Chapter4 solution

# Chapter4 solution - 1 It is important to remember that...

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1. It is important to remember that equity will not increase by the same percentage as the other assets. If every other item on the income statement and balance sheet increases by 15 percent, the pro forma income statement and balance sheet will look like this: Pro forma income statement Pro forma balance sheet Sales \$ 26,450 Assets \$18,170 Debt \$ 5,980 Costs 19,205 Equity 12,190 Net income \$ 7,245 Total \$ 18,170 Total \$ 18,170 In order for the balance sheet to balance, equity must be: Equity = Total liabilities and equity – Debt Equity = \$18,170 – 5,980 Equity = \$12,190 Equity increased by: Equity increase = \$12,190 – 10,600 Equity increase = \$1,590

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Net income is \$7,245 but equity only increased by \$1,590; therefore, a dividend of: Dividend = \$7,245 – 1,590 Dividend = \$5,655 must have been paid. Dividends paid is the plug variable. 2. Here we are given the dividend amount, so dividends paid is not a plug variable. If the company pays out one-half of its net income as dividends, the pro forma income statement and balance sheet will look like this: Pro forma income statement Pro forma balance sheet Sales \$26,450.00 Assets \$18,170.00 Debt \$ 5,980.00 Costs 19,205.00 Equity 14,222.50 Net income \$ 7,245.00 Total \$18,170.00 Total \$19,422.50 Dividends \$3,622.50 Add. to RE \$3,622.50 Note that the balance sheet does not balance. This is due to EFN. The EFN for this company is: EFN = Total assets – Total liabilities and equity EFN = \$18,170 – 19,422.50 EFN = –\$1,252.50 3. An increase of sales to \$7,424 is an increase of: Sales increase = (\$7,424 – 6,300) / \$6,300 Sales increase = .18 or 18% Assuming costs and assets increase proportionally, the pro forma financial statements will look like this: Pro forma income statement Pro forma balance sheet Sales \$ 7,434 Assets \$ 21,594 Debt \$ 12,400 Costs 4,590 Equity 8,744 Net income \$ 2,844 Total \$ 21,594 Total \$ 21,144 If no dividends are paid, the equity account will increase by the net income, so: Equity = \$5,900 + 2,844 Equity = \$8,744 So the EFN is: EFN = Total assets – Total liabilities and equity EFN = \$21,594 – 21,144 = \$450
4. An increase of sales to \$21,840 is an increase of: Sales increase = (\$21,840 – 19,500) / \$19,500 Sales increase = .12 or 12% Assuming costs and assets increase proportionally, the pro forma financial statements will look like this: Pro forma income statement Pro forma balance sheet Sales \$ 21,840 Assets \$109,760 Debt \$52,500 Costs 16,800 Equity 79,208 EBIT 5,040 Total \$109,760 Total \$99,456 Taxes (40%) 2,016 Net income \$ 3,024 The payout ratio is constant, so the dividends paid this year is the payout ratio from last year times net income, or: Dividends = (\$1,400 / \$2,700)(\$3,024) Dividends = \$1,568 The addition to retained earnings is: Addition to retained earnings = \$3,024 – 1,568 Addition to retained earnings = \$1,456 And the new equity balance is: Equity = \$45,500 + 1,456 Equity = \$46,956 So the EFN is: EFN = Total assets – Total liabilities and equity EFN = \$109,760 – 99,456 EFN = \$10,304 5. Assuming costs and assets increase proportionally, the pro forma financial statements will look like this: Pro forma income statement Pro forma balance sheet Sales \$4,830.00 CA \$4,140.00 CL \$2,145.00 Costs 3,795.00 FA 9,085.00 LTD 3,650.00 Taxable income \$1,035.00 Equity 6,159.86 Taxes (34%) 351.90 TA \$13,225.00 Total D&E \$12,224.86 Net income \$ 683.10

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The payout ratio is 40 percent, so dividends will be: Dividends = 0.40(\$683.10) Dividends = \$273.24 The addition to retained earnings is: Addition to retained earnings = \$683.10 – 273.24 Addition to retained earnings = \$409.86 So the EFN is: EFN = Total assets – Total liabilities and equity EFN = \$13,225 – 12,224.86 EFN = \$1,000.14 6.
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