Solutions to End-of-Chapter Problems

17-1 AFN = (A0*/S0)S – (L0*/S0)S – MS1(1 – Payout)

=
($3,000,000
$5,000,000 )
$1,000,000 –
($500,000
$5,000,000 )
$1,000,000 – 0.03($6,000,000)(0.3)
= (0.6)($1,000,000) – (0.1)($1,000,000) – ($180,000)(0.3)
= $600,000 – $100,000 – $54,000
= $446,000.

17-2 AFN =
($4,000,000
$5,000,000 )
$1,000,000−(0 .1 )($1,000,000)−( $ 18 0,000)(0 . 3)

= (0.8)($1,000,000) – $100,000 – $54,000

= $800,000 – $154,000
= $646,000.

The capital intensity ratio is measured as A0*/S0. This firm’s capital intensity ratio is
higher than that of the firm in Problem 17-1; therefore, this firm is more capital
intensive—it would require a large increase in total assets to support the increase in
sales.

17-3 AFN = (0.6)($1,000,000) – (0.1)($1,000,000) – 0.03($6,000,000)(1)

= $600,000 – $100,000 – $180,000
= $320,000.

Under this scenario the company would have a higher level of retained earnings,
which would reduce the amount of additional funds needed.

17-4 a. 2018 Forecast Basis 2019

Sales $700  1.25 $875.00
Operating costs 500  0.70 Sales 612.50
EBIT $200 $262.50
Interest 40 40.00
EBT $160 $222.50
Taxes (40%) 64 89.00
Net income $ 96 $133.50

Dividends (33.33%) $ 32 $ 44.50

Addit. to R/E $ 64 $ 89.00

b. Dividends = ($44.50 – $32.00)/$32.00 = 39.06%.

17-5 Sales = $7,000,000,000; FA = $1,944,000,000; FA are operated at 90% capacity.

a. Full capacity sales = $7,000,000,000/0.90 = $7,777,777,778.

b. Target FA/S ratio = $1,944,000,000/$7,777,777,778 = 0.2499  0.25.

 c. Sales increase 15%; FA = ?

S1 = $7,000,000,000  1.15 = $8,050,000,000.

No increase in FA up to $7,777,777,778.

FA = 0.25  ($8,050,000,000 – $7,777,777,778)

= 0.25  ($272,222,222)
= $68,055,556.

17-6 Sales = $300,000,000; gSales = 12%; Inv. = $25 + 0.125(Sales).

S1 = $300,000,000  1.12 = $336,000,000.

Inv. = $25 + 0.125($336)

= $67 million.

Sales/Inv. = $336,000,000/$67,000,000  5.0149× = 5.01×.

17-7 Actual Forecast Basis

Pro Forma
Sales $3,000  1.10 $3,300
Oper. costs excluding depreciation 2,450  0.80 Sales 2,640
EBITDA $ 550 $ 660
Depreciation 250  1.10 275
EBIT $ 300 $ 385
Interest 125 125
EBT $ 175 $ 260
Taxes (40%) 70 104
Net income $ 105 $ 156

Total liabilities
17-8 a. and equity = Accounts payable + Long-term debt + Common stock + Retained
earnings
$1,800,000 = $450,000 + Long-term debt + $500,000 + $475,000
Long-term debt = $375,000.

Total liabilities = Accounts payable + Long-term debt

= $450,000 + $375,000 = $825,000.

Alternatively,
Total liabilities = Total liabilities and equity – Common stock – Retained
earnings
= $1,800,000 – $500,000 – $475,000 = $825,000.

b. Assets/Sales (A0*/S0) = $1,800,000/$3,000,000 = 60%.

L0*/Sales (L0*/S0) = $450,000/$3,000,000 = 15%.

2019 Sales = (1.25)($3,000,000) = $3,750,000.

 S = $3,750,000 – $3,000,000 = $750,000.

AFN = (A0*/S0)(S) – (L0*/S0)(S) – MS1(1 – Payout) – New common stock

= (0.60)($750,000) – (0.15)($750,000) – (0.05)($3,750,000)(0.35) – $130,000
= $450,000 – $112,500 – $65,625 – $130,000 = $141,875.

Alternatively, using the forecasted financial statements:

Forecast Additions (New 2019
2018 Basis Financing, R/E) Pro Forma
Total assets $1,800,000 × 0.60 Sales18 $2,250,000

Current liabilities $ 450,000 × 0.15 Sales18 $ 562,500

Long-term debt 375,000 375,000
Total liabilities $ 825,000 $ 937,500
Common stock 500,000 130,000* 630,000
Retained earnings 475,000 65,625** 540,625
Total common equity $ 975,000 $1,170,625
Total liabilities and equity$1,800,000 $2,108,125

AFN = New long-term debt = $

141,875

*Given in problem that firm will sell new common stock = $130,000.
**PM = 5%; 1 – Payout = 35%; NI2019 = $3,000,000  1.25  0.05 = $187,500.
Addition to RE = NI  (1 – Payout) = $187,500  0.35 = $65,625.

