Chapter 16, Problem 13P

a.

Summary Introduction

To prepare: The financial statement of M Incorporation for the year ended 2015.

Additional Funds Needed (AFN) Equation:

The AFN equation explains the amount of money that a company needs to fulfill the financial needs of the company. It gives the information related to the external financing, as the options available to a company to finance through external financing methods. This equation basically gives a new capital structure that includes an optimum mix of debt, preferred and common stock.

Financial Statement:

The financial statement is final accounts of the company. Financial statement of the company contains the income statement, statement of retained earnings, balance sheet and cash flow statement.

Explanation of Solution

Prepare Income statement,

M Incorporation
Projected Income Statement
For the year ended December 31,2015
Particulars	Amount ($)
Sales	3,960,000
Less: Operating cost including depreciation	3,465,000
EBIT	495,000
Less: Interest	36,680
EBT	458,320
Less: Taxes (40%)	183,328
Net Income	274,992

Table (1)

Prepare statement of retained earnings

M. Incorporation
Retained Earnings Statement
For the year ended December 31,2015
Particulars	Amount ($)
Opening balance	204,000
Net income	274,992
Total	478,992
Dividends	(164,995)
Retained earnings	313,997

Table (2)

Prepare Balance sheet

Particulars	Amount ($)
Assets
Cash	198,000
Accounts Receivables	396,000
Inventories	792,000
Fixed Assets	1,584,000
Total Assets	2,970,000
Liabilities and Stockholder’s Equity
Liabilities
Accounts Payable	360,000
Accrued Liability	180,000
Short term bank loans	56,000
Long term bonds	191,840
Note payable new issue	39,360
Stockholder’s Equity
Common Stock (Balancing figure)	1,828,803
Retained earnings	313,997
Total stockholders’ equity
Total Liabilities and Stockholder’s equity	2,941,197

Table (3)

Working Notes:

Calculation of increase in sales:

$\begin{array}{c}\text{Sales}=\$3,600,000+\left(\$3,600,000\times 10\%\right)\\ =\$3,600,000+\$360,000\\ =\$3,960,000\end{array}$

Calculation of operating cost including depreciation

$\begin{array}{c}\text{Operating}\text{costs}\text{includying}\text{depreciation}=\$3,960,000\times 87.5\%\\ =\$3,465,000\end{array}$

Calculation of the dividend amount:

$\begin{array}{c}\text{Dividend}=\text{Dividend per share}\times \text{Number of outstanding shares}\\ =\$1.08\times 100,000\\ =\$108,000\end{array}$

Calculation of dividend payout ratio:

$\begin{array}{c}\text{Dividend payout ratio}=\frac{\text{Dividend}}{\text{Net Income}}\\ =\frac{108,000}{180,000}\\ =60\%\end{array}$

Calculation of AFN equation:

$\begin{array}{c}\text{AFN}=\left[\begin{array}{l}\left(\left(\frac{\$2,700,000}{\$3,600,000}\right)\times \$360,000\right)-\left(\left(\frac{\$596,000}{\$3,600,000}\right)\times \$360,000\right)\\ -\left(\left(0.05\times \$3,960,000\right)\times \left(1-0.60\right)\right)\end{array}\right]\\ =\$270,000-\$59,600-\$79200\\ =\$131200\end{array}$

Calculation of the distribution of additional funds:

$\begin{array}{c}\text{Additional Funds}=\text{Notes payable }+\text{ Long term bonds}\\ =\text{AFN}\left(30\%\right)+\text{AFN}\left(70\%\right)\\ =\$131,200\left(30\%\right)+\$131,200\left(70\%\right)\\ =\$39,360+\$91,840\\ =\$131,200\end{array}$

Calculation of interest on bonds:

$\begin{array}{c}\text{Interest on bonds}=\$20,280+\left(\$91,840\times 12.5\%\right)+\left(\$39,360\times 12.5\%\right)\\ =\$20,280+\$11,480+\$4,920\\ =\$36,680\end{array}$

Calculation of taxes:

$\begin{array}{c}\text{Taxes}=\$463,240\times 40\%\\ =\$185,296\end{array}$

Calculation of increase in cash:

$\begin{array}{c}\text{Cash}=\$180,000+\left(\$180,000\times 10\%\right)\\ =\$180,000+\$18,000\\ =\$198,000\end{array}$

