook for his cash position appear to be correct? Compute his likely cash balance or deficit for the end of the year. Start with beginning cash and subtract the asset buildup (equal to 50 percent of the sales increase) and add in profit. Solution: Philip Morris Beginning cash

$100,000

- Asset buildup

(250,000)

Profit

90,000

Ending cash

($60,000)

(1/2 x $500,000) (9% x $1,000,000) Deficit

4-2. In problem 1 if there had been no increase in sales and all other facts were the same, what would his ending cash balance be? What lesson do the examples in problems one and two illustrate? Solution: Philip Morris (continued) Beginning cash No asset buildup Profit

$100,000 ---------45,000

Ending cash

(9% x $500,000)

$145,000

The lesson to be learned is that increased sales can increase the financing requirements and reduce cash even for a profitable firm. 4-3. The Alliance Corp. expects to sell the following number of units of copper cables at the prices indicated under three different scenarios in the economy. The probability of each outcome is indicated. What is the expected value of the total sales projection? Outcome

Probability

Units

Price

A

0.30

200

$15

B

0.50

320

30

C

0.20

410

40

Solution:

Alliance Corporation 1

2

3

4

5 Total Value

6 Expected Value (2 x 5)

Outcome

Probability

Units

Price

A

0.30

200

$15

3,000

900

B

0.50

320

$30

9,600

4,800

C

0.20

410

$40

16,400

3,280

Total expected values

$8,980

4-4. Sales for Boot Stores are expected to be 40,00 units for October. The company likes to maintain 15% of unit sales for each month in ending inventory (i.e., the end of October). Beginning inventory for October is 8,500 units. How many units should the firm produce for the coming month? Solution:

Western Boot Stores + Projected sales.....................

40,000 units

+ Desired ending inventory........

6,000 (15% x 40,000)

- Beginning inventory...............

8,500

Units to be produced..............

37,500

4-5. Vitale Hair Spray had sales of 8,000 units in March. A 50% increase is expected in April. The company will maintain 5% of expected unit sales for April in ending inventory. Beginning inventory for April was 400 units. How many units should the company produce in April? Solution:

Vitale Hair Spray + Projected sales.....................

12,000 units (8,000 x 1.50)

+ Desired ending inventory........

600 (5% x 12,000)

- Beginning inventory...............

400

Units to be produced..............

12,200

4-6. Delsing Plumbing Company has beginning inventory of 14,000 units, will sell 50,000 units for the month, and desires to reduce ending inventory to 40 percent of beginning inventory. How many units should Delsing produce?

Solution:

Delsing Plumbing Company + Projected sales..................... + Desired ending inventory........

50,000 units 5,600 (15% x 40,000)

- Beginning inventory...............

14,000

Units to be produced..............

41,600

4-7. On December 31 of last year, Wolfson Corporation had in inventory 400 units of its product, which cost $21 per unit to produce. During January, the company produced 800 units at a cost of $24 per unit. Assuming that Wolfson Corporation sold 700 units in January, what was the cost of goods sold (assume FIFO inventory accounting)? Solution: Wolfson Corporation

Cost of goods sold on 700 units Old inventory: Quantity (Units)........................

400

Cost per unit............................

$

21

Total.......................................

$ 8,400

New inventory: Quantity (Units)........................

300

Cost per unit............................

$

24

Total.......................................

$ 7,200

Total cost of goods sold.............

$15,600

4-8. At the end of January, Higgins Data Systems had an inventory of 600 units which cost $16 per unit to produce. During February the company produced 850 units at a cost of $19 per unit. If the firm sold 1,100 units in February, what was its cost of goods sold? (Assume LIFO inventory accounting.) Solution: Higgins Data System

Cost of goods sold on 1,100 units Old inventory: Quantity (Units)........................

850

Cost per unit............................

$

19

Total.......................................

$16,150

New inventory: Quantity (Units)........................

250

Cost per unit............................

$

16

Total.......................................

$ 4,000

Total cost of goods sold.............

