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  ADDITIONAL FUNDS NEEDED Morrissey

Technologies Inc.’s 2015 financial statements are shown ...

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ADDITIONAL FUNDS NEEDED Morrissey Technologies Inc.’s 2015 financial statements are shown
here.
                Morrissey Technologies Inc.: Balance Sheet as of December 31, 2015
Cash                                 $ 180,000           Accounts payable                   $ 360,000
Receivable                         360,000           Accrued liabilities                        180,000
Inventories                        720,000           Notes payable                                56,000
Total current assets      $1,260,000          Total currents liabilities              $   596,000
                                                                      Long term debt                            100,000
Fixed assets                    1,440,000           Common stock                         1,800,000
                                                     000          Retained earnings                       204,000
Total assets                    $2,700,000          Total liabilities and equity      $2,700,000
              Morrissey Technologies Inc.: Income Statement for December 31, 2015
                                 Sales                                                                  $3,600,000
                                 Operating cost including depreciation                 3,279,000
                                 EBIT                                                                   $    320,280
                                 Interest                                                                     20,280
                                 EBT                                                                    $    300,000
                                 Taxes (40%)                                                           120,000
                                 Net Income                                                     $   180,000
                                 Per Share Data:
                                Common stock price                                              $45.00
                                Earnings per share (EPS)                                       $ 1.80
                                Dividends per share                                               $ 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 payout ratio and 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 relative 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-term 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.
Construct the forecasted financial statements assuming that these changes are made. What is the
firm’s forecasted notes payable and long-term debt balances? What is the forecasted addition to
retained earnings?
If the profit margin remains at 5% and the dividend payout ratio remains at 60%, at what growth rate
in sales will the additional financing requirements be exactly zero? In other words, what is the firm’s
sustainable growth rate? (Hint: Set AFN equal to zero and solve for g.)
Krogh Lumber's 2012 financial statements are shown here.
Krogh Lumber: Balance Sheet as of December 31, 2015 (Thousands of Dollars)
Cash                                          $1,800                                          Accounts payable           $7,200
Receivables                             10,800                                          Notes payable                   3,472
Inventories                              12,600                                          Accrued liabilities             2,520
Total current assets            $25,200                                         Total current liabilities $13,192
                                                                                                         Mortgage bonds                 5,000
Net fixed assets                      21,600                                         Common stock                    2,000
                                                                                                         Retained earnings            26,608
Total assets                           $46,800                                        Total liabilities and equity $46,800
Krogh Lumber: Income Statement for December 31, 2012 (Thousands of Dollars)
Sales                                                                                                           $36,000
Operating costs including depreciation                                                 30,783
Earnings before interest and taxes                                                         $5,217
Interest                                                                                                          1,017
Earnings before taxes                                                                               $4,200
Taxes (40%)                                                                                                  1,680
Net income                                                                                                $2,520
Dividends (60%)                                                                                        $1,512
Addition to retained earnings                                                                $1,008
Assume that the company was operating at full capacity in 2015 with regard to all items except fixed
assets; fixed assets in 2015 were being utilized to only 80% of capacity. By what percentage could
2016 sales increase over 2015 sales without the need for an increase in fixed assets?
Now suppose 2016 sales increase by 25% over 2015 sales. Assume that Krogh cannot sell any
fixed assets. All assets other than fixed assets will grow at the same rate as sales; however, after
reviewing industry averages, the firm would like to reduce its Operating costs/Sales ratio to 82% and
increase its debt-to-assets ratio to 42%. The firm will maintain its 60% dividend payout ratio, and it
currently has 1 million shares outstanding. The firm plans to raise 35% of its 2016 total debt as notes
payable, and it will issue bonds for the remainder. Its before-tax cost of debt is 10.5%. Any stock
issuances or repurchases will be made at the firm's current stock price of $40. Develop Krogh's
projected financial statements. What are the balances of notes payable, bonds, common stock, and
retained earnings?
17-15: FORECASTING FINANCIAL STATEMENTS Use a spreadsheet model to forecast the financial
statements in Problems 17-13 and 17-14

