Chapter 8 Solutions - 8- 1 Using the template below:...

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Unformatted text preview: 8- 1 Using the template below: a. The sustainable growth rate, g* is 14%. b. An ini>al equity investment of $274 results in expected Year 2 sales of $2,500. c. If the firm pays no dividends, i.e., the reten>on ra>o is 100%, g* increases to 56%. d. A financial leverage ra>o of 7.14 results in a g* of 25%. THE SUSTAINABLE GROWTH MODEL STARTING BALANCE SHEET YEAR 1 INCOME STATEMENT ENDING BALANCE SHEET g* = Initial Equity Investment Sales $100 $800 Initial Equity + Retained Earnings $114 X X X LEVERAGE 4 = E= D= Initial Total Assets $400 $100 $300 TURNOVER 2 ROS 7% RETENTION 25.0% $14 LEVERAGE 4 = Net Income $56 = Dividend Payout 75.0% $42 E= D= Ending Total Assets $456 $114 $342 14.0% Year 2 Sales $912 8- 2 a. What is the sustainable growth rate, g*? Assumptions EBIT/Sales 15.00% Sales/Assets 2.00 Assets/Equity 2.00 Dividend Payout Ratio 10.00% Interest Rate 10.00% Tax Rate 40.00% EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.150 0.500 0.250 Sustainable Growth Rate 27.00% b. How does g* change in response to reductions by half in the variables? Assumptions EBIT/Sales Sales/Assets Assets/Equity Dividend Payout Ratio Interest Rate Tax Rate 7.50% 2.00 2.00 10.00% 10.00% 40.00% Assumptions EBIT/Sales Sales/Assets Assets/Equity Dividend Payout Ratio Interest Rate Tax Rate 15.00% 1.00 2.00 10.00% 10.00% 40.00% Assumptions EBIT/Sales Sales/Assets Assets/Equity Dividend Payout Ratio Interest Rate Tax Rate 15.00% 2.00 1.00 10.00% 10.00% 40.00% Assumptions EBIT/Sales Sales/Assets Assets/Equity Dividend Payout Ratio Interest Rate Tax Rate 15.00% 2.00 2.00 5.00% 10.00% 40.00% Assumptions EBIT/Sales Sales/Assets Assets/Equity Dividend Payout Ratio Interest Rate Tax Rate 15.00% 2.00 2.00 10.00% 5.00% 40.00% Assumptions EBIT/Sales Sales/Assets Assets/Equity Dividend Payout Ratio Interest Rate Tax Rate 15.00% 2.00 2.00 10.00% 10.00% 20.00% EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.075 0.500 0.250 EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.150 1.000 0.500 EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.150 0.500 0.500 EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.150 0.500 0.250 EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.150 0.500 0.250 EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.150 0.500 0.250 Sustainable Growth Rate 10.80% Sustainable Growth Rate 10.80% Sustainable Growth Rate 16.20% Sustainable Growth Rate 28.50% Sustainable Growth Rate 29.70% Sustainable Growth Rate 36.00% 15.00% 3.00 2.00 10.00% 10.00% 40.00% Assumptions EBIT/Sales Sales/Assets Assets/Equity Dividend Payout Ratio Interest Rate Tax Rate 15.00% 2.00 3.00 10.00% 10.00% 40.00% Assumptions EBIT/Sales Sales/Assets Assets/Equity Dividend Payout Ratio Interest Rate Tax Rate 15.00% 2.00 2.00 15.00% 10.00% 40.00% Assumptions EBIT/Sales Sales/Assets Assets/Equity Dividend Payout Ratio Interest Rate Tax Rate 15.00% 2.00 2.00 10.00% 15.00% 40.00% Assumptions EBIT/Sales Sales/Assets Assets/Equity Dividend Payout Ratio Interest Rate Tax Rate 15.00% 2.00 2.00 10.00% 10.00% 60.00% c. How does g* change in response to increases by half in the variables? Assumptions EBIT/Sales Sales/Assets Assets/Equity Dividend Payout Ratio Interest Rate Tax Rate 22.50% 2.00 2.00 10.00% 10.00% 40.00% Assumptions EBIT/Sales Sales/Assets Assets/Equity Dividend Payout Ratio Interest Rate Tax Rate EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.225 0.500 0.250 EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.150 0.333 0.167 EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.150 0.500 0.167 EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.150 0.500 0.250 EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.150 0.500 0.250 EBIT per Dollar of Sales Assets per Dollar of Sales Equity per Dollar of Sales 0.150 0.500 0.250 Sustainable Growth Rate 43.20% Sustainable Growth Rate 43.20% Sustainable Growth Rate 37.80% Sustainable Growth Rate 25.50% Sustainable Growth Rate 24.30% Sustainable Growth Rate 18.00% d. The impact on g* is linear, i.e., a 50% change in either direction has the same percentage impact on g*. However, the impact varies considerably across the different variables. 