17-9 S2018 = $4,000,000; A2018 = $3,200,000; CL2018 = $500,000; NP2018 = $200,000; A/P2018
= $200,000; Accrued liabilities2018 = $100,000; A0*/S0 = 0.80; PM = 3%; (1 – Payout)
= 50%; so AFN = 0, S = ?

AFN = (A0*/S0)S – (L0*/S0)S – MS1(1 – Payout)

$0 = (0.80)S –
($300,000
$ 4 ,000,000 )
S – (0.03)(S1)(0.5)
$0 = (0.80)S – (0.075)S – (0.015)S1
$0 = (0.725)S – (0.015)S1
$0 = 0.725(S1 – S0) – (0.015)S1
$0 = 0.725(S1 – $4,000,000) – (0.015)S1
$0 = 0.725S1 – $2,900,000 – 0.015S1
$2,900,000 = 0.71S1
$4,084,507.04 = S 1.

Sales can increase by $4,084,507.04 – $4,000,000 = $84,507.04 without additional

funds being needed.

17-10 Sales = $320,000,000; gSales = 12%; Rec. = $9.25 + 0.07(Sales).

S1 = $320,000,000  1.12 = $358,400,000.

Rec.= $9.25 + 0.07($358.4)

= $34.338 million.
 DSO= Rec./(Sales/365)
= $34,338,000/($358,400,000/365)
= 34.97 days  35 days.

17-11 Sales = $110,000,000; gSales = 5%; Inv. = $9 + 0.0875(Sales).

S1 = $110,000,000  1.05 = $115,500,000.

Inv. = $9 + 0.0875($115.5)
= $19.10625 million.

Sales/Inv. = $115,500,000/$19,106,250
= 6.0451×.

17-12 a. Sales = $3,000,000,000; FA = $787,500,000; FA are operated at 80% capacity.

Full capacity sales = Actual sales/(% of capacity at which FA are operated)

= $3,000,000,000/0.80
= $3,750,000,000.

b. Target FA/Sales ratio = $787,500,000/$3,750,000,000

= 0.21 = 21.0%.

c. Sales increase 30%; FA = ?

S1 = $3,000,000,000  1.30 = $3,900,000,000.

No increase in FA up to $3,750,000,000.

FA = 0.21  ($3,900,000,000  $3,750,000,000)

= 0.21  $150,000,000
= $31,500,000.
17-13 a. Part II. Income Statements 2018 Change 2019
Sales $3,600,000.0 (1 + g) $3,960,000.0
Operating costs (includes depreciation) 3,279,720.0 0.875 3,465,000.0
Earnings before interest and taxes (EBIT) $ 320,280.0 $ 495,000.0
Less interest expense 20,280.0 See notes 37,125.0
Earnings before taxes (EBT) $ 300,000.0 $ 457,875.0
Taxes 120,000.0 EBT(T) 183,150.0
Net income (NI) $ 180,000.0 $ 274,725.0
Dividends $ 108,000.0 NI(Payout) $ 164,835.0
Addition to retained earnings $ 72,000.0 $ 109,890.0

Part III. Balance Sheets 2018 Change 2019

Assets
Cash $ 180,000.0 ( 1 + g) $ 198,000.0
Accounts receivable 360,000.0 0.1000 396,000.0
Inventories 720,000.0 0.2000 792,000.0
Fixed assets (grow with sales) 1,440,000.0 (1 +g) 1,584,000.0
Total assets $2,700,000.0 $2,970,000.0

Liabilities and Equity

Payables + accruals (both grow with sales)$ 540,000.0 (1 + g) $ 594,000.0
Short-term bank loans 56,000.0 See notes 89,100.0
Total current liabilities $ 596,000.0 $ 683,100.0
Long-term bonds 100,000.0 See notes 207,900.0
Total liabilities $ 696,000.0 $ 891,000.0
Common stock 1,800,000.0 See notes 1,765,110.0
Retained earnings 204,000.0 $109,890.0 313,890.0
Total common equity $2,004,000.0 $2,079,000.0
Total liabilities and equity $2,700,000.0 $2,970,000.0

Part V. Notes on Calculations

Assets in 2019 will change to this amount, from the balance sheet: $2,970,000.0
Target total liabilities-to-assets ratio 30.00%
Resulting total liabilities: (Target total liabilities-to-assets ratio)(2019 assets) $
891,000.0
Less: Payables and accruals -594,000.0
Bank loans and bonds (= Interest-bearing debt) $ 297,000.0
Allocated to bank loans 30.00% 89,100.0
Allocated to bonds 70.00% $ 207,900.0
Interest expense: (Interest rate)(2019 Bank loans plus bonds) 37,125.0
Target equity ratio = 1 – Target total liabilities-to-assets ratio 70%
Required total equity: (2019 assets)(Target equity ratio) $2,079,000.0
Retained earnings, from 2019 balance sheet 313,890.0
Required common stock = Required total equity – Retained earnings $1,765,110.0

