Basic 1. It is important to remember that equity will not increase by the same percentage as the other assets.

If every other item on the income statement and balance sheet increases by 15 percent, the pro forma income statement and balance sheet will look like this: Pro forma income statement Sales Costs Net income $ 26,450 19,205 $ 7,245 Assets Total Pro forma balance sheet $18,170 $18,170 Debt Equity Total $ 5,980 12,190 $ 18,170

In order for the balance sheet to balance, equity must be: Equity = Total liabilities and equity – Debt Equity = $18,170 – 5,980 Equity = $12,190 Equity increased by: Equity increase = $12,190 – 10,600 Equity increase = $1,590 Net income is $7,245 but equity only increased by $1,590; therefore, a dividend of: Dividend = $7,245 – 1,590 Dividend = $5,655 must have been paid. Dividends paid is the plug variable.

Net income is $7,245 but equity only increased by $1,590; therefore, a dividend of: Dividend = $7,245 – 1,590 Dividend = $5,655 must have been paid. Dividends paid is the plug variable. 2. Here we are given the dividend amount, so dividends paid is not a plug variable. If the company pays out one-half of its net income as dividends, the pro forma income statement and balance sheet will look like this:

Pro forma income statement Sales $26,450.00 Costs 19,205.00 Net income $ 7,245.00 Dividends $3,622.50 Add. to RE $3,622.50

Assets Total

Pro forma balance sheet $18,170.00 Debt Equity $18,170.00 Total

$ 5,980.00 14,222.50 $19,422.50

Note that the balance sheet does not balance. This is due to EFN. The EFN for this company is: EFN = Total assets – Total liabilities and equity EFN = $18,170 – 19,422.50 EFN = –$1,252.50 3. An increase of sales to $7,424 is an increase of: Sales increase = ($7,424 – 6,300) / $6,300 Sales increase = .18 or 18% Assuming costs and assets increase proportionally, the pro forma financial statements will look like this: Pro forma income statement Sales Costs Net income $ $ 7,434 4,590 2,844 Assets Total Pro forma balance sheet $ 21,594 $ 21,594 Debt Equity Total $ 12,400 8,744 $ 21,144

If no dividends are paid, the equity account will increase by the net income, so: Equity = $5,900 + 2,844 Equity = $8,744 So the EFN is: EFN = Total assets – Total liabilities and equity EFN = $21,594 – 21,144 = $450

4. An increase of sales to $21,840 is an increase of: Sales increase = ($21,840 – 19,500) / $19,500 Sales increase = .12 or 12% Assuming costs and assets increase proportionally, the pro forma financial statements will look like this: Pro forma income statement Sales $ Costs EBIT Taxes (40%) Net income $ 21,840 16,800 5,040 2,016 3,024 Assets Total Pro forma balance sheet $109,760 $109,760 Debt Equity Total $52,500 79,208 $99,456

The payout ratio is constant, so the dividends paid this year is the payout ratio from last year times net income, or: Dividends = ($1,400 / $2,700)($3,024) Dividends = $1,568 The addition to retained earnings is: Addition to retained earnings = $3,024 – 1,568 Addition to retained earnings = $1,456 And the new equity balance is: Equity = $45,500 + 1,456 Equity = $46,956 So the EFN is: EFN = Total assets – Total liabilities and equity EFN = $109,760 – 99,456 EFN = $10,304 5. Assuming costs and assets increase proportionally, the pro forma financial statements will look like this: Pro forma income statement Pro forma balance sheet Sales $4,830.00 CA $4,140.00 CL $2,145.00 Costs 3,795.00 FA 9,085.00 LTD 3,650.00 Taxable income $1,035.00 Equity 6,159.86 Taxes (34%) 351.90 TA $13,225.00 Total D&E $12,224.86 Net income $ 683.10

The payout ratio is 40 percent, so dividends will be: Dividends = 0.40($683.10) Dividends = $273.24 The addition to retained earnings is: Addition to retained earnings = $683.10 – 273.24 Addition to retained earnings = $409.86 So the EFN is: EFN = Total assets – Total liabilities and equity EFN = $13,225 – 12,224.86 EFN = $1,000.14 6. To calculate the internal growth rate, we first need to calculate the ROA, which is: ROA = NI / TA ROA = $2,262 / $39,150 ROA = .0578 or 5.78% The plowback ratio, b, is one minus the payout ratio, so: b = 1 – .30 b = .70 Now we can use the internal growth rate equation to get: Internal growth rate = (ROA × b) / [1 – (ROA × b)] Internal growth rate = [0.0578(.70)] / [1 – 0.0578(.70)] Internal growth rate = .0421 or 4.21% 7. To calculate the sustainable growth rate, we first need to calculate the ROE, which is: ROE = NI / TE ROE = $2,262 / $21,650 ROE = .1045 or 10.45% The plowback ratio, b, is one minus the payout ratio, so: b = 1 – .30 b = .70 Now we can use the sustainable growth rate equation to get: Sustainable growth rate = (ROE × b) / [1 – (ROE × b)] Sustainable growth rate = [0.1045(.70)] / [1 – 0.1045(.70)] Sustainable growth rate = .0789 or 7.89%

8.