$20,150

4-9. The Bradley Corporation produces a product with the following costs as of July 1, 2001: Material

$6 per unit

Labor

4 per unit

Overhead

2 per unit

Beginning inventory at these costs on July 1 was 3,000 units. From July 1 to December 31, Bradley produced 12,000 units. These units had a material cost of $3, labor of $5, and overhead of $3 per unit. Bradley uses FIFO inventory accounting. Assuming that Bradley sold 13,000 units during the last six months of the year at $16 each, what would gross profit be? What is the value of ending inventory? Solution: Bradley Corporation Sales (13,000 @$16)

$208,000

Cost of goods sold: Old inventory: Quantity (units).............................. Cost per unit..................................

3,000 $

8

Total.............................................

$ 24,000

New inventory: Quantity (units).............................. Cost per unit..................................

10,000 $

11

Total.............................................

$110,000

Total cost of goods sold...................

$134,000

Gross profit....................................

$ 74,000

Value of ending inventory: Beginning inventory (3,000 x $8)......................

$ 24,000

+ Total production (12,000 x $11)....................

$132,000

Total inventory available for sale.......................

$156,000

- Cost of good sold..........................................

$134,000

Ending inventory............................................

$ 22,000

Or 2,000 units x $11 = $22,000 4-10. Assume in problem 7 that Convex used LIFO inventory accounting instead of FIFO, what would gross profit be? What is the value of ending inventory? Solution:

Bradley Corporation Sales (13,000 @$16) Cost of goods sold: New inventory: Quantity (units).............................. Cost per unit.................................. Total............................................. Old inventory: Quantity (units).............................. Cost per unit.................................. Total............................................. Total cost of goods sold................... Gross profit....................................

$208,000

12,000 $ 11 $ 132,000 1,000 $ 8 $ 80,000 $140,000 $ 68,000

Value of ending inventory: Beginning inventory (3,000 x $8)..................

$ 24,000

+ Total production (12,000 x $11)....................

$132,000

Total inventory available for sale....................

$156,000

- Cost of good sold..........................................

$140,000

Ending inventory............................................

$ 16,000

Or 2,000 units x $8 = $16,000 4-11. Sprint Shoes, In., had a beginning inventory of 9,000 units on January 1, 2001. The costs associated with the inventory were: Material....................... Labor........................... Overhead.....................

$13.00 per unit 8.00 per unit 6.10 per unit

During 2001, they produced 42,500 units with the following costs: Material....................... Labor........................... Overhead.....................

$15.50 per unit 7.80 per unit 8.30 per unit

Sales for the year were 74,250 units at $39.60 each. Sprint Shoes uses LIFO accounting. What was the gross profit? What was the values of ending inventory?

Solution:

Sprint Shoes, Inc. Sales (47,250 @ $39.60)

$1,871,100

Cost of goods sold: New inventory: Quantity (units).......................

42,500

Cost per unit............................

$

31.60

Total.......................................

$ 1,343,000

Old inventory: Quantity (units)....................... Cost per unit............................

4,750 $

27.10

Total.......................................

$ 128,725

Total cost of goods sold.............

$1,471,725

Gross profit.............................

$

Value of ending inventory: Beginning inventory (9,000 x $27.10)............ + Total production (42,500 x $31.60)................ Total inventory available for sale.................... - Cost of good sold.......................................... Ending inventory............................................ Or 42,500 units x $27.10 = $16,000

399,375

$ 243,900 $1,343,000 $1,586,900 $1,471,725 $ 115,175

4-12. Victoria’s Apparel has forecast credit sales for the fourth quarter of the year as: September (actual) .................. $50,000 Fourth Quarter October .................................. $40,000 November ...............................

35,000

December ...............................

60,000

Experience has shown that 20% of sales are collected in the month of sale, 70% in the following month, and 10% are never collected. Prepare a schedule of cash receipts for Victoria’s Apparel covering the fourth quarter (October through December). Solution: Victoria’s Apparel Credit sales

September $50,000

October $40,000

November $35,000

December $60,000

20% Collected in month of sales 70% Collected in month after sales Total cash receipts

8,000

7,000

12,000

35,000

28,000

24,500

$43,000

$35,000

$36,500

4-13. Watt’s Lighting Stores made the following sales projections for the next six months. All sales are credit sales. March

$30,000

June

$34,000

April

36,000

July

42,000

May

25,000

August

44,000

Sales in January and February were $33,000 and $32,000, respectively. Experience has shown that of total sales, 10% are uncollectible, 30% are collected in the month of sale, 40% are collected in the following month, and 20% are collected two months after sale. Prepare a monthly cash receipts schedule for the firm for March through August. Of the sales expected to be made during the six months from March through August, how much will still be uncollected at the end of August? How much of this is expected to be collected later? Solution: Watt’s Lighting Stores