50% up 50% down -60% 60% -60% 60% -40% 40% 6% -6% 10% -10% 33% -33% 8- 4 a. With $200 of ini1al equity, the sustainable growth rate is 70%, Year 1 sales will be $1,000, and by Year 3, sales would grow to $2,890. Using Goal Seek, $5,000 of sales in Year 3. b. To achieve $5,000 of Year 3 sales by taking on debt, the leverage ra1o would need to be 1.3X. Lutoj Sustainable Growth Model Assumptions Initial equity Year 1 Financial Results $200.0 Sales $1,000 Operating margin 20% Starting Assets $200.0 Turnover 5.0 Starting Equity $200.0 Leverage 1.0 Debt Retention rate 100% Net Income $0 $ 140.00 Tax rate 30% Return on sales (ROS) 14.0% Interest rate 8.0% Return on assets (ROA) 70.0% Sustainable growth (g*) Year 3 Sales 70.0% $2,890 8- 5 a. Financial Leverage Bloom will require financial leverage of 1.3575 to reach the goal of $8,000,000 of Net Income after taxes in five years. Year 1 2 3 4 5 Investor Equity Debt $5,000,000 $1,787,383 $7,037,932 $2,515,896 $9,906,498 $3,541,340 $13,944,252 $4,984,743 $19,627,739 $7,016,456 Financial Leverage (Assets/Equity) = 1.3575 Total Assets $6,787,383 $9,553,828 $13,447,838 $18,928,994 $26,644,195 Sales $20,362,148 $28,661,483 $40,343,514 $56,786,983 $79,932,586 Asset turnover = 3.0 Interest Taxable Income $142,991 $2,911,332 $201,272 $4,097,951 $283,307 $5,768,220 $398,779 $8,119,268 $561,316 $11,428,571 r = ROS = 8% 15% g* = 41% Tax Net Income $873,399 $2,037,932 $1,229,385 $2,868,566 $1,730,466 $4,037,754 $2,435,780 $5,683,488 $3,428,571 $8,000,000 Tax rate = 30% Bloom's Dist. to Retained Earnings $2,037,932 $2,868,566 $4,037,754 $5,683,488 $8,000,000 $8,000,000 b. Outside Equity Bloom will require about $13.6 million of outside equity to reach the goal of $8,000,000 of Net Income after taxes on his ownership share. Year 1 2 3 4 5 Investor Equity $5,000,000 $7,675,389 $11,193,526 $15,819,876 $21,903,526 Pct. of equity reqd. by investor Outside Equity $13,559,146 $16,729,888 $20,899,413 $26,382,339 $33,592,387 Total Assets $18,559,146 $24,405,277 $32,092,939 $42,202,215 $55,495,913 54.24% Sales $55,677,438 $73,215,831 $96,278,818 $126,606,646 $166,487,739 Asset turnover = 3.0 Interest $0 $0 $0 $0 $0 r = 8% g* = Taxable Income $8,351,616 $10,982,375 $14,441,823 $18,990,997 $24,973,161 ROS = 15% to Retained Tax Net Income Earnings $2,505,485 $5,846,131 $5,846,131 $3,294,712 $7,687,662 $7,687,662 $4,332,547 $10,109,276 $10,109,276 $5,697,299 $13,293,698 $13,293,698 $7,491,948 $17,481,213 $17,481,213 Tax rate = 30% Bloom's Dist. $ 8,000,000 32% c. Discussion By using debt, Bloom retains 100 percent of equity, whereas with outside equity, he has a minority interest. This could favor the use of debt. However, 35.75 percent debt financing is very high for a start- up, and would reduce flexibility if the venture does not develop as expected. Another alternative would be to combine a smaller amount of debt with a smaller amount of equity, to preserve flexibility and control. This might be accomplished by using enhanced equity claims, such as preferred stock with a liquidation preference and/or a preferred dividend. 