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Problem 6-2, pg. 221 AFN EQUATION: Refer to problem 6-1. What additional Funds would be needed if the company’s year-end 2015 assets had been $4 million? Assume that all other numbers are the same. Why is this AFN different from the one you found in problem 6-1? Is the company’s “capital intensity” the same or different? Explain. ANSWER: AFN = (A*/S0) ∆S - (L*/S0) ∆S – MS 1(1 - d) = ($4,000,000/$5,000,000) $1,000,000 - ($500,000/$5,000,000) $1,000,000 0.05($6,000,000) (1 - 0.70) = (0.8) ($1,000,000) - 0.10($1,000,000) - $300,000(0.30) = $800,000 - $100,000 - $90,000 = $610,000 The capital intensity ratio is measured as A*/S0. The AFN was different from the problem 6-1 because I company's year-end assets and of problem with 6-2 was greater than in 6-1. The firm’s capital intensity ratio is higher than that of the firm in Problem 61; therefore, this firm is more capital intensive--it would require a large increase in total assets to support the increase in sales. 1. Problem 6-5, pg. 222 EXCESS CAPACITY: Walter Industries has $5 billion in sales and $1.7 billion in fixed assets. Currently, the company’s fixed assets are operating at 90% of capacity. a) What level of sales would Walter Industries have obtained if it had been operating at full capacity? Full Capacity Sales = Current Sales / Current Operating level = $5,000,000,000 / 90% = $5,555, 555,555

b) What is Walter's Target fixed assets/Sales ratio? Fixed assets/Sales = $1.7/5.0 = 0.34

c) If Walter's sales increase 12%, how large of an increase in fixed assets will the company need to meet its Target fixed assets/sales ratio? Sales increase by 12% = $5,000,000,000(1.12) = $5,600,000,000

Sales / 5,600,000,000 = 0.34 Solve for Sales = 0.34 x 5,600,000,000 = $1.904B The question, however, asks for how large of an increase you will need in fixed assets. Currently you have $1.7 billion, so find the difference $1.904 - $1.7 = $0.204B, or $204M increase in fixed assets

2. Problem 6-7, pg. 222-223

PRO FORMA INCOME STATEMENT: At the end of last year, Roberts Inc. reported the following income statement (in millions of dollars). LAST YEAR

CALCUALTION

FOLLOWING YEAR

Sales Operation cost without depreciation EBITDA Depreciation EBIT Interest EBT Taxes 40% Net Income

3,000

X1.10

3,300

2,450

New Sales x 80%

2,640

550 250 300 125 175 70 105

Sales-Operating system cost New Sales x 8.33% EBITDA-depreciation No change EBIT-Interest EBIT x 40% EBIT-Taxes

660,000 274,890 385,110 125 260,110 104,044 156,070

Net Income = 156, 070 Roberts' year end net income will be $156,070.

3. Problem 6-9, pg. 223 SALES INCREASE: Pierce Furnishings generated $2 million in sales during 2015, and its year-end total assets were $1.5 million. Also, at year-end 2015, current liabilities were $500,000, consisting of $200,000 of notes payable, $200,000 of accounts payable, and $100,000 of accrued liabilities. Looking ahead to 2016, the company estimates that its assets must increase by $0.75 for every $1.00 increase in sales. Pierce’s profit margin is 5% and its retention ratio is 40%. How large of a sales increase can the company achieve without having to raise funds externally? ANSWER: The computation of sales increase that the company can achieve without having to raise funds externally is computed as shown below: Self-sustaining growth rate is computed as shown below: = (Profit margin x retention ratio x sales) / (Total Assets - Accounts payable - Accrued liabilities - profit margin x retention ratio x sales) = (0.05 x 0.40 x $ 2,000,000) / ($ 1,500,000 $200,000 - $ 100,000 - (0.05 x 0.40 x $2,000,000) = 40,000 / 1,160,000 = 0.03448 = 3.45% So, the sales amount will be: = Sales x 3.45% = $ 2,000,000 x 3.45% = $ 6,900,000 Approximately

4. Problem 6-11, pg. 224 REGRESSION AND INVENTORIES: Charlie’s Cycles Inc. has $110 million in sales. The company expects that its sales will increase 5% this year. Charlie’s CFO uses a simple linear regression to forecast the company’s inventory level for a given level of projected sales. On the basis of recent history, the estimated relationship between inventories and sales (in millions of dollars) is as follows; Inventories = $9 + 0.0875 (sales) Given the estimated sales forecast and the estimated relationship between inventories and sales, what are your forecasts of the company’s year-end inventory level and its inventory turnover ratio?

ANSWER: $19,106,250 Sales Forecast = Sales + (Sales x Percentage of increase in sales)

Sales Forecast = 110,000,000 + (110,000,000 x 5%) Sales Forecast = $115,500,000 Inventories = 9,000,000 + 0.0875 (115,500,000) Inventories = $19,106,250 5. Problem 6-13, pg. 224-225 ADDITIONAL FUNDS NEEDED: Morrissey Technologies Inc.’s 2015 financial statements are shown here. Morrissey Technologies Inc.: Balance Sheet as of Dec. 31, 2015 Cash $180,000 Accounts Payable $360,000 Receivables 360,000 Accrued Liabilities 180,000 Inventories 720,000 Notes Payable 56,000 Total current assets $1,260,000 Total current liabilities $596,000 Fixed assets

Total assets

1,440,000 Long-term debt Common Stock Retained earnings $2,700,000 Total liabilities and equity

100,000 1,800,000 204,000 $2,700,000

Morrissey Technologies Inc.: Income Statement as of Dec. 31, 2015 Sales $3,600,000 Operating costs including depreciation 3,279,720 EBIT $320,280 Interest 20,280 EBT $300,000 Taxes (40%) 120,000 Net Income $180,000 Per Share Data: Common Stock Price Earnings per share (EPS) Dividends per share (DPS)

$45.00 $1.80 $1.08

Suppose that in 2016, sales increase by 10% over 2015 sales. The firm currently has 100,000 shares outstanding. It expects to maintain its 2015 dividend pay-out ratio believes that its assets should grow at the same rate as sales. The firm has no excess capacity. However, the firm would like to reduce its operating costs/sales ratio to 87.5% and increase its total liabilities-to-assets ratio to 30%. (it believes its liabilities-to-assets ratio currently is too low relatively to the industry average.) The firm will raise 30% of the 2016 forecasted interest-bearing debt as notes payable, and it will issue long-term bonds for the remainder. The firm forecasts that its before-tax cost of debt (which includes both short-and long-term debt) is 12.5%. Assume that any common stock issuances or repurchases can be made at the firm’s current stock price of $45. a. Construct the forecasted financial statements assuming that these changes are made. What are the firm’s forecasted notes payable and long-term debt balances? What is the forecasted addition retained earnings? b. ANSWER: Notes Payable = $89,100 Long-term Debts = $207,900 Addition to Retained Earnings = $109,89 M Incorporation Projected Income Statement For the year ended December 31, 2015

Particulars Sales Less: Operating cost including depreciation

2015 Change $3,600,000 3,279,720.88

2016 $3,960,000 3,465,000...