Cash Receipts Schedule January $33,000

Sales Collections (30%

February $32,000

March $30,000

April $36,000

May $25,000

June $34,000

July $42,000

August $44,000

9,0

10,8

7,50

10,2

12,6

13,2

of

current sales) Collections

00

00

0

00

00

00

(40% of prior month's

12,8

sales) Collections

00

12,0 00

14,4 00

10,0 00

13,6 00

16,8 00

(20% of sales 2

months

earlier) Total receipts

6,6 00

cash

6,40 0

$28, 400

Still due (uncollected) in August:

6,00 0

$29, 200

7,20 0

$27, 900

5,00 0

$27, 400

6,80 0

$31, 200

$36, 800

Bad debts: ($30,000+36,000+25,000+34,000+42,000+44,000) x 0.1 = (211,000) x 0.1 = $21,100 To be collected from July sales: ($42,000 x 0.20) = $8,400 To be collected from August sales: ($44,000 x 0.60) = $26,400 $21,100 + $8,400 + $26,400 = $55,900 due Expected to be collected: $55,900 due - $21,100 bad debts = $34,800 4-14. Ultravision, Inc., anticipates sales of $240,000 from January through April. Materials will represent 50 percent of sales and because of level production, material purchases will be equal for each month over the four months of January, March, and April. Materials are paid for after the month purchased. Materials purchased in December of last year were $20,000 (half of $40,000 in sales), labor costs for each of the four months are slightly different due to a provision in a labor contract in which bonuses are paid in February and April. The labor figures are: January

$10,000

February

$13,000

March

$10,000

April

$15,000

Fixed overhead is $6,000 per month. Prepare a schedule of cash payments for January through April. Solution: Ultravision, Inc.

Cash Payment Schedule

*Purchases **Payment

to

material

purchases

December

January

February 30,00

March 30,0

April 30,0

$20,000

$30,000 20,00

0

00

00

0

0

30,00

10,00 Labor

0

0

0

For January through April

00

15,0 00

6,0 00

$49,0 00

00

00

0

30,0

10,0

6,00

$36,0 Total cash payments

00 13,00

6,00 Fixed overhead

30,0

6,00 0

$46, 000

$51, 000

*

Monthly purchases equal ($240,000 x 50%)/4 or $120,000/4 = $30,000

** Payment is equal to prior month’s purchases. 4-15. The Denver Corporation has forecast the following sales for the first seven months of the year: January

$10,000

May

$10,000

12,000

June

16,000

February March

14,000

April

July

18,000

20,000 Monthly material purchases are set equal to 30% of forecast sales for the

next month. Of the total material costs, 40% are paid in the month of purchase and 60% in the following month. Labor costs will run $4,000 per month, and fixed overhead is $2,000 per month. Interest payment on the debt will be $3,000 for both March and June. Finally, Denver sales force will receive a 1.5% commission on total sales for the first six months of the year, to be paid on June 30. Prepare a monthly summary of cash payment for the six-month period from January through June. (Note: Compute prior December purchases to help get total material payments for January.) Solution: Denver Corporation Cash Payments Schedule Dec. Sales Purchase

January

February

March

April

May 10,

June 16,0

July 18,

$10,000

$12,000

$14,000

$20,000

000

00

000

6,0

3,00

(30%

of next month's sales) Payment of

3,6 3,000

00

purchases) Material payment

1,4 40

00

0

800

5,4 00

1,68 0

2,4 00

1,20 0

1, 920

2,1 60

(60%

previous

month's purchases) Total

0

4,

(40% current

of

4,20

payment

1,8 00

2,16 0

3,2

2,5 20

3,84

3,60 0

4,9

1, 800

4,80

2,8 80

3,

5,0

for materials

40

0

20

4,0 Labor costs

00

4,00 0

00

4,0 00

2,0 Fixed overhead Interest

0

2,00 0

720 4,00

0 2,0

00

40 4,

000 2,00

0

4,0 00

2, 000

2,0 00 3,0

payments Sales

3,000

00

commission (1.5%

of

1,2

$82,000)

