Mary Mickaella R.

Ventura

BSA 3-A
Chapter 4 Minicase

1. Planning for Growth at S&S Air

After Chris completed the ratio analysis for S&S Air (see Chapter 3), Mark and Todd
approached him about planning for next year’s sales. The company had historically used little
planning for investment needs. As a result, the company experienced some challenging times
because of cash flow problems. The lack of planning resulted in missed sales, as well as periods
when Mark and Todd were unable to draw salaries. To this end, they would like Chris to prepare
a financial plan for the next year so the company can begin to address any outside investment
requirements. The income statement and balance sheet are shown here:
QUESTIONS:

1. Calculate the internal growth rate and sustainable growth rate for S&S Air. What do these
numbers mean?

Solution:
ROA = NI / TA
ROA = $1,537,452 / $18,309,920
ROA = .0840 or 8.40%

b = Addition to RE / NI
b=$977,452 / $1,537,452
b = 0.64

Internal growth rate = (ROA × b) / [1 – (ROA × b)]

Internal growth rate = [0.0840(.64)] / [1 – 0.0840(.64)]
Internal growth rate = .0564 or 5.64%

ROE = NI / TE
ROE = $1,537,452 / $10,069,920
ROE = .1527 or 15.27%

Sustainable growth rate = (ROE × b) / [1 – (ROE × b)]

Sustainable growth rate = [0.1527(.64)] / [1 – 0.1527(.64)]
Sustainable growth rate = .1075 or 10.75%

2. S&S Air is planning for a growth rate of 12 percent next year. Calculate the EFN for the company
assuming the company is operating at full capacity. Can the company’s sales increase at this
growth rate?

Solution:
12% growth rate draft of financial statement:
Sales $ 34,159,350
COGS 24,891,530
Other expenses 4,331,600
Depreciation 1,366,680
EBIT $ 3,569,541
Interest 478,240
Taxable income $ 3,091,301
Taxes (40%) 1,236,520
Net income $ 1,854,780

Dividends $ 675,583
Add to RE 1,179,197
 Provided Balance Sheet:

Balance sheet

Assets Liabilities & Equity

Current Assets Current Liabilities

Cash $493,920 Accounts Payable $995,680

Accounts rec. 793,408 Notes Payable 2,030,000
Inventory 1,161,574 Total CL $3,025,680
Total CA $ 2,448,902

Long-term debt $5,320,000

Shareholder Equity
Common stock
$ 350,000
Fixed assets Retained earnings 10,899,117
Net PP&E $ 18,057,088 Total Equity $ 11,249,117
Total Assets $ 20,505,990 Total L&E $ 19,594,787

Assume:
EFN = Total assets – Total liabilities and equity
EFN = $20,505,990 – 19,594,797
EFN = $911,193

3. Most assets can be increased as a percentage of sales. For instance, cash can be increased by
any amount. However, fixed assets must be increased in specific amounts because it is
impossible, as a practical matter, to buy part of a new plant or machine. In this case, a company
has a “staircase” or “lumpy” fixed cost structure. Assume S&S Air is currently producing at 100
percent capacity. As a result, to increase production, the company must set up an entirely new
line at a cost of $5,000,000. Calculate the new EFN with this assumption. What does this imply
about capacity utilization for the company next year?

Solution:
Depreciation percentage = $1,366,680 / $16,122,400
 Depreciation percentage = .0848 or 8.48%

Fixed assets with the $5 million purchase will be:

New fixed assets = $16,122,400 + 5,000,000 =$21,122,400

Pro forma depreciation = .0848($21,122,400)

Pro forma depreciation = $1,790,525

Income statement provided:

Sales $ 34,159,350
COGS 24,891,530
Other expenses 4,331,600
Depreciation 1,790,525
EBIT $ 3,145,696
Interest 478,240
Taxable income $ 2,667,456
Taxes (40%) 1,066,982
Net income $ 1,600,473

Dividends $ 582,955
Add to RE 1,017,519
Note: The pro forma balance sheet will remain the same except for the fixed asset and equity
accounts. The fixed asset account will increase by $5 million, rather than the growth rate of
sales.

Provided Balance Sheet:

Balance sheet

Assets Liabilities & Equity

Current Assets Current Liabilities

Cash $493,920 Accounts Payable $995,680
Accounts rec. 793,408 Notes Payable 2,030,000
Inventory 1,161,574 Total CL $3,025,680
Total CA $2,448,902

Long-term debt $5,320,000

 Shareholder Equity
Commonstock
$350,000
Fixed assets Retained earnings 10,737,439
Net PP&E $ 21,122,400 Total Equity $ 11,087,439
Total Assets $ 23,571,302 Total L&E $ 19,433,119

Assume:
EFN = Total assets – Total liabilities and equity
EFN = $23,581,302 – 19,433,119
EFN = $4,138,184