Calculation of increase in receivables:

$\begin{array}{c}\text{Receivables}=\$360,000+\left(\$360,000\times 10\%\right)\\ =\$360,000+\$36,000\\ =\$396,000\end{array}$

Calculation of increase in inventories:

$\begin{array}{c}\text{Inventories}=\$720,000+\left(\$720,000\times 10\%\right)\\ =\$720,000+\$72,000\\ =\$792,000\end{array}$

Calculation of increase in fixed assets:

$\begin{array}{c}\text{Fixed assets}=\$1,440,000+\left(\$1,440,000\times 10\%\right)\\ =\$1,440,000+\$144,000\\ =\$1,584,000\end{array}$

Calculation of notes payable:

$\begin{array}{c}\text{Notes payable }=\$56,000+\$39360\\ =\$95,360\end{array}$

Calculation of total liability:

$\begin{array}{c}\text{Total Liability}=\text{Total assets}\times 30\%\\ =\$2,970,000\times 30\%\\ =\$891,000\end{array}$

Calculation of accrued liability:

$\begin{array}{c}\text{Accrued liability}=\$180,000+\text{Accrued Interest}\\ =\$180,000+\$114,80+\$4,920\\ =\$196,400\end{array}$

Calculation of the amount of accounts payable:

$\begin{array}{c}\text{Accounts payable}=\text{Total liabilities}-\text{Notes payable-Accrued liability}-\text{Bonds}\\ =\$891,000-\$95,360-\$196,400-\$191,840\\ =\$407,400\end{array}$

Calculation of dividend of 2015:

$\begin{array}{c}\text{Dividend}=\text{Net income}\times 60\%\\ =\$277,944\times 60\%\\ =\$166,766.4\end{array}$

b.

Summary Introduction

To compute: The growth in sales using AFN equation.

Additional Funds Needed (AFN) Equation:

The AFN equation explains the amount of money that a company needs to fulfill the financial needs of the company. It gives the information related to the external financing, as the options available to a company to finance through external financing methods. This equation basically gives a new capital structure that includes an optimum mix of debt, preferred and common stock.

Financial Statement:

The financial statement is final accounts of the company. Financial statement of the company contains the income statement, statement of retained earnings, balance sheet and cash flow statement.

Explanation of Solution

Given:

Sales in 2014 is $3,600,000

Sales in 2015 is $3,960,000

Current liability at the end of 2014 is $596,000. It includes $360,000 of accounts payable, $56,000 of notes payable, and $180,000 of accrued liability

Forecasted Profit margin is 5%

Forecasted retention ratio is 60%.

The formula to calculate the additional funds is:

$\begin{array}{c}\text{AFN}=\left(\begin{array}{l}\text{Projected}\text{increase}\text{in}\text{assets}\\ -\text{Spontaneous}\text{increase}\text{in}\text{liabilities}\\ -\text{Increase}\text{in}\text{retained}\text{earnings}\end{array}\right)\\ =\left(\frac{{\text{A}}_0}{{\text{S}}_0}\right)\times \Delta \text{S}-\left(\frac{{\text{L}}_0}{{\text{S}}_0}\right)\times \Delta \text{S}-{\text{MS}}_1\left(1-\text{payout}\right)\end{array}$

Where,

• ${\text{A}}_0$ is original assets.
• ${\text{S}}_0$ is current sales.
• ${\text{L}}_0$ is original liabilities.
• $\Delta \text{S}$ is increase in sales.
• ${\text{MS}}_1$ is profit margin.

Substitute $2,700,000 for current assets, $3,600,000 for current sales, $3,960,000 for expected sales, assume growth rate of sales is g

$\begin{array}{c}\text{AFN}=\left[\begin{array}{l}\left(\left(\frac{\$2,700,000}{\$3,600,000}\right)\times \text{g}\right)-\left(\left(\frac{\$596,000}{\$3,600,000}\right)\times \text{g}\right)\\ -\left(\left(0.05\times \$3,960,000\right)\times \left(1-0.60\right)\right)\end{array}\right]\\ 0=0.75\text{g}-0.165g-\$79200\\ 0.585\text{g}=\$79,200\\ \text{g}=\frac{\$79,200}{0.585}\\ \text{g}=\$135,384.615\end{array}$

Conclusion

Thus, the growth in sales of M Incorporation is $135,384.615.