Landis Corporation
The Landis Corporation had 2008 sales of $100 million. The balance sheet items that
vary directly with sales and the profit margin are as follows:
Percent
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5%
Accounts receivable. . . . . . . . . . . . . . . . . . . . . . 15
Inventory . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25
Net fixed assets . . . . . . . . . . . . . . . . . . . . . . . . . 40
Accounts payable . . . . . . . . . . . . . . . . . . . . . . . 15
Accruals . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
Profit margin after taxes . . . . . . . . . . . . . . . . . . 6%
The dividend payout rate is 50 percent of earnings, and the balance in retained earnings
at the end of 2008 was $33 million. Common stock and the company’s long-term
bonds are constant at $10 million and $5 million, respectively. Notes payable are currently
$12 million.
a. How much additional external capital will be required for next year if sales
increase 15 percent? (Assume that the company is already operating at full
capacity.)
b. What will happen to external fund requirements if Landis Corporation reduces
the payout ratio, grows at a slower rate, or suffers a decline in its profit margin?
Discuss each of these separately.
c. Prepare a pro forma balance sheet for 2009 assuming that any external funds
being acquired will be in the form of notes payable. Disregard the information in
part b in answering this question (that is, use the original information and part a
in constructing your pro forma balance sheet).
To determine the additional external capital required for next year if sales increase by 15 percent, we need to calculate the change in the balance sheet items that vary directly with sales.
The given percentages show how each item changes relative to sales. We'll use these percentages to calculate the change in each item.
a. Calculation of Additional External Capital Required:
1. Calculate the dollar amount change for each balance sheet item:
Cash = 0.05 * 15% * $100 million = $0.75 million
Accounts Receivable = 0.15 * 15% * $100 million = $2.25 million
Inventory = 0.25 * 15% * $100 million = $3.75 million
Net Fixed Assets = 0.40 * 15% * $100 million = $6 million
2. Calculate the change in accounts payable and accruals:
Accounts Payable = 0.15 * 15% * $100 million = $2.25 million
Accruals = 0.10 * 15% * $100 million = $1.5 million
3. Calculate the change in retained earnings:
Profit Margin after Taxes = 0.06 * $100 million = $6 million
Dividend Payout Rate = 50% of Earnings = 0.50 * $6 million = $3 million
Change in Retained Earnings = Profit Margin after Taxes - Dividend Payout = $6 million - $3 million = $3 million
4. Calculate the change in notes payable:
Change in Notes Payable = 15% * $12 million = $1.8 million
5. Calculate the total change in external capital required:
Total Change in External Capital = Change in the sum of Cash, Accounts Receivable, Inventory, Net Fixed Assets, Accounts Payable, Accruals, Retained Earnings, and Notes Payable
= $0.75 million + $2.25 million + $3.75 million + $6 million + $2.25 million + $1.5 million + $3 million + $1.8 million
= $21.3 million
Therefore, if sales increase by 15 percent, Landis Corporation will require an additional $21.3 million in external capital.
b. The impact on external fund requirements for different scenarios:
- If the payout ratio is reduced: Lowering the dividend payout ratio will result in higher retained earnings, reducing the need for external funds.
- If the growth rate is slower: A slower growth rate would lead to smaller changes in the balance sheet items that vary directly with sales. Consequently, external funding requirements would decrease.
- If the profit margin declines: A decline in the profit margin would reduce the amount of profit available for retained earnings, increasing the external funding requirements.
c. Pro forma balance sheet for 2009 (assuming external funds are acquired in the form of notes payable):
Start with the balance sheet items from the previous year (2008):
Assets:
Cash
Accounts Receivable
Inventory
Net Fixed Assets
Liabilities and Equity:
Accounts Payable
Accruals
Notes Payable
Common Stock
Retained Earnings
Long-term Bonds
Add the changes calculated in part a to the respective balance sheet items for 2008.
Make assumptions regarding other potential changes, such as changes in long-term debt or common stock.
Sum up the changes and adjust the balance sheet accordingly.
The pro forma balance sheet will provide an estimate of the asset, liability, and equity balances for 2009 after accounting for the changes in sales and corresponding balance sheet items.