6-14 ADDITIONAL FUND NEED Morissey Techologies Inc.

’s 2015 financial statement

are shown

Suppose that in 2016, sales increase by 10% over 2015 sales. The firm currently has
100,000 shares outstanding. It expects to maintain it 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%. (recent LTA is to low relative to 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 sort and long-term debt) is 12.5%. assume that any common stock
issuances of 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 to retained earnings?
b. 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, AFN = 0, solve g)
 a.

Morissey Technologies Inc.

Balance Sheet as of 31 December 2015 (in $)
  
  Expected
FY 2015 FY 2016
growth
Cash 180,000 10% 198,000
Receivables 360,000 10% 396,000
Inventories 720,000 10% 792,000
Total Current Assets 1,260,000 1,386,000
 
Fixed Assets 1,440,000 10% 1,584,000
TOTAL ASSETS 2,700,000 2,970,000
 
 
Accounts payable 360,000 30% 468,000
Accrued liabilites 180,000 30% 234,000
Notes payable 56,000 30% 72,800
Total Current Liabilities 596,000 774,800
 
Long-term debt 100,000 30% 130,000
Total Liabilities 696,000 904,800
 
Common stock 1,800,000 1,800,000
Retained earnings 204,000 + 113,933 317,933
TOTAL LIABILITIES AND
2,700,000 3,022,733
EQUITY
   
   
Total liabilities to assets ratio 25.8% 30%
 Morissey Technologies Inc. Income Statement
For the Year ended in 31 December 2015 (in $)

FY 2015 Expected growth FY 2016

Sales 3,600,000 10% 3,960,000
Operating costs including depreciation 3,279,720 87.5% sales 3,465,000
EBIT 320,280 495,000
Interest assumption:
20,280 20,280
remain the same
EBT 300,000 474,720
Taxes (40%) 120,000 189,888
Net Income 180,000 284,832

Per share data

Comoon stock price 45
EPS 1.80
Dividend per share 1.08

Total dividend paid 108,000 % DPR remains 170,899

Dividend Payout ratio 60.0% the same 60%

Addition to retained earnings 72,000 113,933

Operating cost/sales ratio 91.1% 87.5%

By expecting liabilities-to-assets ratio by 30% Morrissey Tech.'s notes payable

expected balance in 2016 is $72,800, while long-term-debt balance is $130,000. With all
expected growth given, Morrissey Tech. expected addition to retained earnings $113,000 in
2016 (as shown at calculation above).
 b.

Additional Funds Needed (AFN)

Part I
A0*= Assets at 2015 $2,700,000
S0 = 2015 sales $3,600,000
2015 Net income $180,000
2015 Devidens $108,000
L0* = 2015 payable + acruals, $540,000
ROE 8.98

Part II
g = Target growth rate in sales 0.1
A0*/S0 0.75
S1 = 2016 sales = (1+g) (S0)
3,960,000
= (1.1)(3600)
∆S = Growth in sales = S1 - So = 360,000
L0*/S0 0.15
M =Profit Margin on sales = 2015 net
0.05
income/So
1-devidend payout ratio = 1-
0.4
(devidend/net income)

Part III
Required incrase in assets -
Spontaneous increase in payables and accruals -
Fund obtained as new retained earning.
(A0*/S0) ∆S –
AFN = (L0*S0) ∆S –
MS1(1-Payout)
$270,000 -
$54,000 –
$79,200

AFN = $136,800

Sustainable growth rate (SGR)

SGR = ROE* (1- payout ratio) 3.59

SGR 3.59%
 Increase in sales (S) if AFN = 0
S = (S1-S0) 360,000
Growth in sales 9.09%

Morrissey Tech. must increase it sales by 9.09% ($360,000) without any additional financing.