8- 6 a. Good case (outside equity) The sustainable growth rate is 53% and entrepreneur can reach the target without outside debt and only $2.8 million of equity. Year 1 2 3 4 5 Investor Equity $2,817,418 $4,296,563 $6,552,258 $9,992,194 $15,238,095 Outside Equity $0 $0 $0 $0 $0 Total Assets $2,817,418 $4,296,563 $6,552,258 $9,992,194 $15,238,095 Pct. of equity reqd. by investor 0.00% Sales $10,565,318 $16,112,110 $24,570,968 $37,470,726 $57,142,857 Asset turnover = 3.75 Interest $0 $0 $0 $0 $0 r = 8% Taxable Income $2,113,064 $3,222,422 $4,914,194 $7,494,145 $11,428,571 ROS = 20% g* = to Retained Tax Net Income Earnings $633,919 $1,479,145 $1,479,145 $966,727 $2,255,695 $2,255,695 $1,474,258 $3,439,936 $3,439,936 $2,248,244 $5,245,902 $5,245,902 $3,428,571 $8,000,000 $8,000,000 Tax rate = 30% Bloom's Dist. $ 8,000,000 53% b. Bad case (outside equity) The sustainable growth rate is 18% and the $8 million goal is not feasible. The best Bloom can do is $3 million with $10 million of outside equity. Year 1 2 3 4 5 Investor Equity $5,000,000 $6,575,000 $8,425,625 $10,600,109 $13,155,129 Outside Equity $10,000,000 $11,050,000 $12,283,750 $13,733,406 $15,436,752 Pct. of equity reqd. by investor Total Assets $15,000,000 $17,625,000 $20,709,375 $24,333,516 $28,591,881 40.00% Sales $37,500,000 $44,062,500 $51,773,438 $60,833,789 $71,479,702 Asset turnover = 2.50 Interest $0 $0 $0 $0 $0 r = 8% Taxable Income $3,750,000 $4,406,250 $5,177,344 $6,083,379 $7,147,970 ROS = 10% g* = to Retained Tax Net Income Earnings $1,125,000 $2,625,000 $2,625,000 $1,321,875 $3,084,375 $3,084,375 $1,553,203 $3,624,141 $3,624,141 $1,825,014 $4,258,365 $4,258,365 $2,144,391 $5,003,579 $5,003,579 Tax rate = 30% Bloom's Dist. $ 3,002,147 18% c. Good case (financial leverage) The sustainable growth rate is 53% and entrepreneur can reach the target without outside debt and only $2.8 million of equity. Year 1 2 3 4 5 Investor Equity Debt $2,817,418 $0 $4,296,563 $0 $6,552,258 $0 $9,992,194 $0 $15,238,095 $0 Financial Leverage (Assets/Equity) = 1.0000 Total Assets $2,817,418 $4,296,563 $6,552,258 $9,992,194 $15,238,095 Sales $10,565,318 $16,112,110 $24,570,968 $37,470,726 $57,142,857 Asset turnover = 3.75 Interest $0 $0 $0 $0 $0 r = 8% g* = Taxable Income $2,113,064 $3,222,422 $4,914,194 $7,494,145 $11,428,571 ROS = 20% Tax Net Income $633,919 $1,479,145 $966,727 $2,255,695 $1,474,258 $3,439,936 $2,248,244 $5,245,902 $3,428,571 $8,000,000 Tax rate = 30% Bloom's Dist. to Retained Earnings $1,479,145 $2,255,695 $3,439,936 $5,245,902 $8,000,000 $8,000,000 53% c. Bad case (financial leverage) With financial leverage of 2.95, the target return can be reached. Year 1 2 3 4 5 Investor Equity Debt $5,000,000 $9,772,539 $7,037,932 $13,755,692 $9,906,498 $19,362,326 $13,944,251 $27,254,147 $19,627,739 $38,362,567 Financial Leverage (Assets/Equity) = 2.9545 Total Assets $14,772,539 $20,793,625 $29,268,823 $41,198,398 $57,990,306 Sales $36,931,346 $51,984,061 $73,172,059 $102,995,996 $144,975,764 Asset turnover = 2.50 Interest Taxable Income $781,803 $2,911,332 $1,100,455 $4,097,951 $1,548,986 $5,768,220 $2,180,332 $8,119,268 $3,069,005 $11,428,571 r = ROS = 8% 10% g* = 41% Tax Net Income $873,399 $2,037,932 $1,229,385 $2,868,566 $1,730,466 $4,037,754 $2,435,780 $5,683,487 $3,428,571 $8,000,000 Tax rate = 30% Bloom's Dist. to Retained Earnings $2,037,932 $2,868,566 $4,037,754 $5,683,487 $8,000,000 $8,000,000 8- 7 a. Annual operation The initial $3.5 million investment is a sunk cost. Years Cash Flow Breakeven Sales Variable cost Fixed cost Total cash expenses Operating cash flow Net Income Breakeven Sales Variable cost Fixed cost Depreciation expense Total expenses Net income 1 - 5 6 $923,077 $323,077 $600,000 $923,077 $0 $1,384,615 $484,615 $900,000 $1,384,615 $0 $2,000,000 $700,000 $600,000 $700,000 $2,000,000 $0 $1,384,615 $484,615 $900,000 $0 $1,384,615 $0 Ignoring growth and initial investment, the venture reaches cash flow breakeven at sales of $923,077 in the