30 $9,

Total payment

240

$ 9,840

$13, 920

$10, 800

$9 ,720

$15, 270

2-16. The Boswell Corporation forecasts its sales in units for the next four months as follows: March

$6,000

May

$5,500

April

$8,000

June

$4,000

Boswell maintains an ending inventory for each month in the amount of one and one-half times the expected sales in the following month. The ending inventory for February (March’s beginning inventory) reflects this policy. Materials cost $5 per unit and are paid for in the month after production. Labor cost is $10 per unit and is paid for in the month incurred. Fixed overhead is $12,000 per month. Dividends of $20,000 are to be paid in May. 5,000 units were produced in February. Complete a production schedule and a summary of cash payments for March, April, and May. Remember that production in any one month is equal to sales plus desired ending inventory minus beginning inventory. Solution: Boswell Corporation Production Schedule March

April

May 8,00

Forecasted unit sales + Desired ending inventory - Beginning inventory

6,000 12,00 0

0

5,50 0

8,25 0

9,000

June 0 6,00

0 12,000

4,00

8,25

0 4,25 = Units to be produced Cash Payments

9,000 Feb

0

3,25 0

March

April 9,00

Units produced Materials ($5/unit)

5,000

0

May 4,25

0

3,25 0

month

after production Labor ($10/unit) month of

$ 25,000

production Fixed overhead Dividends Total cash payments

90,000 12,000 $127,000

$45,000

$ 21,250

42,500 12,000 $99,500

32,500 12,000 20,000 $ 85,750

4-17. The Volt Battery Company has forecast its sales in units as follow: January

800

May

1,350

February

650

June

1,500

March

600

July

1,200

April

1,100

Volt Battery always keeps an ending inventory equal to 120 percent of the next month’s expected sales. The ending inventory for December (January’s beginning inventory) is 960 units, which is consistent with this policy. Materials cost $12 per unit and are paid in the month after purchase. Labor cost is $5 per unit and is paid in the month the cost is incurred. Overhead costs are $6,000 per month. Interest of $8,000 is schedule to be paid in March, and employee bonuses of $13,200 will be paid in June. Prepare a monthly production schedule and a monthly summary of cash payments for January through June. Volt produced 600 units in December. Solution: Volt Battery Company Production Schedule Jan.

Feb.

March

8 Forecast unit sales + Desired ending

00 7

650 720

600 1,32

April 1,10

May 1,35

0

0 1,62

1,80

June 1,500 1,440

July 1,200

inventory Beginning

80

inventory = Units

60 to

0 9

be

($12/unit)

780

720 1,20

6

0

month

after purchase Labor cost ($5/unit)

0 1,32

produced 20 590 Summary of Cash Payments Dec. Jan. 60 Units produced Material cost

0

1,40

Feb.

March 1,20

April 1,40

0

0

$7,20

$7,4 40

$7,0 80

0

6,000

00

0

0

1,140 June

1,530

1,140

$16,8

$18,36

00

0

7,00 0

6,00 0

May

$14,4

6,00

6,00 Overhead cost

1,53 0

590

3,100

1,800

0

2,95

month incurred

0

0

620

0

0

1,62

7,650

5,700

6,000

6,000

$30,4

13,200 $43,26

6,00 0

8,00 Interest Employee bonuses Total cash payments

0 $16,30 0

$16,3 90

$27,0 80

$27,4 00

50

4-18. Lansing Auto Parts, Inc., has projected sales of $25,000 in October, $35,000 in November, $30,000 in December. Of the company’s sales, 20% are paid for by cash and 80% are sold on credit. The credit sales are collected one month after sale. Determine collections for November and December. Also assume that company’s cash payment for November and December are $30,400 and $29,800, respectively. The beginning cash balance in November is $6,000, which is the desired minimum balance. Prepare a cash budget with borrowing needed or repayment for November and December. (You will need to prepare a cash receipt schedule first.) Solution: Lansing Auto Part, Inc. Cash Receipts Schedule

Sales Cash sales (20%)

October $25,00

November $35,

December $30,0

0

000

00 7,00

6,00

0

0 Collections

(80%

of

0

previous

20,0

month's sales)