The maximum percentage sales increase is the sustainable growth rate. To calculate the sustainable growth rate, we first need to calculate the ROE, which is: ROE = NI / TE ROE = $8,910 / $56,000 ROE = .1591 or 15.91% The plowback ratio, b, is one minus the payout ratio, so: b = 1 – .30 b = .70 Now we can use the sustainable growth rate equation to get: Sustainable growth rate = (ROE × b) / [1 – (ROE × b)] Sustainable growth rate = [.1591(.70)] / [1 – .1591(.70)] Sustainable growth rate = .1253 or 12.53% So, the maximum dollar increase in sales is: Maximum increase in sales = $42,000(.1253) Maximum increase in sales = $5,264.03

9.

Assuming costs vary with sales and a 20 percent increase in sales, the pro forma income statement will look like this: HEIR JORDAN CORPORATION Pro Forma Income Statement Sales $45,600.00 Costs 22,080.00 Taxable income $23,520.00 Taxes (34%) 7,996.80 Net income $ 15,523.20 The payout ratio is constant, so the dividends paid this year is the payout ratio from last year times net income, or: Dividends = ($5,200/$12,936)($15,523.20) Dividends = $6,240.00 And the addition to retained earnings will be: Addition to retained earnings = $15,523.20 – 6,240 Addition to retained earnings = $9,283.20

10. Below is the balance sheet with the percentage of sales for each account on the balance sheet. Notes payable, total current liabilities, long-term debt, and all equity accounts do not vary directly with sales. HEIR JORDAN CORPORATION Balance Sheet ($) (%) Assets Current assets Cash $ 3,050 Accounts receivable 6,900 Inventory 7,600 Total $ 17,550 Fixed assets Net plant and equipment 34,500 Liabilities and Owners’ Equity Current liabilities Accounts payable Notes payable Total Long-term debt Owners’ equity Common stock and paid-in surplus Retained earnings Total Total liabilities and owners’ equity

($)

(%)

8.03 18.16 20.00 46.18

$ 1,300 6,800 $ 8,100 25,000

3.42 n/a n/a n/a

90.79

$15,000 3,950 $18,950 $52,050

n/a n/a n/a n/a

Total assets

$52,050 136.97

11. Assuming costs vary with sales and a 15 percent increase in sales, the pro forma income statement will look like this: HEIR JORDAN CORPORATION Pro Forma Income Statement Sales $43,700.00 Costs 21,160.00 Taxable income $22,540.00 Taxes (34%) 7,663.60 Net income $ 14,876.40 The payout ratio is constant, so the dividends paid this year is the payout ratio from last year times net income, or: Dividends = ($5,200/$12,936)($14,876.40) Dividends = $5,980.00 And the addition to retained earnings will be: Addition to retained earnings = $14,876.40 – 5,980 Addition to retained earnings = $8,896.40 The new accumulated retained earnings on the pro forma balance sheet will be: New accumulated retained earnings = $3,950 + 8,896.40 New accumulated retained earnings = $12,846.40

The pro forma balance sheet will look like this: HEIR JORDAN CORPORATION Pro Forma Balance Sheet Assets Current assets Cash Accounts receivable Inventory Total Fixed assets Net plant and equipment Liabilities and Owners’ Equity Current liabilities Accounts payable $ Notes payable Total $ Long-term debt Owners’ equity Common stock and paid-in surplus Retained earnings Total Total liabilities and owners’ equity

$ 3,507.50 7,935.00 8,740.00 $20,182.50

1,495.00 6,800.00 8,295.00 25,000.00

39.675.00

$ 15,000.00 12,846.40 $ 27,846.40 $ 61,141.40

Total assets So the EFN is:

$ 59,857.50

EFN = Total assets – Total liabilities and equity EFN = $59,857.50 – 61,141.40 EFN = –$1,283.90 12. We need to calculate the retention ratio to calculate the internal growth rate. The retention ratio is: b = 1 – .20 b = .80 Now we can use the internal growth rate equation to get: Internal growth rate = (ROA × b) / [1 – (ROA × b)] Internal growth rate = [.08(.80)] / [1 – .08(.80)] Internal growth rate = .0684 or 6.84% 13. We need to calculate the retention ratio to calculate the sustainable growth rate. The retention ratio is: b = 1 – .25 b = .75 Now we can use the sustainable growth rate equation to get: Sustainable growth rate = (ROE × b) / [1 – (ROE × b)] Sustainable growth rate = [.15(.75)] / [1 – .15(.75)] Sustainable growth rate = .1268 or 12.68%

14. We first must calculate the ROE to calculate the sustainable growth rate. To do this we must realize two other relationships. The total asset turnover is the inverse of the capital intensity ratio, and the equity multiplier is 1 + D/E. Using these relationships, we get: ROE = (PM)(TAT)(EM) ROE = (.082)(1/.75)(1 + .40) ROE = .1531 or 15.31% The plowback ratio is one minus the dividend payout ratio, so: b = 1 – ($12,000 / $43,000) b = .7209 Now we can use the sustainable growth rate equation to get: Sustainable growth rate = (ROE × b) / [1 – (ROE × b)] Sustainable growth rate = [.1531(.7209)] / [1 – .1531(.7209)] Sustainable growth rate = .1240 or 12.40% 15. We must first calculate the ROE using the DuPont ratio to calculate the sustainable growth rate. The ROE is: ROE = (PM)(TAT)(EM) ROE = (.078)(2.50)(1.80) ROE = .3510 or 35.10% The plowback ratio is one minus the dividend payout ratio, so: b = 1 – .60 b = .40 Now we can use the sustainable growth rate equation to get: Sustainable growth rate = (ROE × b) / [1 – (ROE × b)] Sustainable growth rate = [.3510(.40)] / [1 – .3510(.40)] Sustainable growth rate = .1633 or 16.33% Intermediate