CHAPTER 4

LONG-TERM FINANCIAL PLANNING AND GROWTH

1. Pro Forma Statements [LO1] Consider the following simplified financial statements for
the Fire Corporation (assuming no income taxes):

The company has predicted a sales increase of 15 percent. It has predicted that every item
on the balance sheet will increase by 15 percent as well. Create the pro forma statements
and reconcile them. What is the plug variable here?

2. Pro Forma Statements and EFN [LO1, 2] In the previous question, assume Fire pays out
half of net income 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.

3. Calculating EFN [LO2] The most recent financial statements for Dockett, Inc., are shown
here (assuming no income taxes):

Assets and costs are proportional to sales. Debt and equity are not. No dividends are paid.
Next year’s sales are projected to be $8,449. What is the external financing needed?

4. EFN [LO2] The most recent financial statements for GPS, Inc., are shown here:
Assets and costs are proportional to sales. Debt and equity are not. A dividend of $2,300
was paid, and the company wishes to maintain a constant payout ratio. Next year’s sales
are projected to be $30,360. What is the external financing needed?

5. EFN [LO2] The most recent fi nancial statements for Xporter, Inc., are shown here:

Assets, costs, and current liabilities are proportional to sales. Long-term debt and equity
are not. The company maintains a constant 40 percent dividend payout ratio. As with every
other fi rm in its industry, next year’s sales are projected to increase by exactly 15 percent.
What is the external financing needed?

6. Calculating Internal Growth [LO3] The most recent financial statements for Live Co. are
shown here:

Assets and costs are proportional to sales. Debt and equity are not. The company
maintains a constant 30 percent dividend payout ratio. No external equity financing is
possible. What is the internal growth rate?
7. Calculating Sustainable Growth [LO3] For the company in the previous problem, what is
the sustainable growth rate?

8. Sales and Growth [LO2] The most recent fi nancial statements for McGovney Co. are
shown here:

Assets and costs are proportional to sales. The company maintains a constant 30 percent
dividend payout ratio and a constant debt–equity ratio. What is the maximum increase in
sales that can be sustained assuming no new equity is issued?

9. Calculating Retained Earnings from Pro Forma Income [LO1] Consider the following
income statement for the Heir Jordan Corporation:

A 20 percent growth rate in sales is projected. Prepare a pro forma income statement
assuming costs vary with sales and the dividend payout ratio is constant. What is the
projected addition to retained earnings?

10. Applying Percentage of Sales [LO1] The balance sheet for the Heir Jordan Corporation
follows. Based on this information and the income statement in the previous problem,
supply the missing information using the percentage of sales approach. Assume that
accounts payable vary with sales, whereas notes payable do not. Put “n/a” where needed.
11. EFN and Sales [LO2] From the previous two questions, prepare a pro forma balance
sheet showing EFN, assuming a 15 percent increase in sales, no new external debt or
equity financing, and a constant payout ratio.

12. Internal Growth [LO3] If the Boddy Shoppe has a 7 percent ROA and a 25 percent
payout ratio, what is its internal growth rate?

13. Sustainable Growth [LO3] If Rondo Corp. has a 14 percent ROE and a 30 percent payout
ratio, what is its sustainable growth rate?

14. Sustainable Growth [LO3] Based on the following information, calculate the
sustainable growth rate for Kaleb’s Kickboxing:

Profit margin = 7.1%

Capital intensity ratio = 0.75

Debt–equity ratio= 0.60

Net income = $48,000

Dividends = $13,000

15. Sustainable Growth [LO3] Assuming the following ratios are constant, what is the
sustainable growth rate?
Total asset turnover = 2.70

Profit margin = 6.5%

Equity multiplier = 1.2

Payout ratio = 35%

16. Full-Capacity Sales [LO1] Alter Bridge Mfg., Inc., is currently operating at only 92
percent of fixed asset capacity. Current sales are $640,000. How fast can sales grow before
any new fixed assets are needed?

17. Fixed Assets and Capacity Usage [LO1] For the company in the previous problem,
suppose fixed assets are $490,000 and sales are projected to grow to $730,000. How much
in new fixed assets are required to support this growth in sales? Assume the company
maintains its current operating capacity.

18. Growth and Profit Margin [LO3] Abacus Co. wishes to maintain a growth rate of 13
percent per year, a debt–equity ratio of 1.20, and a dividend payout ratio of 30 percent. The
ratio of total assets to sales is constant at .95. What profit margin must the firm achieve?