00

28,00 0

$27, Total cash receipts

000

$34,0 00

Cash Budget

Cash receipts Cash payments Net cash flow Beginning cash balance Cumulative cash balance Monthly loan or (repayment) Cumulative loan balance Ending cash balance

November $27,000 30400 (3,400) 6,000 2,600 3,400 3,400 $ 6,000

December $34,000 29,800 4,200 6,000 10,200 (3,400) $ 6,800

4-19. Harry’s Carryout Stores has eight locations. The firm wishes to expand by two more stores and needs a bank loan to do this. Mr. Wilson, the banker, will finance construction if firm can present an acceptable three-month financial plan for January through March. Following are actual and forecasted sales figures: Actual

Forecast

November

$120,000

December

140,000

January February March April

$190,000 210,000 230,000 230,000

Of the firm’s sales, 40 percent are for cash and the remaining 60 percent are on credit. Of credit sales, 30 percent are paid in the month after sale and 70 percent are paid in the second month after the sale. Materials cost 30 percent of sales and are purchased and received each month in amount sufficient to cover the following month’s expected sales. Materials are paid for in the month after they are received. Labor expense is 40 percent of sales and is paid in the month of sales. Selling and administrative expense is 5 percent of sales and is also paid in the month of sales. Overhead expense is $28,000 in cash per month. Depreciation expense is $10,000 per month. Taxes of $8,000 will be paid in January, and dividends of $2,000 will be paid in March. Cash at the beginning of January is $80,000 and the minimum desired cash balance is $75,000.

For January, February, and March, prepares a schedule of monthly cash receipts, monthly cash payments, and a complete monthly cash budget with borrowings and repayments. Solution: Harry’s Carryout Stores Cash Receipts Schedule

Sales

November $200,0

December $220,

January $280,

February $320,0

March $340,0

April $330

00

000

000

00

00

00

80,00 Cash sales (40%)

0

88,0 00

120,00 Credit sales (60%) Collections (month after

credit

0

credit

00 132,0

sales)

128,00 0

168,0

00

00

136,00 0 204,00 0

00

57,60 50,400

sales)

0

00

117,60 92,400

0

600

$270,800

$311,200

Harry’s Carryout Stores Cash Payments Schedule Jan.

Feb.

March

Payments for purchases (30% of next month's

sales

paid

in

month

after

purchases - equivalent to 30% of current sales)

$84, 000

$96 ,000

112,0 Labor expense (40% of sales)

00 00

00

000

00

136,0

16,

28,0 Overhead

00

000 14,0

Selling and Admin. expense (5% of sales)

$102,0

128,

17,0 00

28, 000

28,0 00

8,0 Taxes Dividends

134,4 0

$235, Total cash receipts

61,2 0

84,0

70%

198,0 0

39,6

00

132,0 0

192,00 0

36,0

30% Collections (2 months after

112,0

00 2,0

00 $246, Total cash payments*

000

$268 ,000

$285, 000

* The $10,000 of depreciation is excluded because it is not a cash expense. Harry’s Carryout Stores Cash Budget Jan.

Feb.

March 270,8

Cash receipts

235,600

00

311,200 268,0

Cash payments

246,000

00

285,000 2,80

Net cash flow

(10,400)

0

26,200 75,0

Beginning cash balance

80,000

00

75,000 77,8

Cumulative cash balance

69,600

00

101,200 (2,600

(2,8 Monthly loan or (repayment)

5,400

00)

) 2,60

Cumulative loan balance

5,400

0

75,0

Ending cash balance

75,000

4-20. Archer Electronics Company’s actual

00

98,600

sales and purchases for April and

May are shown here along with forecasted sales and purchases for June through September.

April (actual) May (actual) June (forecast) July (forecast) August (forecast) September (forecast)

Sales $320,000 300,000 275,000 275,000 290,000 330,000

Purchases $130,000 120,000 120,000 180,000 200,000 170,000

The company makes 10 percent of its sales for cash and 90 percent on credit. Of the credit sales, 20 percent are collected in the month after the sale and 80

percent are collected two months after. Archer pays for 40 percent of its purchases in the month after purchase and 60 percent two months after. Labor expense equals 10 percent of the current month’s sales. Overhead expense equals $12,000 per month. Interest payments of $30,000 are due in June and September. A cash dividend of $50,000 is scheduled to be paid in June. Tax payments of $25,000 are due in June and September. There is a scheduled capital outlay of $300,000 in September. Archer Electronics’ ending cash balance in May is $20,000. The minimum desired cash balance is $10,000. Prepare a schedule of monthly cash receipts, monthly cash payments, and a complete monthly cash budget with borrowing and payments for June through September. The maximum desired cash balance is $50,000. Excess cash (above $50,000) is used to buy marketable securities. Marketable securities are sold before borrowing funds in case of a cash shortfall (less than $10,000). Solution: Archer Electronics Cash Receipts Schedule

