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Unformatted text preview: bt Owners’ equity Total liabilities and owners’ equity External financing needed Liabilities and Owners’ Equity $ $250.0 302.8 $552.8 $ 47.2 PERCENTAGE OF SALES n/a n/a n/a n/a $600.0 480.0 $120.0 40.8 $ 79.2 $26.4 52.8 Notice that the debt-equity ratio for Hoffman was originally (from Table 3.15) equal to $250/250 1.0. We will assume that the Hoffman Company does not wish to sell new equity. In this case, the $47.2 in EFN will have to be borrowed. What will the new debt-equity ratio be? From Table 3.16, we know that total owners’ equity is projected CHAPTER 3 Financial Statements Analysis and Long-Term Planning 73 ros82361_ch03.indd ros82361_ch03.indd 73 5/27/08 10:15:10 AM Confirming Pages TABL E 3 .1 7 Growth and Projected EFN for the Hoffman Company PROJECTED SALES GROWTH 0% 5 10 15 20 25 INCREASE IN ASSETS REQUIRED $0 25 50 75 100 125 ADDITION TO RETAINED EARNINGS $44.0 46.2 48.4 50.6 52.8 55.0 EXTERNAL FINANCING NEEDED, EFN −$44.0 − 21.2 1.6 24.4 47.2 70.0 PROJECTED DEBT-EQUITY RATIO .70 .77 .84 .91 .98 1.05 at $302.8. The new total debt will be the original $250 plus $47.2 in new borrowing, or $297.2 total. The debt-equity ratio thus falls slightly from 1.0 to $297.2 302.8 .98. Table 3.17 shows EFN for several different growth rates. The projected addition to retained earnings and the projected debt-equity ratio for each scenario are also given (you should probably calculate a few of these for practice). In determining the debtequity ratios, we assumed that any needed funds were borrowed, and we also assumed any surplus funds were used to pay off debt. Thus, for the zero growth case, the debt falls by $44, from $250 to $206. In Table 3.17, notice that the increase in assets required is simply equal to the original assets of $500 multiplied by the growth rate. Similarly, the addition to retained earnings is equal to the original $44 plus $44 times the growth rate. Table 3.17 shows that for relatively low growth rates, Hoffman will run a surplus, and its debt-equity ratio will decline. Once the growth rate increases to about 10 percent, however, the surplus becomes a deficit. Furthermore, as the growth rate exceeds approximately 20 percent, the debt-equity ratio passes its original value of 1.0. Figure 3.2 illustrates the connection between growth in sales and external financing needed in more detail by plotting asset needs and additions to retained earnings from Table 3.17 against the growth rates. As shown, the need for new assets grows at a much faster rate than the addition to retained earnings, so the internal financing provided by the addition to retained earnings rapidly disappears. Asset needs and retained earnings ($) F I GURE 3 .2 Growth and Related Financing Needed for the Hoffman Company 125 100 75 50 44 25 Increase in assets required EFN 0 (deficit) EFN 0 (surplus) Projected addition to retained earnings 5 10 15 20 Projected growth in sales (%) 25 74 PART 1 Overview ros82361_ch03.indd 74 5/27/08 10:15:10 AM Confirming Pages As this disc...
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This note was uploaded on 10/28/2009 for the course FINA 505 taught by Professor Deborahcernauskas during the Summer '09 term at Northern Illinois University.

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