Consider the financial statements for New England Corporation provided below. Th
ID: 2811003 • Letter: C
Question
Consider the financial statements for New England Corporation provided below. The company expects sales to increase by 25% in 2019. Its applicable tax rate in 2019 is expected to be 21% (note that this is significantly less than the rate implied by the Income Statement for 2018). Its dividend payout ratio in 2019 will be exactly the same as what it is in 2018. Accounts payable are the only “spontaneous liability” for this firm. New England’s management plans to raise any funding needed for growth through long-term debt only. Its current interest rate on its existing short-term and long-term debt will remain the same for 2019, and it does not propose to pay down any of its existing short-term or long-term debt (so, effectively, it will be able to “roll over” its existing short-term debt at the same rate as it is paying currently). On any new long-term borrowings in 2019, New England’s creditors have indicated that they will charge 7.25%.
For New England Corporation mentioned above:
A. Estimate the EFN for 2019 using the “Direct Method”.
B. The “direct method” EFN formula has three parts to it. Briefly explain what each part of the formula measures. No more than 1 sentence is necessary to explain each part. Make sure to use your own words.
New England Corporation
Income Statement ($ thousands)
2018
Sales
$95,023
Cost of goods sold
63,186
SG&A expense
8,241
Depreciation expense
6,106
EBIT
17,490
Interest expense
6,724
EBT
10,766
Taxes
5,092
Net income
5,674
Allocation of net income:
Dividends
$2,921
Addition to retained earnings
$2,753
Balance Sheet ($ thousands)
31-Dec-18
ASSETS
Current assets
Cash and marketable securities
$7,916
Accounts receivable
$22,854
Inventory
$30,991
Total current assets
$61,761
Net PPE
331,083
Total assets
$392,844
LIABILITIES AND EQUITY
Current liabilities
Accounts payable
$63,250
Short-term debt
$53,258
Total current liabilities
$116,508
Long-term debt
$58,757
Total liabilities
$175,265
Shareholders' equity
Common Stock & Paid-In Capital
$147,400
Retained earnings
$70,179
Total shareholders' equity
$217,579
Total liabilities and shareholders' equity
$392,844
New England Corporation
Income Statement ($ thousands)
2018
Sales
$95,023
Cost of goods sold
63,186
SG&A expense
8,241
Depreciation expense
6,106
EBIT
17,490
Interest expense
6,724
EBT
10,766
Taxes
5,092
Net income
5,674
Allocation of net income:
Dividends
$2,921
Addition to retained earnings
$2,753
Explanation / Answer
WORKINGS: New England Corporation Forecast Income Statement ($ thousands) 2018 2019 Sales 95023 95023*1.25= 118779 Cost of goods sold 63,186 63186*1.25= 78983 SG&A expense 8,241 8241*1.25= 10301 Depreciation expense 6,106 6106*1.25= 7633 EBIT 17,490 21863 Interest expense 6,724 Same 6724 EBT 10,766 15139 Taxes 5,092 21%*15139= 3179 Net income 5,674 11959 10.07% 5.97% Allocation of net income: Dividends 2921 51.48% 6157 Addition to retained earnings 2753 48.52% 5803 A. EFN=Needed Increase in assets-Corresponding increase in liabilities-Increase in Retained earnings Needed Increase in assets= 392844*0.25= 98211 Corresponding increase in liabilities= 63250*0.25= 15813 Increase in Retained earnings= New sales*Profit Margin*Retention ratio 118779*10.07%*48.52%= 5803 (or simply as worked out in the Income Statement) So, EFN=98211-15813-5803= 76595 B. EFN=Needed Increase in assets-Corresponding increase in liabilities-Increase in Retained earnings So the THREE parts are: Needed Increase in assets---- to support the increase in sales Corresponding increase in liabilities---ie. Spontaneous to increased activity --trade liabilities incurred -again as a consequence to increased activity.These are subtracted as they provide funds for the firm. Increase in Retained earnings--- this amount represents the new additions to equity ,which will ,to a certain exytent ,meet the increased need for funding the asset -base increase.
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