Chapter 3 Tutorial Solutions Corporate Finance

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CHAPTER 3 TUTORIAL SOLUTIONS

21.Assuming costs vary with sales and a 20 percent increase in sales, the pro forma income statement will look like this:

MOOSE TOURS INC.
Pro Forma Income Statement
Sales$1,114,800
Costs867,600
Other expenses22,800
EBIT$224,400
Interest14,000
Taxable income$210,400
Taxes(35%)73,640
Net income$136,760

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

Dividends = ($33,735/$112,450)($136,760)
Dividends = $41,028

And the addition to retained earnings will be:

Addition to retained earnings = $136,760 – 41,028
Addition to retained earnings = $95,732

The new retained earnings on the pro forma balance sheet will be:

New retained earnings = $182,900 + 95,732
New retained earnings = $278,632

The pro forma balance sheet will look like this:

MOOSE TOURS INC.
Pro Forma Balance Sheet

AssetsLiabilities and Owners’ Equity
-------------------------------------------------

Current assets Current liabilities
Cash$30,360Accounts payable$81,600
Accounts receivable48,840Notes payable17,000
Inventory104,280Total$98,600
Total$183,480Long-term debt158,000
Fixed assets
Net plant andOwners’ equity
equipment495,600Common stock and
paid-in surplus$140,000
Retained earnings278,632
Total$418,632
Total liabilities and owners’
Total assets$679,080equity$675,232

So the EFN is:

EFN = Total assets – Total liabilities and equity
EFN = $679,080 – 675,232
EFN = $3,848

22.First, we need to calculate full capacity sales, which is:

Full capacity sales = $929,000 / .75
Full capacity sales = $1,238,667

The full capacity ratio at full capacity sales is:

Full capacity ratio = Fixed assets / Full capacity sales
Full capacity ratio = $413,000 / $1,238,667
Full capacity ratio = .33342

The fixed assets required at full capacity sales is the full capacity ratio times the projected sales level:

Total fixed assets = .33342($1,114,800) = $371,700

So, EFN is:

EFN = ($183,480 + 371,700) – $675,232 = –$120,052

Note that this solution assumes that fixed assets are decreased (sold) so the company has a 100 percent fixed asset utilization. If we assume fixed assets are not sold, the answer becomes:

EFN = ($183,480 + 413,000) – $675,232 = –$78,752

23.The D/E ratio of the company is:

D/E = ($85,000 + 158,000) / $322,900
D/E = .7526

So the new total debt amount will be:

New total debt = .7526($418,632)
New total debt = $315,044

This is the new total debt for the company. Given that our calculation for EFN is the amount that must be raised externally and does not increase spontaneously with sales, we need to subtract the spontaneous increase in accounts payable. The new level of accounts payable will be, which is the current accounts payable times the sales growth, or:

Spontaneous increase in accounts payable = $68,000(.20)
Spontaneous increase in accounts payable = $13,600

This means that $13,600 of the new total debt is not raised externally. So, the debt raised externally, which will be the EFN is:

EFN = New total debt – (Beginning LTD + Beginning notes payable + Spontaneous increase in AP)
EFN = $315,044 – ($158,000 + 68,000 + 17,000 + 13,600) = $58,444

The pro forma balance sheet with the new long-term debt will be:

MOOSE TOURS INC.
Pro Forma Balance Sheet

AssetsLiabilities and Owners’ Equity...
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