complete the finance hw use the attached example

Complete the following three problems. For assistance, you may want to refer to these examples: Week 10 Example Problems .Required:

1. Given the following information:

   Total

   assets$100,000Debt (12% interest rate)$80,000

   Equity

   $20,000Variable costs of production$14 per unitFixed cost of production$27,000Units Sold12,300Sales price$19.75 per unitWhat happens to operating income and net income if output is increased by 10 percent? Verify your answer.

1. A firm needs $100 to start and has the following expectations: Sales$200Expenses$185Tax rate33% of earningsWhat are earnings if the owners invest the $100?If the firm borrows $40 of the $100 at an interest rate of 10%, what are the firm’s net earnings?What is the return on the owners’ investment in each case? Why do the returns differ?If expenses rise to $194, what will be the returns in each case?In which case did the returns decline more?What generalization can you draw from the above?

1. A firm with sales of $5,000 has the following balance sheet:

,

as of xx/xx/xx

AssetsLiabilities and Equity

Equity

Total

Total$4,600

	Assets Save Time On Research and Writing Hire a Pro to Write You a 100% Plagiarism-Free Paper. Get My Paper	Liabilities and Equity
Accounts receivable	$1,300	Accounts payable	$1,200
Inventory	1,600	Long-term debt	2,500
Plant	1,700	900
	$4,600

The firm earns 20 percent on sales and expects those sales to rise to $5,500. The increased sales may require additional financing. Accounts receivable and inventory will increase, and trade accounts will also spontaneously increase with the increase in sales. Management expects to distribute 75% of earnings.

1. Determine the new balance sheet entries for those assets and liabilities that spontaneously change with the level of sales using the percent of sales technique. (Accounts receivable, inventory, and accounts payable vary with sales; the other entries do not). Round off to nearest percentage point, such as 22% or .22.
2. Will the firm need external financing to achieve sales of $5,500?
3. Construct the pro forma balance sheet for sales of $5,500. Any new financing should be obtained by issuing new long‑term debt. Any excess funds should be held in cash.

Week 1

0

Example Problems

1. Given the following information:

Total assets	$250,000
Debt (12% interest rate)	$ 150 ,000
		Equity	$ 40 ,000
Variable costs of production	$150 per unit
Fixed cost of production	$50,000
Units Sold	1,000
Sales price	$210 per unit

What happens to operating income and net income if output is increased by 10 percent? Verify your answer.

Solution:

The operating income:

Revenues: $210 x (1,000) = $210,000

Expenses

: $150 x (1,000) + $50,000 = $200,000

Operating income: $210,000 – 200,000 = $10,000

Net income: $10,000 – (.12 x 150,000) = ($8,000)

With 10% increase in revenue:

Revenues: $210 x (1,

100

) = 231,000

Expenses: $150 x (1,100) + $50,000 = $215,000

Operating income: $231,000 – $215,000
= $

16,000

Net income $16,000 – (.12 x $150,000) = ($2,000)

Operating income rose from $10,000 to $16,000 for a

60

% increase.

Net income rose from ($8,000) to ($2,000) which cut losses by $6,000. Losses were cut by 75%.

2. A firm needs $800 to start and has the following expectations:

		Sales					$1,600
		Expenses	$1,450
Tax rate	33% of earnings

a.

What are earnings if the owners invest (use their own money) for the $800 needed to start?

b.

If the firm borrows $400 of the $800 at an interest rate of 10%, what are the firm’s net earnings?

c. What is the return on the owners’ investment in each case? Why do the returns differ?

d. If expenses rise to $1,500, what will be the returns in each case?

e. In which case did the returns decline more?

f. What generalization can you draw from the above?

Solution:

a. and b.

Sales

$1,600

$1,600

Expenses

1,450

150

150

a.	b.
	No financial leverage		With financial leverage
	1,450
	EBIT			150
	Interest		0		40
	EBT	110
	Taxes	50	36.30
	Net earnings	$100	$73.70

c.

Return on equity

$100/$800 = 12.5% $73.70/$400 = 18.4%

The return for b is higher because of the successful use of financial leverage. (Operating income is 18.75% of assets versus the 10% interest rate and the reduction in taxes that results from the interest expense.)

No financial leverage

With financial leverage

Sales

$1,600

$1,600

Expenses

1,500

EBIT

100

Interest

0

40

EBT

100

Taxes

Net earnings

	1,500
		100
60
33	20
$66.67	$40
Return on equity	66.67/800 = 8.3%	40/400 = 10%

d. The return on equity fell more for the firm that was financially leveraged.

e. The generalization is that the use of financial leverage to increase the return on equity works both ways. If revenues fall and/or expenses rise, the use of financial leverage will magnify the swing in the firm’s return on equity.

3. A firm with sales of $30,000 has the following balance sheet:

Equity

Total

$29,730

Assets , Liabilities and Equity as of xx/xx/xx
	Assets		Liabilities and Equity
		Accounts receivable	$8,450			Accounts payable	$7,800
		Inventory	10,400		Long-term debt	16,000
	Plant		10,880		5,930
			Total		$29,730

The firm earns 20 percent on sales and expects those sales to rise to $35,000. The increased sales may require additional financing. Accounts receivable and inventory will increase, and trade accounts will also spontaneously increase with the increase in sales. Management expects to distribute 75% of earnings.

a. Determine the new balance sheet entries for those assets and liabilities that spontaneously change with the level of sales using the percent of sales technique. (Accounts receivable, inventory, and accounts payable vary with sales; the other entries do not). Round off to nearest percentage point, such as 22% or .22.

b. Will the firm need external financing to achieve sales of $35,000?

c. Construct the pro forma balance sheet for sales of $35,000. Any new financing should be obtained by issuing new long‑term debt. Any excess funds should be held in cash.

Solution:

a. The assets and liabilities that vary with sales, their percent of sales, and the forecasted level of these assets and liabilities are:

Accounts receivable

Inventory

Accounts payable

Assets and Liability	Percent of Sales	Forecasted Level
$8,450/$30,000 = 28%	28% x $35,000 = $ 9,800
$10,400/$30,000 = 35%	35% x $35,000 = $ 12,250
$7,800/$30,000 = 26%	26% x $35,000 = $9,100

b. The spontaneous increase in assets is:

($9,800 new Accts Rec. + 12,250 new Inv.) – (old Acct. Rec. $8,450 + old Inv. $10,400) = $3,200.

The increase in liabilities is $1,300 ($9,100 – $7,800).

The spontaneous increase in liabilities is insufficient to meet the expansion in assets. Increased assets needed 3,200 – spontaneous liability increase 1,300 = financing needed, 1,900. The firm will need additional financing. Such funds may come from external sources (e.g., commercial bank loan) or internal sources (e.g., retained earnings).

In this problem the firm earns $7,000 (.20 x $35,000), distributes .75 x $7,000 = $5,250, and retains $1,750, which does not cover the additional $1,900 needed. $1,900 – $1,750 = $150 needed

c. The new project balance sheet as of xx/xx/xx:

Assets

Liabilities and Equity

Accounts payable

Accounts receivable

Long-term debt

Inventory

Equity

5,930

Plant

10,880

Total

Total

$32,930

Cash	$0	$9,100
9,800	16,150
12,250
	$32,930

Adapted from:

Mayo, H. (2007). Basic finance: An introduction to financial institutions, investments & management. United States: Thomson South-Western.