Sales

April $20,0

May $00,0

June $75,00

July $75,00

August $90,00

September $330,00

00

00

0

0

0

0

32,0 +

Cash sales (10%)

00

30,0 00

288,0 Credit sales (90%) Collections (month

00

20% Collections

00

0

0

0

33,000 261,00

0

54,00

297,000 49,50

0

49,500

0

52,200

(2

months after credit +

27,500 247,50

247,50

57,6 00

29,00

0 270,0

after credit sales) +

27,50

sales) 80%

230,40 0

216,00 0

$311,9 Total cash receipts

00

198,00 0

$293,0 00

198,000 $283,20

$276,5 00

0

Archer Electronics Cash Payments Schedule April $ Purchases Payments (month after

130,000

purchases -40%) Payments (second month

after

May $120,00

June $120,00

July $180,00

August $200,00

0

0

0

0

52,00 0

48,00 0

purchases 0

sales)

0

0

72,00 0

108,00

27,50 0

29,00 0

12,00 0

80,00

72,00

27,50

Overhead

72,00 0

78,00

-60%) Labor expense (10% of

$ 170,00

48,00 0

Septemb

33,00

12,00 0

12,00 0

12,00

30,00 Interest payments

0

30,00 50,00

Cash dividends

0 25,00

Taxes

0

25,00 300,0

Capital outlay

0 $270,50

Total cash payments

0

$159,50 0

$185,00 0

Archer Electronics Cash Budget June 311,900

Cash receipts

$

July 293,000 $159,50

August 276,500 $185,00

September $283,200

Cash payments Net cash flow Beginning cash balance Cumulative cash balance Monthly loan or (repayment) Cumulative loan balance Marketable securities

270,500 41,400 20,000 61,400 ---

0 133,500 50,000 183,500 ---

0 91,500 50,000 141,500 ---

$588,000 (304,800) 50,000 (254,800) *28,400 28,400

purchased (Sold) Cumulative

11,400

133,500 --

91,500 --

-(236,400)

11,400

144,900

236,400

--

securities

marketable

$ 588,00

Ending cash balance

50,000

50,000

*Cumulative cash balance securities (August)

50,000

10,000

$236,400

Cumulative cash balance (September)

- 254,800

Required (ending) cash balance

-

Monthly borrowing

- $28,400

10,000

4-21. Owen’s Electronic has 90 operating plants in seven southwestern states. Sales for last year were $100 million, and the balance sheet at year-end is similar in percentage of sales to that of previous years (and this will continue in the future). All assets (including fixed assets) and current liabilities will vary directly with sales.   Balance Sheet

 

(in $ millions) Assets Cash Account receivable Inventory Current assets Fixed assets

$2 20 23 $45 40

Total assets  

$85  

 

 

Liabilities & Stockholder’s Equity Account payable $15 Accrued wages 2 Accrued taxes 8 Current liabilities $25 Notes payable 10 Common stock 15 Retained earnings 35 Total liabilities & stockholders’ equity  

$85  

Owen’s has an after tax profit margin of 7 percent and a dividend payout ratio of 40 percent. If sales grow by 10 percent next year, determine how many dollars of new funds are needed to finance the growth. Solution: Owens Electronics Required new funds = A/S (S) – L/S (S) – PS2 (1- D) S = (10%) ($100 mil.) S = $10,000,000 RNF (millions) = 85/100 ($10,000,000) – 25/100 ($10,000,000) – 0.07 ($110,000,000) (1 -0.40) = 0.85($10,000,000) – 0.25($10,000,000) – 0.07($110,000,000) (0.60) = $8,500,000 - $2,500,000 - $4,620,000

RNF = $1,380,000 4-22. The Manning Company has the following financial statement, which are representative of the company’s historical average. Income Statement

Sales........................................... Expenses...................................... Earning before interest and taxes.... Interest........................................ Earnings before taxes..................... Taxes........................................... Earnings after taxes....................... Dividends.....................................