first five years. This is lower that net income breakeven, which also considers non- cash expenses like depreciation. After the 5th year cash flow breakeven and net income breakeven are identical, as there are no non- cash expenses. b. Cumulative operation Year Sales Variable cost Fixed cost Depreciation expense Net income Operating cash flow Fixed investment Increase in working capital Net cash flow Cumulative cash required Working capital balance 0 1 $1,000,000 $350,000 $600,000 $700,000 ($650,000) $50,000 2 $4,000,000 $1,400,000 $600,000 $700,000 $1,300,000 $2,000,000 3 4 5 $1,800,000 $1,800,000 $1,800,000 $630,000 $630,000 $630,000 $600,000 $600,000 $600,000 $700,000 $700,000 $700,000 ($130,000) ($130,000) ($130,000) $570,000 $570,000 $570,000 6 $1,800,000 $630,000 $900,000 $0 $270,000 $270,000 $3,500,000 $250,000 ($3,500,000) $3,500,000 $750,000 ($550,000) $0 $0 $0 $1,250,000 $1,120,000 $570,000 $570,000 $270,000 $3,700,000 $2,450,000 $1,330,000 $760,000 $190,000 ($80,000) $250,000 $1,000,000 $450,000 $450,000 $450,000 $450,000 ($200,000) Cumulative financing required peaks at $3.7 million in year. The venture generates positive cumulative free cash flow by year six. 8- 9 Net income breakeven analysis is based on the comparison of revenue against all expenses, whereas cash flow breakeven is based on the comparison of revenue against only cash expenses. So, for example, depreciaAon and similar non- cash expenses are excluded and the analysis considers the Aming of cash receipt from sales (instead of the accounAng Aming of revenue recogniAon. The two approaches are similar when a business operates without major capital investments and operates on a cash basis for sales and pays for inventory and other expenses at the Ame of sales. AlternaAvely, cash flows and net income will tend to be similar if a business is not growing. Rapid growth and Aming differences related to payables and receivables would cause the two to diverge. 8- 10 (a) Problem 7-6a With No Outside Equity Expected Scenario with Outside Equity Bloom will require about $13.6 million of outside equity to reach the goal of $8,000,000 of Net Income after taxes on his ownership share. Year 1 2 3 4 5 Investor Equity $5,000,000 Outside Equity $0 $6,575,000 $8,646,125 $11,369,654 $14,951,096 $0 $0 $0 $0 Pct. of equity reqd. by investor Total Assets $5,000,000 $6,575,000 $8,646,125 $11,369,654 $14,951,096 0.00% Sales $15,000,000 $19,725,000 $25,938,375 $34,108,963 $44,853,287 Interest $0 $0 $0 $0 $0 Taxable Income $2,250,000 $2,958,750 $3,890,756 $5,116,344 $6,727,993 Tax $675,000 $887,625 $1,167,227 $1,534,903 $2,018,398 S/A = 3 r = 8% ROS= 15% t=30% Total Assets Sales Interest Taxable Income Tax $5,000,000 $7,625,000 $11,628,125 $17,732,891 $27,042,658 $18,750,000 $28,593,750 $43,605,469 $66,498,340 $101,409,968 $3,750,000 $5,718,750 $8,721,094 $13,299,668 $20,281,994 $1,125,000 $1,715,625 $2,616,328 $3,989,900 $6,084,598 ROS= 20% t=30% Taxable Income Tax to Retained Earnings Net Income $1,575,000 $2,071,125 $2,723,529 $3,581,441 $4,709,595 Bloom's Dist. $1,575,000 $2,071,125 $2,723,529 $3,581,441 $4,709,595 $ 4,709,595 Good Scenario with Outside Equity Year 1 2 3 4 5 Investor Equity Outside Equity $5,000,000 $0 $0 $0 $0 $0 $7,625,000 $11,628,125 $17,732,891 $27,042,658 Pct. of equity reqd. by investor 0.00% $0 $0 $0 $0 $0 S/A = 3.75 Net Income $2,625,000 $4,003,125 $6,104,766 $9,309,768 $14,197,396 Bloom's Dist. to Retained Earnings $2,625,000 $4,003,125 $6,104,766 $9,309,768 $14,197,396 $14,197,396 Bad Scenario with Outside Equity Year 1 2 3 4 5 Investor Equity Outside Equity $5,000,000 $5,875,000 $6,903,125 $8,111,172 $9,530,627 Pct. of equity reqd. by investor With No Outside Equity Bloom's Ownership $0 $0 $0 $0 $0 Total Assets $5,000,000 $5,875,000 $6,903,125 $8,111,172 $9,530,627 0.00% 100.00% Sales $12,500,000 $14,687,500 $17,257,813 $20,277,930 $23,826,567 S/A = 2.50 Interest $0 $0 $0 $0 $0 $1,250,000 $1,468,750 $1,725,781 $2,027,793 $2,382,657 ROS= 10% Net Income $375,000 $440,625 $517,734 $608,338 $714,797 t=30% $875,000 $1,028,125 $1,208,047 $1,419,455 $1,667,860 Bloom's Dist. Bloom's Expected Distribution to Retained Earnings $875,000 $1,028,125 $1,208,047 $1,419,455 $1,667,860 $1,667,860 $6,643,415 8- 10 (b) Problem 7-6b With No Debt With 0.2:1.0 Debt:Equity Expected Scenario with Outside Equity Bloom will require about $13.6 million of outside equity to reach the goal of $8,000,000 of Net Income after taxes on his ownership share. Expected Scenario with Outside Equity Bloom will require about $13.6 million of outside equity to reach the goal of $8,000,000 Year 1 2 3 4 5 Investor Equity Debt $5,000,000 $0 $0 $0 $0 $0 $6,575,000 $8,646,125 $11,369,654 $14,951,096 Debt/Equity Total Assets $5,000,000 $6,575,000 $8,646,125 $11,369,654 $14,951,096 0.00% Sales $15,000,000 $19,725,000 $25,938,375 $34,108,963 $44,853,287 S/A = 3 Interest $0 $0 $0 $0 $0 Taxable Income $2,250,000 $2,958,750 $3,890,756 $5,116,344 $6,727,993 Tax $675,000 $887,625 $1,167,227 $1,534,903 $2,018,398 r = 8% ROS= 15% t=30% Interest Taxable Income Tax $3,750,000 $5,718,750 $8,721,094 $13,299,668 $20,281,994 $1,125,000 $1,715,625 $2,616,328 $3,989,900 $6,084,598 ROS= 20% t=30% to Retained Earnings Net Income $1,575,000 $2,071,125 $2,723,529 $3,581,441 $4,709,595 Bloom's Dist. $1,575,000 $2,071,125 $2,723,529 $3,581,441 $4,709,595 $ 4,709,595 Good Scenario with Outside Equity Year 1 2 3 4 5 Investor Equity Debt/Equity Total Assets $0 $0 $0 $0 $0 $7,625,000 $11,628,125 $17,732,891 $27,042,658 Sales $5,000,000 $7,625,000 $11,628,125 $17,732,891 $27,042,658 $18,750,000 $28,593,750 $43,605,469 $66,498,340 $101,409,968 0.00% $0 $0 $0 $0 $0 S/A = 3.75 Net Income $2,625,000 $4,003,125 $6,104,766 $9,309,768 $14,197,396 Bloom's Dist. to Retained Earnings $2,625,000 $4,003,125 $6,104,766 $9,309,768 $14,197,396 Investor Equity Debt/Equity With No Debt Bloom's Equity Total Assets $0 $0 $0 $0 $0 $5,875,000 $6,903,125 $8,111,172 $9,530,627 $6,890,000 $9,494,420 $13,083,311 $18,028,802 Debt $1,000,000 $1,378,000 $1,898,884 $2,616,662 $3,605,760 Total Assets $6,000,000 $8,268,000 $11,393,304 $15,699,973 $21,634,563 20.00% Year 1 2 3 4 5 Investor Equity $5,000,000 $8,150,000 $13,284,500 $21,653,735 $35,295,588 Debt/Equity Debt $1,000,000 $1,630,000 $2,656,900 $4,330,747 $7,059,118 Total Assets $6,000,000 $9,780,000 $15,941,400 $25,984,482 $42,354,706 20.00% Bad Scenario with Outside Equity Debt $5,000,000 $5,000,000 Debt/Equity $14,197,396 Bad Scenario with Outside Equity Year 1 2 3 4 5 Investor Equity Good Scenario with Outside Equity Debt $5,000,000 Year 1 2 3 4 5 $5,000,000 $5,875,000 $6,903,125 $8,111,172 $9,530,627 0.00% Sales $12,500,000 $14,687,500 $17,257,813 $20,277,930 $23,826,567 S/A = 2.50 100.00% Interest $0 $0 $0 $0 $0 Taxable Income $1,250,000 $1,468,750 $1,725,781 $2,027,793 $2,382,657 ROS= 10% Tax Net Income $375,000 $440,625 $517,734 $608,338 $714,797 t=30% $875,000 $1,028,125 $1,208,047 $1,419,455 $1,667,860 Bloom's Dist. Bloom's Expected Distribution to Retained Earnings $875,000 $1,028,125 $1,208,047 $1,419,455 $1,667,860 Year 1 2 3 4 5 Investor Equity $5,000,000 $6,050,000 $7,283,750 $8,733,406 $10,436,752 $1,667,860 Debt/Equity $6,643,415 With 0.2:1.0 Debt:Equity Bloom's Equity Debt $1,000,000 $1,210,000 $1,456,750 $1,746,681 $2,087,350 Total Assets $6,000,000 $7,050,000 $8,283,750 $9,733,406 $11,436,752 20.00% 100.00% 8- 10 (b) With 0.4:1.0 Debt:Equity Expected Scenario with Outside Equity Bloom will require about $13.6 million of outside equity to reach the goal of $8,000,000 of Net Income after taxes on