132 1250 1 1 3 565 in this calculation notice

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Unformatted text preview: 3,000 and $1,000, respectively, so we have: EFN $3,000 ________ 1,000 $250 $300 _______ 1,000 $250 .132 $1,250 (1 1 __ 3 ) $565 In this calculation, notice that there are three parts. The first part is the projected increase in assets, which is calculated using the capital intensity ratio. The second is the spontaneous increase in liabilities. The third part is the product of profit margin and projected sales, which is projected net income, multiplied by the retention ratio. Thus, the third part is the projected addition to retained earnings. A PARTICULAR SCENARIO Our financial planning model now reminds us of one of those good news–bad news jokes. The good news is we’re projecting a 25 percent increase in sales. The bad news is this isn’t going to happen unless Rosengarten can somehow raise $565 in new financing. This is a good example of how the planning process can point out problems and potential conflicts. If, for example, Rosengarten has a goal of not borrowing any additional funds and not selling any new equity, then a 25 percent increase in sales is probably not feasible. If we take the need for $565 in new financing as given, we know that Rosengarten has three possible sources: short-term borrowing, long-term borrowing, and new equity. The choice of some combination among these three is up to management; we will illustrate only one of the many possibilities. Suppose Rosengarten decides to borrow the needed funds. In this case, the firm might choose to borrow some over the short term and some over the long term. For example, current assets increased by $300 whereas current liabilities rose by only $75. Rosengarten 70 PART 1 Overview ros82361_ch03.indd 70 5/27/08 10:15:08 AM Confirming Pages TABLE 3 .1 4 R O S E N G A R T E N C O R P O R AT I O N P r o Fo r m a B a l a n c e S h e e t Assets NEXT YEAR Current assets Cash Accounts receivable Inventory Total Fixed assets Net plant and equipment CHANGE FROM CURRENT YEAR Current liabilities Accounts payable Notes payable Total Long-term debt Owners’ equity Common stock and paid-in surplus Retained earnings Total Total liabilities and owners’ equity Liabilities and Owners’ Equity NEXT YEAR CHANGE FROM CURRENT YEAR $ 200 550 750 $1,500 $ 40 110 150 $300 $ 375 325 $ 700 $1,140 $ 75 225 $300 $340 $2,250 $450 $ 800 1,110 $1,910 $3,750 $0 110 $110 $750 Total assets $3,750 $750 could borrow $300 75 $225 in short-term notes payable and leave total net working capital unchanged. With $565 needed, the remaining $565 225 $340 would have to come from long-term debt. Table 3.14 shows the completed pro forma balance sheet for Rosengarten. We have used a combination of short- and long-term debt as the plug here, but we emphasize that this is just one possible strategy; it is not necessarily the best one by any means. There are many other scenarios we could (and should) investigate. The various ratios we discussed earlier come in very handy here. For example, with the scenario we have just examined, we would surely want to examine the current...
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