19. Growth and Assets [LO3] A firm wishes to maintain an internal growth rate of
6.5 percent and a dividend payout ratio of 25 percent. The current profit margin is
6 percent, and the firm uses no external financing sources. What must total asset turnover
be?

20. Sustainable Growth [LO3] Based on the following information, calculate the
sustainable growth rate for Clapton Guitars, Inc.:

Profit margin = 5.3%

Total asset turnover = 1.60

Total debt ratio = .45

Payout ratio = 30%

21. Sustainable Growth and Outside Financing [LO3] You’ve collected the following
information about Odyssey, Inc.:

Sales = $165,000

Net income = $14,800

Dividends = $9,300

Total debt = $68,000

What is the sustainable growth rate for the company? If it does grow at this rate, how much
new borrowing will take place in the coming year, assuming a constant debt–equity ratio?
What growth rate could be supported with no outside financing at all?

22. Sustainable Growth Rate [LO3] Cambria, Inc., had equity of $145,000 at the beginning
of the year. At the end of the year, the company had total assets of $275,000. During the
year, the company sold no new equity. Net income for the year was $26,000 and dividends
were $5,500. What is the sustainable growth rate for the company? What is the sustainable
growth rate if you use the formula ROE x b and beginning of period equity? What is the
sustainable growth rate if you use end of period equity in this formula? Is this number too
high or too low? Why?

23. Internal Growth Rates [LO3] Calculate the internal growth rate for the company in the
previous problem. Now calculate the internal growth rate using ROA x b for both beginning
of period and end of period total assets. What do you observe?

24. Calculating EFN [LO2] The most recent financial statements for Fleury, Inc., follow.
Sales for 2012 are projected to grow by 20 percent. Interest expense will remain constant;
the tax rate and the dividend payout rate will also remain constant. Costs, other expenses,
current assets, fixed assets, and accounts payable increase spontaneously with sales. If
the firm is operating at full capacity and no new debt or equity is issued, what external
financing is needed to support the 20 percent growth rate in sales?
25. Capacity Usage and Growth [LO2] In the previous problem, suppose the fi rm was
operating at only 80 percent capacity in 2011. What is EFN now?

26. Calculating EFN [LO2] In Problem 24, suppose the fi rm wishes to keep its debt– equity
ratio constant. What is EFN now?

27. EFN and Internal Growth [LO2, 3] Redo Problem 24 using sales growth rates of 15 and
25 percent in addition to 20 percent. Illustrate graphically the relationship between EFN
and the growth rate and use this graph to determine the relationship between them. At
what growth rate is the EFN equal to zero? Why is this internal growth rate different from
that found by using the equation in the text?

28. EFN and Sustainable Growth [LO2, 3] Redo Problem 26 using sales growth rates of 30
and 35 percent in addition to 20 percent. Illustrate graphically the relationship between
EFN and the growth rate and use this graph to determine the relationship between them. At
what growth rate is the EFN equal to zero? Why is this sustainable growth rate different
from that found by using the equation in the text?

29. Constraints on Growth [LO3] Seether, Inc., wishes to maintain a growth rate of 12
percent per year and a debt–equity ratio of .40. Profit margin is 5.8 percent, and the ratio of
total assets to sales is constant at 1.55. Is this growth rate possible? To answer, determine
what the dividend payout ratio must be. How do you interpret the result?

30. EFN [LO2] Defi ne the following:

S = Previous year’s sales

A = Total assets
E = Total equity

g = Projected growth in sales

PM = Profit margin

b = Retention (plowback) ratio

Assuming all debt is constant, show that EFN can be written as follows:

EFN = -PM(S) b + (A - PM(S) b ) x g

Hint: Asset needs will equal A x g. The addition to retained earnings will equal PM(S) b x
(1+g).

31. Growth Rates [LO3] Based on the results in Problem 30, show that the internal and
sustainable growth rates are as given in the chapter. Hint: For the internal growth rate, set
EFN equal to zero and solve for g.

32. Sustainable Growth Rate [LO3] In the chapter, we discussed the two versions of the
sustainable growth rate formula. Derive the formula ROE 3 b from the formula given in the
chapter, where ROE is based on beginning of period equity. Also, derive the formula ROAxb
from the internal growth rate formula.