14-4. (Financial forecasting—percent of sales) Tulley Appliances Inc. projects n

Question

14-4. (Financial forecasting—percent of sales) Tulley Appliances Inc. projects next year’s sales to be $20 million. Current sales are $15 million, based on current assets of $5 million and fixed assets of $5 million. The firm’s net profit margin is 5 percent after taxes. Tulley forecasts that its current assets will rise in direct proportion to the increase in sales, but that its fixed assets will increase by only $100,000. Currently, Tulley has $1.5 million in accounts payable (which vary directly with sales), $2 million in long-term debt (due in 10 years), and common equity (including $4 million in retained earnings) totaling $6.5 million. Tulley plans to pay $500,000 in common stock dividends next year.

a. What are Tulley’s total financing needs (i.e., total assets) for the coming year?

b. Given the firm’s projections and dividend payments plans, what are its discretionary financing needs?

c. Based on your projections, and assuming that the $100,000 expansion in fixed assets will occur, what is the largest increase in sales the firm can support without having to resort to the use of discretionary sources of financing?

(Keown. Foundations of Finance: The Logic and Practice of Financial Management, 6th Edition. Pearson Learning Solutions p. 453).
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Explanation / Answer

(a) What are Tulley’s Total financing needs (i.e., total assets) for the coming year?


Tulley’s total financing needs are also known as expected total assets.
Expected Total Assets = [Expected Current Assets + Expected Fixed Assets]
Expected Total Assets = [($5,000,000 / $15,000,000) * $20,000,000] +
[$5,000,000 + $100,000]
Expected Total Assets = [$6,666,666.66 + $5,100,000]
Expected Total Assets = $11,766,666.66
Tulley’s total financing needs for the coming year would be = $11,766,666.66


(b) Given the firm’s projections and dividend payments plans, what are its discretionary financing needs?

Discretionary Financing Needs (DFN) = [Expected Current Assets + Expected Fixed Assets – Current Long-term Debt – Current Owner’s Equity – Expected Net Income – Dividends – Spontaneous Financing]

Expected Current Assets = $6,666,666.66
Expected Fixed Assets = [$5,000,000 + $100,000]
Expected Fixed Assets = $5,100,000

Expected Net Income = [$20,000,000 * 5%]
Expected Net Income = $1,000,000 – Common Dividend payment
Expected Net Income= $500,000

Spontaneous Financing = [($1,500,000 / $15,000,000) * $20,000,000]
Spontaneous Financing = $2,000,000

Accounts Payable = $1,500,000
Current Sales = $15,000,000
Project’s Next year (or) Expected Sales = $20,000,000

DFN = [$6,666,666.66 + $5,100,000 - $8,500,000 - $500,000 - $2,000,000]

DFN = $766,666.66

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