Fadhil Consultancy and Training



WEEK 3TUTORIAL QUESTIONSChapter 4Question 2.Swimming Pool has predicted a sales increase of 20 per cent. It has also predicted that every item on the Balance Sheet will increase by 20 per cent as well. Create the pro-forma statements and reconcile them. What is the plug variable here?Net profit is $1 200, but equity only increased by $500; therefore, a dividend of $700 must have been paid. Dividends paid is the plug variable.Question3.In the previous question, assume that Swimming Pool pays out half of net profit in the form of a cash dividend. Costs and assets vary with sales, but debt and equity do not. Prepare the pro-forma statements and determine the external financing needed.Dividends $600Retained Profits$600EFN = 6 000 – 5 600 = $400Question 4.What are the advantages and disadvantages of the percentage of sales approach? In particular, is the assumption that many of the firm's costs and assets are directly proportional to sales a reasonable assumption? Does your answer depend on the time horizon being considered?One advantage is that it is easy to implement. A big disadvantage is that the relationships between factors are assumed to be static, at least within each scenario. It is probably true that sales, costs and asset needs are closely associated over the long term, but in the short term, they need not be.Question 6.The most recent financial statements for Small Fry Ltd are shown below.Assets and costs are proportional to sales. Debt is not. Small Fry maintains a constant 15 per cent dividend payout. No external financing is possibleWhat is the sustainable growth rate?Let g = sustainable growthEFN= 0p = profit margin= 840/2,620= 0.3206R= retention = 1 – 0.15 = 0.850= –0.3206(2 620)(0.85) + [13?300 – 0.3206 (2 620)(0.85)]g0= –713.98 + 12 586.02gg= 713.98/12 586.02g= 0.0567 = 5.67%If the government were to reduce company tax by 3 per cent, what would be the new sustainable growth rate?Question 7.Consider the following Income Statement for Poppins Ltd:Pay-out ratio .18A 10% per cent growth rate is projected. Prepare a pro-forma Income Statement assuming that costs vary with sales and the dividend pay-out ratio is constant. What is the projected addition to retained profit?Question 8 & 9.The Balance Sheet for Poppins Ltd is shown below. Based on this information and the Income Statement apply the percentage of sales approach. Assume that accounts payable vary with sales while notes payable do not. Prepare a partial pro-forma Balance Sheet showing EFN, assuming a 10 per cent increase in salesEFN = 605 – 633.14 = –$28.14Question 10.From the previous question, assuming that non-current debt is the plug, prepare the completed pro-forma Balance Sheet. What is the projected ROE? Question 11.The most recent financial statements for Redflower Ltd are shown below.Assets and costs are proportional to sales. Redflower maintains a constant 30 per cent dividend pay-out and a constant debt-to-equity ratio. What is the maximum increase in sales that can be sustained assuming no new equity is issued?ROE = 7 000/123 000 = 0.0569R = 1 – 0.3 = 0.7g* = 0.0569(0.7)/[1 – 0.0569(0.7)] = 0.0415 = 4.15%Maximum increase in sales = 50?000(0.0415) = $2 075Question 12.The most recent financial statements for Tropicana Ltd are shown below.Assets and costs are proportional to sales. Debt is not. No dividends are paid. Next year's sales are projected to be $5,500. What are the external funds needed (EFN)?EFN = 14?300 – 16?300 = –$2 000. No external financing is needed. There is a surplus of cash, so either debt can be retired or dividends can be paid after all.Question 13.The most recent financial statements for Frangipani Pty Ltd are shown below.Growth in Sales0.15Tax