Old shares outstanding 100,000

Increase in common stock = 2019 Common stock – 2018 Common stock -$34,890.0
Initial price per share $45.00
Change in shares = Change in equity/Initial price per share -775.33
New shares outstanding = Old shares +  Shares 99,224.67
Old EPS = 2018 Net income/Old shares outstanding $1.80
New EPS = 2019 Net income/New shares outstanding $2.77
 b. AFN = $2,700,000/$3,600,000(Sales) – ($360,000 +
$180,000)/$3,600,000(Sales)
– (0.05)($3,600,000 + Sales)0.4
$0 = 0.75(Sales) – 0.15(Sales) – 0.02(Sales) – $72,000
$0 = 0.58(Sales) – $72,000
$72,000 = 0.58(Sales)
Sales = $124,138.

Δ Sales $124,138
¿ ¿
Growth rate in sales = $3,600,000 $3,600,000

Full Current sales

capacity % of capacity at which $ 36 ,000
17-14 a. sales = FA were operated = 0 . 75 = $48,000.

New sales−Old sales $48,000−$36,000

% increase = Old sales = $36,000 = 0.33 = 33%.

Therefore, sales could expand by 33% before the firm would need to add fixed
assets.

b. Part II. Income Statements (in thousands) 2018 Change 2019

Sales $36,000.0 (1 + g) $45,000.0
Operating costs (includes depreciation) 30,783.0 0.820 36,900.0
Earnings before interest and taxes (EBIT) $ 5,217.0 $ 8,100.0
Less interest expense 1,017.0 See notes 1,116.7
Earnings before taxes (EBT) $ 4,200.0 $ 6,983.3
Taxes 1,680.0 EBT(T) 2,793.3
Net income (NI) $ 2,520.0 $ 4,190.0
Dividends $ 1,512.0 NI(Payout) $ 2,514.0
Addition to retained earnings $ 1,008.0 $ 1,676.0

Part III. Balance Sheets (in thousands) 2018 Change 2019

Assets
Cash $ 1,800.0 (1 + g) $ 2,250.0
Accounts receivable 10,800.0 0.3000 13,500.0
Inventories 12,600.0 0.3500 15,750.0
Fixed assets 21,600.0 See notes 21,600.0
Total assets $46,800.0 $53,100.0

Liabilities and Equity

Payables + accruals (both grow with sales) $ 9,720.0 (1 + g) $12,150.0
Short-term bank loans 3,472.0 See notes 3,553.2
Total current liabilities $13,192.0 $15,703.2
Long-term bonds 5,000.0 See notes 6,598.8
Total liabilities $18,192.0 $22,302.0
Common stock 2,000.0 See notes 2,514.0
Retained earnings 26,608.0 $1,676.0 28,284.0
Total common equity $28,608.0 $30,798.0
Total liabilities and equity $46,800.0 $53,100.0
Part V. Notes on Calculations (in thousands)
Full capacity sales $48,000.00
Target fixed assets/Sales 45.00%
Required level of fixed assets $20,250.00
Current level of fixed assets $21,600.00
Addition to fixed assets (= zero, if negative) $0.00
2019 Fixed assets $21,600.00

Assets in 2019 will change to this amount, from the balance sheet: $53,100.0
Target total liabilities-to-assets ratio 42.00%
Resulting total liabilities: (Target total liabilities-to-assets ratio)(2019 assets)
$22,302.0
Less: Payables and accruals -12,150.0
Bank loans and bonds (= Interest-bearing debt) $10,152.0
Allocated to bank loans 35.00% 3,553.2
Allocated to bonds 65.00% $ 6,598.8
Interest expense: (Interest rate)(2019 Bank loans plus bonds) $ 1,116.7
Target equity ratio = 1 – Target total liabilities-to-assets ratio 58%
Required total equity: (2019 assets)(Target equity ratio) $30,798.0
Retained earnings, from 2019 balance sheet 28,284.0
Required common stock = Required total equity – Retained earnings $ 2,514.0

Old shares outstanding (in thousands) 1,000

Increase in common stock = 2019 Common stock – 2018 Common stock $514.0
Initial price per share $40.00
Change in shares = Change in equity/Initial price per share 12.85
New shares outstanding = Old shares +  Shares 1,012.85
Old EPS = 2018 Net income/Old shares outstanding $2.52
New EPS = 2019 Net income/New shares outstanding $4.14