his ownership share. f outside equity to reach the goal of $8,000,000 of Net Income after taxes on his ownership share. Sales $18,000,000 $24,804,000 $34,179,912 $47,099,919 $64,903,688 S/A = 3 Interest $0 $0 $0 $0 $0 Taxable Income $2,700,000 $3,720,600 $5,126,987 $7,064,988 $9,735,553 Tax $810,000 $1,116,180 $1,538,096 $2,119,496 $2,920,666 r = 8% ROS= 15% t=30% Interest Taxable Income Tax $4,500,000 $7,335,000 $11,956,050 $19,488,362 $31,766,029 $1,350,000 $2,200,500 $3,586,815 $5,846,508 $9,529,809 ROS= 20% t=30% to Retained Earnings Net Income $1,890,000 $2,604,420 $3,588,891 $4,945,491 $6,814,887 Bloom's Dist. $1,890,000 $2,604,420 $3,588,891 $4,945,491 $6,814,887 $ Year 1 2 3 4 5 6,814,887 Investor Equity $5,000,000 $7,205,000 $10,382,405 $14,961,046 $21,558,867 Debt/Equity Debt $2,000,000 $2,882,000 $4,152,962 $5,984,418 $8,623,547 Total Assets $7,000,000 $10,087,000 $14,535,367 $20,945,464 $30,182,413 40.00% Sales $21,000,000 $30,261,000 $43,606,101 $62,836,392 $90,547,240 Interest $0 $0 $0 $0 $0 Taxable Income Tax $3,150,000 $4,539,150 $6,540,915 $9,425,459 $13,582,086 $945,000 $1,361,745 $1,962,275 $2,827,638 $4,074,626 S/A = 3 r = 8% ROS= 15% t=30% Total Assets Sales Interest Taxable Income Tax $7,000,000 $12,145,000 $21,071,575 $36,559,183 $63,430,182 $26,250,000 $45,543,750 $79,018,406 $137,096,935 $237,863,182 Net Income $2,205,000 $3,177,405 $4,578,641 $6,597,821 $9,507,460 Bloom's Dist. Good Scenario with Outside Equity Sales $22,500,000 $36,675,000 $59,780,250 $97,441,808 $158,830,146 $0 $0 $0 $0 $0 S/A = 3.75 Net Income $3,150,000 $5,134,500 $8,369,235 $13,641,853 $22,236,220 Bloom's Dist. to Retained Earnings $3,150,000 $5,134,500 $8,369,235 $13,641,853 $22,236,220 Year 1 2 3 4 5 Investor Equity Debt/Equity $22,236,220 $8,675,000 $15,051,125 $26,113,702 $45,307,273 Debt $2,000,000 $3,470,000 $6,020,450 $10,445,481 $18,122,909 40.00% $5,000,000 $0 $0 $0 $0 $0 S/A = 3.75 $5,250,000 $1,575,000 $9,108,750 $2,732,625 $15,803,681 $4,741,104 $27,419,387 $8,225,816 $47,572,636 $14,271,791 ROS= 20% t=30% Net Income $3,675,000 $6,376,125 $11,062,577 $19,193,571 $33,300,845 Bloom's Dist. Bad Scenario with Outside Equity Sales $15,000,000 $17,625,000 $20,709,375 $24,333,516 $28,591,881 S/A = 2.50 Interest $0 $0 $0 $0 $0 Taxable Income $1,500,000 $1,762,500 $2,070,938 $2,433,352 $2,859,188 ROS= 10% Tax Net Income $450,000 $528,750 $621,281 $730,005 $857,756 t=30% $1,050,000 $1,233,750 $1,449,656 $1,703,346 $2,001,432 Bloom's Dist. Bloom's Expected Distribution to Retained Earnings $1,050,000 $1,233,750 $1,449,656 $1,703,346 $2,001,432 Year 1 2 3 4 5 Investor Equity $5,000,000 $6,225,000 $7,664,375 $9,355,641 $11,342,878 $2,001,432 Debt/Equity $9,997,251 With 0.4:1.0 Debt:Equity Bloom's Equity Debt $2,000,000 $2,490,000 $3,065,750 $3,742,256 $4,537,151 Total Assets $7,000,000 $8,225,000 $9,664,375 $11,355,641 $13,342,878 40.00% Sales $17,500,000 $20,562,500 $24,160,938 $28,389,102 $33,357,194 S/A = 2.50 100.00% Interest $0 $0 $0 $0 $0 Taxable Income $1,750,000 $2,056,250 $2,416,094 $2,838,910 $3,335,719 ROS= 10% Tax Net Income $525,000 $616,875 $724,828 $851,673 $1,000,716 t=30% $1,225,000 $1,439,375 $1,691,266 $1,987,237 $2,335,004 Bloom's Dist. Bloom's Expected Distribution 8- 10 (b) With 0.6:1.0 Debt:Equity Expected Scenario with Outside Equity Bloom will require about $13.6 million of outside equity to reach the goal of $8,000,000 of Net Income after taxes on his ownership share. n his ownership share. to Retained Earnings $2,205,000 $3,177,405 $4,578,641 $6,597,821 $9,507,460 $ Year 1 2 3 4 5 Investor Equity Debt/Equity 9,507,460 $7,520,000 $11,310,080 $17,010,360 $25,583,582 Debt $3,000,000 $4,512,000 $6,786,048 $10,206,216 $15,350,149 60.00% $5,000,000 Total Assets Sales $8,000,000 $12,032,000 $18,096,128 $27,216,577 $40,933,731 $24,000,000 $36,096,000 $54,288,384 $81,649,730 $122,801,193 Interest $0 $0 $0 $0 $0 Taxable Income Tax $3,600,000 $5,414,400 $8,143,258 $12,247,459 $18,420,179 $1,080,000 $1,624,320 $2,442,977 $3,674,238 $5,526,054 S/A = 3 r = 8% ROS= 15% t=30% Total Assets Sales Interest Taxable Income Tax $8,000,000 $14,720,000 $27,084,800 $49,836,032 $91,698,299 $30,000,000 $55,200,000 $101,568,000 $186,885,120 $343,868,621 to Retained Earnings Net Income $2,520,000 $3,790,080 $5,700,280 $8,573,222 $12,894,125 Bloom's Dist. $2,520,000 $3,790,080 $5,700,280 $8,573,222 $12,894,125 $ 12,894,125 Good Scenario with Outside Equity to Retained Earnings $3,675,000 $6,376,125 $11,062,577 $19,193,571 $33,300,845 Year 1 2 3 4 5 Investor Equity Debt/Equity $33,300,845 $9,200,000 $16,928,000 $31,147,520 $57,311,437 Debt $3,000,000 $5,520,000 $10,156,800 $18,688,512 $34,386,862 60.00% $5,000,000 $0 $0 $0 $0 $0 S/A = 3.75 $6,000,000 $1,800,000 $11,040,000 $3,312,000 $20,313,600 $6,094,080 $37,377,024 $11,213,107 $68,773,724 $20,632,117 ROS= 20% t=30% Net Income $4,200,000 $7,728,000 $14,219,520 $26,163,917 $48,141,607 Bloom's Dist. to Retained Earnings $4,200,000 $7,728,000 $14,219,520 $26,163,917 $48,141,607 $48,141,607 Bad Scenario with Outside Equity to Retained Earnings $1,225,000 $1,439,375 $1,691,266 $1,987,237 $2,335,004 Year 1 2 3 4 5 Investor Equity $5,000,000 $6,400,000 $8,045,000 $9,977,875 $12,249,003 $2,335,004 Debt/Equity $14,493,739 With 0.6:1.0 Debt:Equity Bloom's Equity Debt $3,000,000 $3,840,000 $4,827,000 $5,986,725 $7,349,402 Total Assets $8,000,000 $9,400,000 $11,045,000 $12,977,875 $15,249,003 60.00% Sales $20,000,000 $23,500,000 $27,612,500 $32,444,688 $38,122,508 S/A = 2.50 100.00% Interest $0 $0 $0 $0 $0 Taxable Income $2,000,000 $2,350,000 $2,761,250 $3,244,469 $3,812,251 ROS= 10% Tax Net Income $600,000 $705,000 $828,375 $973,341 $1,143,675 t=30% $1,400,000 $1,645,000 $1,932,875 $2,271,128 $2,668,576 Bloom's Dist. Bloom's Expected Distribution to Retained Earnings $1,400,000 $1,645,000 $1,932,875 $2,271,128 $2,668,576 $2,668,576 $20,400,705 8- 11 (a) Table 8.1 (revised) Table 8.2 (revised) Revenue and Expense Assumptions of iFree at Various User Levels Pro Forma Financial Data for iFree at Various User Levels Number of Users (thousands) Top of Range Average over All Users Revenue per User at Top of Range Subscriptions Advertising Average Total Revenue Expenses per User at Top of Range Average Variable Expenses Average Contribution to Operating Profit Average over Incremental Users Revenue per User Subscriptions Advertising Total Expenses per User Variable Expenses Incremental Contribution to Operating Profit up to 25 25 25-40 40 40 to 55 55 $12.00 $9.00 $21.00 $12.00 $9.19 $21.19 $12.00 $9.48 $21.48 $22.00 -$1.00 $18.25 $2.94 $16.20 $5.27 $8.00 $9.00 $17.00 $8.00 $9.50 $17.50 $8.00 $10.25 $18.25 $22.00 ($5.00) $12.00 $5.50 $10.75 $7.50 Users (000s) Total Subscription revenue Total Advertising revenue Total Revenue Variable Expenss Fixed Expenses Operating profit Tax @ 40% Net Income Plus Depreciation (nonrecurring) Plus Depreciation (recurring) Capital Investment/Replacement Cash flow 0 25 40 55 $0 $0 $0 $0 $0 $300 $225 $525 $550 $190 $480 $368 $848 $730 $190 $660 $521 $1,181 $891 $190 $0 ($215) ($73) $100 $0 $0 $0 ($215) $0 ($73) $40 $60 $0 $0 ($300) ($300) $75 $20 ($20) ($140) $75 $20 ($20) $3 $75 $20 ($20) $135 8- 11 (b) High cost Sales Subs Adv VC FC - $8.00 $9.00 $22.00 $ 190.00 $ 75.00 $8.00 $8.00 $9.50 $10.25 $12.00 $10.75 $ 190.00 $ 190.00 $ $ 75.00 75.00 25 40 Depr Subs Adv $ 200.00 $ 320.00 $ 225.00 $ 367.50 $ 550.00 $ 730.00 Low cost High Rev Low Rev VC Adv BASE CASE VC $26.40 $17.60 $10.80 $7.20 $9.00 $22.00 $14.40 $12.90 $9.60 $8.60 $11.40 $12.30 $7.60 $8.20 $9.50 $10.25 $12.00 $10.75 55 Volume