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Solution:1

Morrissey Technologies Inc.Pro Forma Income StatementDecember 31, 2003 2016

forecast 2016
2015 basis Proforma

sales 3600000 1.1 3960000

Operating costs 3279720 0.911 3607692

EBIT 320280 352308

Interest 20280 20280

EBT 300000 332028

Taxes(40%) 120000 132811.2

Net income 180000 199216.8

Dividends:$1.08*100000 108000 112000

Addition to RE: 72000 87216.8

2016 dividends = $1.12*100000 = $112000

Morrissey Technologies Inc.Pro Forma Balance StatementDecember 31, 2003 2016

Forecast
basis 2016 2016
2015 sales additions ProFOrma

cash 180000 0.05 198000

 Receivables 360000 0.1 396000

Inventories 720000 0.2 792000

Total current assets 1260000 1386000

fixed assets 1440000 0.4 1584000

Total assets 2700000 2970000

Accounts payable 360000 0.1 396000

Notes payable 156000 156000

Accrued liabilities 180000 0.05 198000

Total current liabilities 696000 750000

common stock 1800000 1800000

Retained earnings 204000 87217 291217

Total liability and equity 2700000 2841217

AFN= 128783

AFN = $2,700,000/$3,600,000(change in Sales)

- ($360,000 + $180,000)/$3,600,000(change in Sales)

- (0.05)($3,600,000 +change in Sales)0.4

$0 = 0.75(change in Sales) - 0.15(change in Sales) - 0.02(change in Sales) - $72,000

$0 = 0.58(change in Sales) - $72,000

$72,000 = 0.58(change in Sales)

change in Sales = $124,138

Growth rate in sales = change in sales/3600000 = $124138/3600000 = 3.45%

Solution:2

(a)

Full capacity sales= current sales/% of capacity at which FA were operated = $36000/0.75 =
$48000
%increase = New sales-old sales/old sales=48000-36000/36000 = 33%

Therefore, sales could expand by 33 percent before the firm would need to add fixed assets.

Solution: b

Krogh Lumber Pro

Forma income
statement december ement december 31,
31, 2016

forecast 2016 Pro

2015 basis Forma

sales 36000 1.25 45000

operating
cost 30783 0.8551 38479

EBIT 5217 6521

interest 1017 1017

Ebt 4200 5504

Taxes @
40% 1680 2201.6

Net
income 2520 3302.4

dividends
@60% 1512 1981.44

addition to
RE 1008 1320.96

Krogh Lumber Pro

Forma balance ement december 31,
sheet december 31 2016

Forecast
basis*2016 addition 2016 second
2015 sales s 2016 first pass AFN pass

cash 1800 0.05 2250 2250

 receivables 10800 0.3 13500 13500

inventory 12600 0.35 15750 15750

Total
current
assets 25200 31500 31500

net fixed
assets 21600 21600 21600

Total
assets 46800 53100 53100

accounts
payable 7200 0.2 9000 9000

notes
payable 3472 3472 2549 6021

accruals 2520 0.07 3150 3150

total
current
liabilities 13192 15622 18171

mortagage
bonds 5000 5000 5000

common
stock 2000 2000 2000

retained
earnings 26608 1321 27929 27929

total
liability
and equity 46800 50551 53100

AFN= 2549

Solution: c

The rate of return projected for 2001 under the conditions in Part b is (calculations in
thousands):

                                                                                                                     
ROE = = 11.03%.

If the firm attained the industry average DSO and inventory turnover ratio, this would mean a
reduction in financial requirements of:

Receivables:        = 90

New A/R       = $11,250.

D in A/R = $13,500 - $11,250 = $2,250.

Inventory:      = 3.33; I = $13,500.

D in Inv = $15,750 - $13,500 = $2,250.

Total D = $2,250 + $2,250 = $4,500.

If this freed capital was used to reduce equity, the new figures for common equity would be
$29,929 - $4,500 = $25,429. Assuming no change in net income, the new ROE would be:

ROE = = 13.0%.

One would, in a real analysis, want to consider both the feasibility of maintaining sales if
receivables and inventories were reduced and also other possible effects on the profit
margin. Also, note that the current ratio was $25,200/$13,192 = 1.91 in 2000. It is projected
to decline in Part b to $31,500/$18,171 = 1.73, and the latest change would cause a further
reduction to ($31,500 - $4,500)/$18,171 = 1.49. Creditors might not tolerate such a reduction
in liquidity and might insist that at least some of the freed capital be used to reduce notes
payable. Still, this would reduce interest charges, which would increase the profit margin,
which would in turn raise the ROE. Management should always consider the possibility of
changing ratios as part of financial projections