Richmond Coffee, Inc. was founded by Gail McCornell and his wife in 2010 in Rich
ID: 2771530 • Letter: R
Question
Richmond Coffee, Inc. was founded by Gail McCornell and his wife in 2010 in Richmond, Indiana. Due to the lack of the related expertise, the company has not been using much financial planning for its investment needs. Therefore, RC is currently undergoing some hard times resulted in some severe cash flow problems. In addition to losing sales, RC is also falling short of profit to pay salaries to the founders. So, there is an urgent need for the company to prepare a financial plan for the next year to cope with the anticipated investment requirements. Richmond Coffee, Inc. 2015 Income Statement Sales $6,854,000 Cost of goods sold 5,231,000 Other expenses 472,000 Depreciation 186,000 EBIT $965,000 Interest 124,800 Taxable income $840,200 Taxes (40%) 336,080 Net income 504,120 Dividends $201,648 Add to retained earnings 302,472 Richmond Coffee, Inc. 2015 Balance Sheet Assets Liabilities and Equity Current assets Current liabilities Cash $282,000 Accounts payable $265,000 Accounts receivable 342,000 Notes payable 168,000 Inventory 650,000 Total current liabilities $433,000 Total current assets $1,274,000 Long-term debt $2,080,000 Fixed assets Net plant and equipment $2,854,000 Shareholder equity Common stock $450,000 Retained earnings 1,165,000 Total equity $1,615,000 Total assets $4,128,000 Total liabilities and equity $4,128,000 RC is looking forward to a growth rate of 14 percent in 2016 (i.e. its sales is expected to increase by 14%). The firm has decided to hire you as a financial consultant to fix all the cash flow problems for them. 1. You are expected to calculate the internal growth rate and sustainable growth rate for RC, and explain to the founders what these numbers mean. (20 points) 2. RC is currently operating at full (100%) capacity. Gail McCornell, one of the founders of the company, would like you to advise them on what amount of external financing will be needed (EFN) for 2016 and whether RC’s sales can rise at this particular rate of growth? 01 F15 BUS-F301 Case Study 1 - Description and Requirements 3/3 Please be reminded to include the necessary assumptions, pro forma income statement and pro forma balance sheet in your answer in addition to other workings. (50 points) 3. RC’s fixed assets can only be acquired in multiples of $1,500,000 (i.e. adding a new product line will call for an additional investment of $1,500,000 in new equipment) once RC has reached its full operating capacity. Gail is eager to know what the new external financing needed (EFN) should be as the firm is now already operating at its full capacity. In addition, he also asks you to estimate the new level of capacity utilization of the fixed assets for RD in next year when the new production line has been implemented. Please be reminded to include the new pro forma income statement and pro forma balance sheet in your answer in addition to other workings. (50 points) 4. Gail is interested in knowing as well how the firm’s ROE will change from 2015 to 2016 according to the projected growth rate (subject to the condition that the firm can only acquire the required fixed assets in multiples of $1,500,000, the owners are not going to put in more capital and the firm’s payout ratio remains at the 2015 level). You are expected to do a Du Pont analysis comparison between the two years. For the Du Pont analysis, you must include both the calculations and the explanations.
Explanation / Answer
Net Income for 2015 = $ 504120
Dividend Paid = $ 201648
Retained earnings for 2015 = $ 302,472
Total Assets of the Company for 2015 = $ 4,128,000
Total Equity of the Company for 2015 = 1,615,000
Return on Assets ROA= Net Income / Total Assets = 504120/4128000 = 0.1221 or 12.21%
Return on Equity ROE = Net Income / Share Holders Equity = 504120 /1615000 = 0.3121 or 31.21%
Dividend Payout Ratio a = Total Dividend / Net Income = 201648 / 504120 = 0.40
Retention Ratio b = 1 – Dividend Payout Ratio = 1 – 0.40 = 0.60
Profit Margin = Net Income / Sales = 504120/6854000 = 0.07355 or 7.355%
Internal growth rate denotes the highest growth rate achievable for a business without any outside financing. Sustainable growth rate is the rate at which the company’s sales can grow without External Financing while maintaining a constant Debt-Equity Ratio.
Internal Growth Rate can be calculated using the formula
Internal Growth Rate = ROA * b/ (1 – ROA * b)
where ROA is return on Assets and b is retention ratio
Sustainable growth rate can be calculated using the formula
Sustainable growth rate = ROE* b / (1- ROE*b)
where ROE is return on equity and b is retention ratio
Internal Growth Rate for Richmond for 2015 = 0.1221 * 0.60 / (1- 0.1221 * 0.60)
= 0.07326/1-0.07326 = 0.07326/0.92674
= 0.07905 or 7.91% (rounded off)
Sustainable Growth rate for Richmond for 2015 = 0.3121 * 0.6 / 1 – 3121 * 0.06 = 0.18726/1-0.18726
= 0.18726/0.81274 = 0.2304 or 23.04%
Answer (2)
Sustainable growth rate = 23.04%
Based on the sustainable growth rate the proforma income statement and balance sheet are as given below
2015
2016
Sales
6854000
8433162
Cost of Goods Sold
5231000
6436222
Other Expenses
472000
580748.8
Depreciation
186000
228854.4
EBIT
965000
1187336
Interest
124800
153553.9
Taxable Income
840200
1033782
Tax (40%)
336080
413512.8
Net Income
504120
620269.2
Dividends
201648
248107.7
Retained Earnings
302472
372161.5
Sustainable growth rate
23.04%
2015
2016
Cash
282000
492524.1
Accounts Paybale
265000
462832.9
Notes Payable
168000
168000
Inventory
650000
1135251
Total Current Assets
1274000
2225091
Fixed Assets
2854000
2854000
Total Assets
4128000
5079091
Accounts Receivable
342000
420787.9
Total Current Liabilities
433000
532751.9
Long Term Debt
2080000
2559178
Liabilities
2513000
3091929
Common Stock
450000
450000
Retained Earnings
1165000
1537162
Total Equity
1615000
1987162
Assumptions
Sales expected at grow at the sustainable growth rate of the company which is 23.04%
All other components of the Income statement are expected to be at the same proportion of 2015 in 2016 also.