  Balance Sheet (in $ millions) Assets Cash Account receivable Inventory

 

$ 5,000 40,000 75,000 $120,00

$200,000 158,000 42,000 7,000 35,000 15,000 20,000 $ 6,000

 

 

Liabilities & Stockholder’s Equity Account payable $25,000 Accrued wages 1,000 Accrued taxes 2,000

Current assets Fixed assets

0 80,000

Current liabilities Notes payable Long-term debt Common stock Retained earnings Total liabilities &

$28,000 7,000 15,000 120,000 30,000

Total assets  

$200,000  

stockholders’ equity  

$200,000  

The firm is expecting a 20 percent increase in sales next year, and management is concerned about the company’s need for external funds. The increase in sales is expected to be carried out without any expansion of fixed assets, but rather through more efficient asset utilization in the existing store. Among liabilities, only current liabilities vary directly with sales. Using the percent-of-sales method, determine whether the company has external financing needs, or a surplus of funds. (Hint: A profit margin and payout ratio must be found from the income statement.)

Solution: Manning Company Profit margin = Earnings after taxes/Sales = $20,000 / $200,000 = 10% Payout ratio = Dividends / Earnings =

$6,000 / 20,000 = 30%

Change in sales = 20% x $200,000 = $40,000 Spontaneous assets = Current assets = Cash + Acc. Rec. + Inventory Spontaneous liabilities = Acc. Payable + Accr. Wages + Accr. Taxes Required new funds = A/S (S) – L/S (S) – PS2 (1- D) =

$120,000/$200,000

($40,000)

-

$28,000/$200,000

($40,000)

–

0.10

($240,000) (1 – 0.30) = 0.60($40,000) – 0.14($40,000) – 0.10($240,000) (0.70) = $24,000 - $5,600 - $16,800 RNF = $1,600 The firm needs $1,600 in external funds. 4-23. Conn Man’s Shops, Inc., a national clothing chain, had sales of $300 million last year. The business has a steady net profit margin of 8 percent and a dividend payout ratio of 25 percent. The balance sheet for the end of last year is shown below.

  Balance Sheet

 

(in $ millions) Assets Cash Account receivable Inventory Plant & equipment

$ 20 25 75 120

Total assets  

$240  

 

 

Liabilities & Stockholder’s Equity Account payable $70 Accrued expenses 20 Other payable 30 Common stock 40 Retained earnings 80 Total liabilities & stockholders’ equity  

$240  

The firm’s marketing staff has told the president that in the coming year there will be a large increase in the demand for overcoats and wool slacks. A sales increase of 15 percent is forecast for the company.

All balance sheet items are expected to maintain the same percent-of-sales relationships as last year, except for common stock and retained earnings. No change is scheduled in the number of common stock shares outstanding, and retained earnings will changes as dictated by the profits and dividend policy of the firm. (Remember the net profit margin is 8 percent.) a. Will external financing be required for the company during the coming year? b. What would be the need for external financing if the net profit margin went up to 9.5 percent and the dividend payout ratio was increased to 50 percent? Explain. Solution: Conn Man’s Shops, Inc. a. Required new funds = A/S (S) – L/S (S) – PS2 (1- D) S = 15% x $300,000,000 = $45,000,000 RNF = 240/300 ($45,000,000) – 120/300 ($45,000,000) – 0.08 ($345,000,000) (1 – 0.25) = 0.80($45,000,000) – 0.40($45,000,000) – 0.08($345,000,000) (0.75) = $36,000,000 - $18,000,000 - $20,700,000 RNF = ($2,700,000) A negative figure for required new funds indicates that an excess of funds ($2.7 mil.) is available for new investment. No external funds are needed. b. RNF = $36,000,000 - $18,000,000 – 0.095($345,000,000) (1 – 0.5) = $36,000,000 - $18,000,000 - $16,387,500 = $1,612,500 external funds required The net profit margin increased slightly, from 8% t0 9.5%, which decreases the need for external funding. The dividend payout ratio increased tremendously, however, from 25% to 50%, necessitating more external financing. The effect of the dividend policy change overpowered the effect of the net profit margin change.