Subsc. Revenue Adv. Revenue Total Revenue FC VC Depre EBIT Tax Net Income Plus Dep Cash Flow 67 $ 532.0 $ 639.1 $ 1,171.1 $ (190.0) $ (1,014.9) Total expenses Cash outflow $ 1,204.9 $ 1,129.9 $ $ $ $ $ (33.8) (33.75) 75 41 Circ 0 5 10 12 15 18 20 25 30 35 36 40 45 50 54 55 60 65 70 75 80 85 90 95 100 125 130 135 140 0 5 10 12 15 18 20 25 30 35 36 40 45 50 54 55 60 65 70 75 80 85 90 95 100 125 130 135 140 Subsc Rev Total Exp Cash outflow Adv. Rev. Tax $ 532.0 $ 1,171.1 $ 1,204.9 $ 1,129.9 $ 639.1 $ 0 0 190 115 0 0 40 85 300 225 45 0 80 170 410 335 90 0 96 204 454 379 108 0 120 255 520 445 135 0 144 306 586 511 162 0 160 340 630 555 180 0 200 425 740 665 225 0 240 513 800 725 273 0 280 600 860 785 320 0 288 618 872 797 330 0 320 688 920 845 368 0 360 779 974 899 419 0 400 870 1,028 953 470 0 432 943 1,071 996 511 0 440 961 1,081 1,006 521 0 480 1,053 1,135 1,060 573 0 520 1,144 1,189 1,114 624 0 560 1,235 1,243 1,168 675 0 600 1,326 1,308 1,233 726 (12) 640 1,418 1,377 1,302 778 (27) 680 1,509 1,446 1,371 829 (42) 720 1,600 1,515 1,440 880 (57) 760 1,691 1,583 1,508 931 (72) 800 1,783 1,652 1,577 983 (87) 1,000 2,239 1,996 1,921 1,239 (162) 1,040 2,330 2,065 1,990 1,290 (177) 1,080 2,421 2,133 2,058 1,341 (192) 1,120 2,513 2,202 2,127 1,393 (207) Depr. Cash Flow FC VC $ 75 $ 41 $ (190.0) $ (1,014.9) 75 (115) (190) 0 75 (140) (190) (110) 75 (165) (190) (220) 75 (175) (190) (264) 75 (190) (190) (330) 75 (205) (190) (396) 75 (215) (190) (440) 75 (240) (190) (550) 75 (213) (190) (610) 75 (185) (190) (670) 75 (180) (190) (682) 75 (158) (190) (730) 75 (120) (190) (784) 75 (83) (190) (838) 75 (53) (190) (881) 75 (45) (190) (891) 75 (8) (190) (945) 75 30 (190) (999) 75 68 (190) (1,053) 75 93 (190) (1,106) 75 116 (190) (1,160) 75 138 (190) (1,214) 75 161 (190) (1,268) 75 183 (190) (1,321) 75 206 (190) (1,375) 75 318 (190) (1,644) 75 341 (190) (1,698) 75 363 (190) (1,751) 75 386 (190) (1,805) 8- 12 Table 8.3 (revised) iFree Scenario Analysis Growth Rate of Users 1 Expected Growth High Growth Variable Cost 2 Expected Cost High Cost Expected Cost Low Cost High Cost Expected Growth Expected Cost Low Cost High Cost Low Growth Expected Cost Low Cost Advertising Revenue 3 Expected Revenue High Revenue Low Revenue High Revenue Expected Revenue Low Revenue High Revenue Low Revenue High Revenue Low Revenue High Revenue Low Revenue High Revenue Low Revenue High Revenue Low Revenue High Revenue Expected Revenue Low Revenue High Revenue Low Revenue Projected Cash Flow Time 0 Year 1 Year 2 Year 3 Cumulative Cash Need Year 3 Net Income ($300,000) ($215,000) ($45,000) $183,000 ($560,000) $108,000 ($300,000) ($239,000) ($54,000) $124,000 ($593,000) $25,830 ($300,000) ($235,000) $77,000 $311,000 ($535,000) $236,250 ($300,000) ($300,000) ($179,000) ($251,000) ($14,000) ($76,000) $251,000 $115,000 ($493,000) ($627,000) $176,650 $40,350 ($300,000) ($185,000) ($166,000) $41,000 ($651,000) ($33,750) ($300,000) ($98,000) ($108,000) $122,000 ($506,000) $46,530 1. Expected users are 20,000 in the first year, 55,000 in the second year, and 95,000 the third. High growth is 30 percent above these expected numbers and low growth is 30 percent below. 2. Expected variable expense and advertising are as shown in Table 8.1. High cost is variable expense 20 percent higher than expected and low cost is variable expense 20 percent less than expected for all user levels. 3. High advertising revenue is 20 percent above the expected levels in Table 8.2 and low advertising revenue is 20 percent below expected. ...
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This note was uploaded on 02/19/2012 for the course FIN 124 taught by Professor Jackson during the Spring '05 term at University of Texas at Dallas, Richardson.

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