Answer to Part
1)
INCOME STATEMENT, 2001
(figures in thousands of dollars)
Revenue $2250
Fixed costs 56
Variable costs (80% of revenue) 1,800
Depreciation 100
Interest (8% of beginning-of-year debt) 30
Taxable income 264
Taxes (at 40%) 105.6
Net income $ 158.4
Dividends (2/3 of N.I) $105.6
Retained Earnings $ 52.8
BALANCE SHEET, YEAR-END
(figures in thousands of dollars)
2000 2001
Assets
Net Working Capital $ 400 $ 500
Fixed Assets 800 1000
Total assets $1,200 $1,500
Liabilities and shareholders’ equity
Debt $ 300 $ 375
Equity 900 1125
Total liabilities and
Shareholders’ equity $1,200 $1,500
STATEMENT OF RETAINED EARNINGS (DEC 31, 2001)
Balance of Retained Earning (Dec 31, 2000) $ 40,000
Add: 2001 Net Income 158,400
Less: 2001 Dividends to stockholders (105,600)
Balance of Retained Earnings (Dec 31, 2001) 92.800
Working:
Fixed Assets = $ 800,000 + 200,000 = $ 1000,000
Net Working Capital = 50 % of Fixed Assets = 50
% of $ 1000,000 = $ 500,000
Total Assets = $ 1000,000 + 500,000 = $ 1500,000
Since Revenue / Total Assets = 1.5, Therefore
Revenue = $ 1500,000 * 1.5 = $ 2250,000
Variable Costs = 80% of Revenue = 80% of $ 2250,000
= $ 1800,000
Depreciation = 10 % of Fixed Assets = 10 % of
$ 1000,000 = $ 100,000
Since Debt Ratio = 25%, Therefore, 25% of $ 1500,000
= $ 375,000
Interest = 8 % of Debt = 8% of $ 375,000 = $ 30,000
Answer to Part 2)
Assuming that the balancing item is debt, and
that no equity is to be issued:
PRO-FORMA BALANCE SHEET, YEAR-END
(figures in thousands of dollars)
2000 2001
Assets
Net Working Capital $ 400 $ 500
Fixed Assets 800 1000
Total assets $1,200 $1,500
Liabilities and shareholders’ equity
Debt $ 300 $ 600
Equity 900 900
Total liabilities and
Shareholders’ equity $1,200 $1,500
Working:
If the balancing item is going to be debt and
equity is to remain constant, then
Debt = Total Liabilities and Shareholder’s
Equity less Equity
= $ 1,500,000 less $ 900,000
= $ 600,000
In which case, the projected debt ratio will be:
(Debt / Total Assets) * 100 %
(600,000 / 1,500,000) * 100%
40%
Projected Debt ratio = 40%
Credit Policy
Answer to Part 3)
Yes, the firm should change its credit policy,
because doing so would mean an increase in revenue
by $ 420, i.e. (220*21) less (200*21) or $ 4620
less $ 4200.
Answer to Part 4)
Yes, the company should still change its credit
policy because its revenue would still increase
from $ 4,200 to $ 4,389.
Answer to Part 5)
Assuming that 5 percent of only the new customers
fail to pay their bills, then total new revenue
would be:
200 * 21 = $ 4200 Added to
20 * 21 * 0.95 = $ 399
Hence, Total Revenue is $ 4599.
This represents a change of ($4599 - $4200) $399
over the previous revenue, and hence the company
should even now change its credit policy.
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