Profit Margin is expected to continue at the same level as in 2015 which is 7.355%
Total Assets are estimated to go up by the sustainable growth rate as that will be the requirement for operations.
No increase in Fixed Assets is expected as the firm is already operating at full capacity.
Liabilities increase in same proportion as previous year.
Based on the above balance sheet, the additional fund requirement is
AFN = Increase in Total Assets – Increase in Liabilities – Increase in Retained Earnings
= (5079091 – 4128000) – (3091929 – 2513000) – (372162 – 302472)
= 951091 – 578929 – 69690 = $ 302,472
However this may not be sustainable as the company is already operating at 100% capacity utilisation level unless the sales realisations increases by the sustainable growth rate.
Answer (3)
If the Fixed Assets can increase by multiples of 1,500,000
Capacity Utilization will be at 80% level
Calculation of EFN based on the assumption of fixed assets calculated in Excel is as below
2015
2016
Sales
6854000
8433162
Cost of Goods Sold
5231000
6436222
Other Expenses
472000
580748.8
Depreciation
186000
283757.5
EBIT
965000
1132433
Interest
124800
153553.9
Taxable Income
840200
978878.9
Tax (40%)
336080
391551.6
Net Income
504120
587327.4
Dividends
201648
234930.9
Retained Earnings
302472
352396.4
Sustainable growth rate
23.04%
2015
2016
Cash
282000
160499
Accounts Paybale
265000
150823.5
Notes Payable
168000
168000
Inventory
650000
369944.5
Total Current Assets
1274000
725091.2
Fixed Assets
2854000
4354000
Total Assets
4128000
5079091
Accounts Receivable
342000
423477.7
Total Current Liabilities
433000
536157.5
Long Term Debt
2080000
2575537
Liabilities
2513000
3111695
Common Stock
450000
450000
Retained Earnings
1165000
1517396
Total Equity
1615000
1967396
Total Liabilities
4128000
5079091
Capacity Utilization Level
2.401541696
1.936877
0.806514
The assumptions as same as above except that the depreciation is expected to change in proportion to the fixed assets increase.
EFN = 951091 – 598694.6 – 49924.42 = $ 302,472
Capacity Uitilisation = (Sales / Fixed Assets for 2015) /(Sales/Fixed Assets in 2016)
Answer (4)
ROE = 587327/1967396 = 0.29853 or 29.853%
Dupont Analysis for 2015 = Profit / Sales * Sales / Total Assets * Assets / Equity
= 504120/6854000 * 6854000 /4128000 * 4128000/1615000
= 0.07355 * 1.66 * 2.556 = 0.3121
Dupont Analysis for 2016 = 587327/8433162 * 8433162/5079091 * 5079091/1967396
= 0.0696 * 1.66 * 2.582 = 0.2983
Dupont analysis is a method of performance assessment started by Dupont Corporation. This is basically breaking down the ROE calculations into components to see how the three components viz, profit margin, Asset turnover and Assets to Equity ratio are performing over the period. For Richmond, the profit margins are expected to come down with increase in fixed assets and consequent increase in depreciation and interest costs. The turnover ratio is expected to remain the same. However the Assets to Equity ratio is expected to go up because of higher fixed assets and the additional fund requirement to support sales. This will consequently result in the reduction of Return on Equity.
2015
2016
Sales
6854000
8433162
Cost of Goods Sold
5231000
6436222
Other Expenses
472000
580748.8
Depreciation
186000
228854.4
EBIT
965000
1187336
Interest
124800
153553.9
Taxable Income
840200
1033782
Tax (40%)
336080
413512.8
Net Income
504120
620269.2
Dividends
201648
248107.7
Retained Earnings
302472
372161.5
Sustainable growth rate
23.04%
2015
2016
Cash
282000
492524.1
Accounts Paybale
265000
462832.9
Notes Payable
168000
168000
Inventory
650000
1135251
Total Current Assets
1274000
2225091
Fixed Assets
2854000
2854000
Total Assets
4128000
5079091
Accounts Receivable
342000
420787.9
Total Current Liabilities
433000
532751.9
Long Term Debt
2080000
2559178
Liabilities
2513000
3091929
Common Stock
450000
450000
Retained Earnings
1165000
1537162
Total Equity
1615000
1987162
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