Exam1 Key

Topics: Finance, Corporate finance, Generally Accepted Accounting Principles Pages: 9 (3307 words) Published: July 12, 2015
Exam1 Spring 2015 Key
1. Nelson's Landscaping Services just completed a pro forma statement using the percentage of sales approach. The pro forma has a projected external financing need of -$5,500. What are the firm's options in this case?  With a negative external financing need, the firm has a surplus of funds that it can use to reduce current liabilities, reduce long-term debt, buy back common stock, or increase dividends. If acceptable opportunities exist, the firm might also use the extra funds to purchase fixed assets thereby increasing its maximum capacity level, should that need be anticipated. 2. In the chapter, we used Rosengarten Corporation to demonstrate how to calculate EFN. The ROE for Rosengarten is about 7.3 percent, and the plowback ratio is about 67 percent. If you calculate the sustainable growth rate for Rosengarten, you will find it is only 5.14 percent. In our calculation for EFN, we used a growth rate of 25 percent. Is this possible? Two assumptions of the sustainable growth formula are that the company does not want to sell new equity, and that financial policy is fixed. If the company raises outside equity, or increases its debt-equity ratio it can grow at a higher rate than the sustainable growth rate. Of course the company could also grow faster than its profit margin increases, if it changes its dividend policy by increasing the retention ratio, or its total asset turnover increases. 3. You are at your desk at work when a co-worker excitedly comes to your desk and shows you the scenario analysis that he has just completed for a potential new project. All three scenarios show a positive NPV. He states, “We have to take this project!” What is your initial reaction regarding this new project. Do you believe the results of the scenario analysis? While that fact that the worst-case NPV is positive is interesting, it also indicates that there is likely a problem with the inputs and/or analysis. While we would like all of our projects to be guaranteed to make money, as a practical matter, it doesn’t seem likely that these types of projects are very prevalent.  4.The most recent financial statements for GPS, Inc., are shown here:

Income Statement
 
Balance Sheet
 
  Sales
$
28,300
 
  Assets
$
58,400
 
  Debt
$
25,400
 
  Costs
 
19,800
 
 
 
 
 
  Equity
 
33,000
 
  Taxable income
$
8,500
 
    Total
$
58,400
 
    Total
$
58,400
 
  Taxes (40%)
 
3,400
 
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
    Net income
$
5,100

 

Assets and costs are proportional to sales. Debt and equity are not. A dividend of $2,000 was paid, and the company wishes to maintain a constant payout ratio. Next year’s sales are projected to be $32,545.

What is the external financing needed?

An increase of sales to $32,545 is an increase of:

Sales increase
=
 ($32,545 – 28,300) / $28,300
Sales increase
=
 0.15, or 15%

Assuming costs and assets increase proportionally, the pro forma financial statements will look like this:

  Pro forma income statement
 
Pro forma balance sheet
 
  Sales
$
32,545
 
Assets
$
67,160
 
Debt
$
25,400
 
  Costs
 
22,770
 
 
 
 
 
Equity
 
36,565
 
  EBIT
$
9,775
 
  Total
$
67,160
 
  Total
$
61,965
 
  Taxes (40%)
 
3,910
 
 
 
 
 
 
 
 
 
 

 
 
 
 
 
 
 
 
 
  Net income
$
5,865

 

 

The payout ratio is constant, so the dividends paid this year is the payout ratio from last year times net income, or:

Dividends
=
 ($2,000 / $5,100)($5,865)
Dividends
=
 $2,300

The addition to retained earnings is:

Addition to retained earnings
=
 $5,865 – 2,300
Addition to retained earnings
=
 $3,565

And the new equity balance is:

Equity
=
 $33,000 + 3,565
Equity
=
 $36,565

So the EFN is:

EFN
=
 Total assets – Total liabilities and equity
EFN
=
 $67,160 – 61,965
EFN
=
 $5,195
5....
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