rate0.30Payout Ratio0.762INCOME STATEMENTBALANCE SHEET (20XX) $Sales$80,000CA$240,000LT Debt$150,000Costs$20,000NCA$0Equity$90,000$60,000Total$240,000Total$240,000Less tax$18,000?Net profit$42,000Dividend$32,000Assets and costs are proportional to sales. Debt is not. A dividend of $32,000 was paid, and Frangipani wishes to maintain a constant pay-out. Next year's sales are projected to be $92,000. What are the EFN (external funds needed)?Question 14.The most recent financial statements for Big Winners Ltd are shown below.Assets, costs and current liabilities are proportional to sales. Non-current debt is not. Big Winners maintains a constant 70 per cent dividend pay-out. Next year's sales are projected to be $6400. What are the external funds needed (EFN)?Question 15.Assuming a firm does not wish to sell new equity, what are the four determinants of growth? Explain how an increase in each of these affects the firm's growth rate. If these four elements are taken as fixed and no new equity will be issued, then what must be true?Profit margin: As the profit margin increases, the firm’s sustainable growth rate increases.Dividend payout: As the dividend payout increases, the firm’s sustainable growth rate decreases.Debt/equity ratio: As the debt/equity ratio increases, the firm’s sustainable growth rate increases.Total asset turnover: As the total asset turnover increases, the firm’s sustainable growth rate increases.If these are fixed and no new equity will be issued, then there is only one growth rate which is possible, and that is the sustainable growth rate.Question 16.Assuming that the following ratios are constant, what is the sustainable growth rate?Total assets/sales= 1.0Net profit/sales= 0.05Debt/equity= 0.5Dividends/net profit= 0.6R = 1 – 0.6 = 0.4ROE = 0.05(1/1)(1 + 0.5) = 0.075g* = (ROE × i) / (1 – ROE × i)= 0.075(0.4)/[1 – 0.075(0.4)] = 0.0309 = 3.09% Question 17.Based on the following information, calculate the sustainable growth rate:Profit margin= 5%Capital intensity ratio= 2Debt/equity ratio= 0.5Net profit= $10,000Dividends= $3,000What is the ROE here?Retained earnings = 10?000 – 3 000 = 7 000R = 7 000/10?000 = 0.7ROE = 0.05(1/2)(1 + 0.5) = 0.0375 = 3.75%g* = (ROE × R) / (1 – ROE × i)= 0.0375(0.7)/[1 – 0.0375(0.7)] = 0.02695 = 2.695%Question 18, 19 & 20.Regina Stone operates a mining firm and she has a tax rate of 30 per cent. Her accountant has provided the following financial statements:Assume the firm is operating at full capacity and that Regina Stone will draw a salary as a constant percentage of profit. Sales are predicted to grow at 10 per cent. Use the percentage of sales approach to calculate the EFN. Assume current liabilities and assets grow at the same rate as that of sales.What is the EFN if capacity is 60 per cent for fixed assets? If the capacity is 95 per cent?Full-capacity sales are equal to current sales divided by the capacity utilisation.At 60% capacity: $5 250/0.60 = $8 750With forecast sales of $5 775 well below full-capacity sales, no net new fixed assets will be needed. In solution 17, it was estimated that fixed assets would increase by $255 ($2 805 – $2 550); however, this investment is not needed as sales are below capacity. The new EFN will be –$190.10 (from solution 17) plus –$255, which is a negative $445.10. A surplus exists and no external financing is needed in this case.At 95% capacity, full capacity is $5 250/0.95 = $5 526.The ratio of non-current assets to full capacity sales is $2 550/$5 526 = 0.46157. Therefore, at the forecast sales level of $5 775, we will need $5 775 × 0.46157 = $2 665 in net fixed assets, an increase of $115. This is $140 less than predicted in solution 17 ($255 – $115 = $140). The EFN is now –$190.10 – $140 = –$330.10, which is a surplus. Therefore, no additional financing is needed.What growth can Regina Store maintain if no external financing is used? What is the sustainable growth rate?Regina Stone retains R = 1 – 0.4 = 0.6, 60% of net profit. The return on assets is $735/$3 750 = 0.196, or 19.6%.The internal growth rate is:(ROA × R)/(1 – ROA × R )= (0.196 × 0.6)/(1 – 0.196 × 0.6)= 0.1176/0.8824= 0.1333 or 13.33%Return on equity for Regina Stone is $735/$1 150 = 0.6391, or 63.91%, so we calculate sustainable growth as:(ROE × R)/(1 – ROE × R ) = (0.6391 × 0.6)/(1 – 0.6391 × 0.6)= 0.3835/0.6165 = 0.6221 or 62.21%Question 21.Assuming the following ratios are constant, what is the sustainable growth rate?Sales/total assets= 0.6Net profit/sales= 0.1Debt/total assets= 0.5Retained profit/net profit= 0.8D/E = 0.5/0.5 = 1ROE = 0.1(0.6)(1 + 1) = 0.12g* = (ROE × R)/(1 – ROE × R) = 0.12(0.8)/[1 – 0.12(0.8)] = 0.1062 = 10.62%Question 22.Preference Ltd wishes to maintain a growth rate of 10 per cent per year and a dividend pay-out of 20 per cent. The ratio of total assets to sales is constant at 2, and profit margin is 10 per cent. What must the debt/equity ratio be?g* = 0.1R = 1 – payout ratio = 1 - 0.2 = 0.8p = 0.1A/S = 2 so that S/A = ? = 0.5g*= [p(S/A) (1 + D/E) R]/(1 – [p(S/A) (1+ D/E) R ])0.1 = (0.1)(0.5)(1 + D/E) 0.8/[1 – (0.1)(0.5)(1 + D/E)0.8]0.1 = 0 .05 (1 + D/E)/(1 – 0.05 (1 + D/E))D/E = 1.2744 Question 23.Mansions Ltd wishes to maintain a growth rate of 5 per cent per year, a debt-to-equity ratio of 0.5, and a dividend payout of 60 per cent. The ratio of total assets to sales is constant at 2. What profit margin must it achieve?R = 1 – payout ratio = 1 – 0.6 = 0.4 A/S = 2 so that S/A = ? = 0.5i* =[p(i) (1 + D/E) R]/(1 – [p(S/A)(1+ D/E) R])0.05 = [p(0.5)(1.5)0.4]/[1 – [p(0.5)(1.5)0.4]0.05 = [0.3p]/[1 – 0.3p]0.05*(1 – 0.3p) = 0.3p0.05 – 0.015p = 0.3p0.05= 0.3p + 0.015pp = 0.1587 = 15.87% Question 24.Based on the following information, calculate the sustainable growth rate and the ROA:Profit margin= 4%Total asset turnover= 2Total debt ratio= 0.5Payout ratio= 60%g*=[p(S/A)(1 + D/E)R]/1 – [p(S/A)(1+ D/E)R]= 0.04(2)(2)(0.4)/[1 – 0.04(2)(2)(0.4)] = 0.0684 = 6.84%ROA = 0.04(2) = 0.08 = 8%Question 25.Postal Note Ltd has $50 000 in total assets. The retention ratio is 0.50, the debt/equity ratio is 1, and the profit margin is 5 per cent. Sales for the year just ended were $20 000. If sales are to rise by 10 per cent, what is the EFN?EFN= –(0.05)(20 000)(0.5) + [50 000 – (0.05)(20 000)(0.5)](0.1)= $4 450Question 26.In the previous question, what is the general relationship between growth in sales and EFN? What growth rate can be supported with no external financing? What would happen if growth were zero? How do you interpret this?EFN = –500 + 495g0 = –500 + 495gg = 0.0101 = 1.01%If growth is 0, then there is a $500 surplus in funds that could be used to retire debt or pay a larger dividend.Question 27.In the previous question, what is the sustainable growth rate?ROE = 0.05(20?000/50?000)(1 + 1) = 0.04g* = 0.04(0.5)/[1 – (0.04)(0.5)] = 0.0204 = 2.04%Question 28.Beanie Ltd wishes to maintain a growth rate of 4 per cent per year, a debt-to-equity ratio of 0.5, and a dividend payout of 80 per cent. If the profit margin is 8 per cent and next year's sales are projected at $1500, what is the total asset projection?R + 1 – 0.8 + 0.2 g* = [p(S/A)(1 + D/E)R]/1 – [p(S/A)(1+ D/E)R]0.04 = (0.08)(1500/A)(1.5)(0.2)/[1 – (0.08)(1500)/A)(1.5)(0.2)]A = $936Question 29.If a firm has a 20 per cent ROE and a 35 per cent payout ratio, what is its sustainable growth rate?R = 1 – 0.35 = 0.65g* = 0.2(0.65)/[1 – 0.2(0.65)] = 0.1494 = 14.94% ................
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