EFN and Internal Growth [LO2, 3] Redo Problem 24 using sales growth rates of 15 and 25 percent in addition to 20 percent. Illustrate graphically the relationship between EFN and the growth rate, and use this graph to determine the relationship between them. At what growth rate is the EFN equal to zero? Why is this internal growth rate different from that found by using the equation in the text?
To determine: The grow rate at which external financing needed is zero.
Introduction:
Using the graphical presentation for external financing needed and growth rate, the relationship between the both can be determined. The rate at which the EFN is zero can be determined using this representation.
Answer to Problem 27QP
The growth rate at which the external financing needed is zero is 15%.
Explanation of Solution
Given information:
The various sales growth rates in addition to 20% are given as 15% and 25%.
Compute pro forma income statement at the rates of 15%, 20%, 25%:
The graphical relationship between external financing needed and growth rate:
Pro forma statement at 15% growth rate
Pro forma income statement | ||
Particulars |
Current year Amount ($) |
Amount ($) (15%) |
Sales | $891,600 | $1,025,340 |
Costs | $693,600 | $797,640 |
Other expenses | $18,240 | $20,976 |
EBIT | $179,760 | $206,724 |
Interest paid | $13,400 | $13,400 |
Taxable income | $166,360 | $193,324 |
Taxes (35%) | $58226 | $67,663 |
Net income | $108,134 | $125,661 |
Hence, net income increased at the rate of 15%.
Compute dividend and addition to retained earnings:
Dividend and addition to retained earnings for the rate of 15% sales growth:
Hence, dividend and addition to retained earnings is $41,468 and $84,193.
Pro forma balance sheet after adjusting 15% of growth rate
Pro forma balance sheet | |||
Assets |
Amount ($) | Liabilities |
Amount ($) |
Current assets: | Current liabilities: | ||
Cash | $27,922 | Accounts payable | $74,980 |
Accounts receivable | $42,631 | Notes payable | $16,320 |
Inventory | $95,910 | ||
Total | $166,463 | Total | $91,300 |
Fixed assets: | Long-term debt | $155,000 | |
Net plant and equipment | $455,975 | Owner's equity: | |
Common stock and paid in surplus | $130,000 | ||
Retained earnings | $258,923 | ||
Total owner’s equity | $388,923 | ||
Total | $622,438 | Total | $635,223 |
The difference between the total assets and the total liabilities and owner’s equity is termed as external financing needed.
Hence, external financing needed at the rate of 15% growth rate is -$12,785.
Pro forma income statement at 20% growth rate
Pro forma income statement | ||
Particulars |
Current Year Amount ($) |
Amount ($) (20%) |
Sales | $891,600 | $1,069,920 |
Costs | $693,600 | $832,320 |
Other expenses | $18,240 | $21,888 |
EBIT | $179,760 | $215,712 |
Interest paid | $13,400 | $13,400 |
Taxable income | $166,360 | $202,312 |
Taxes (35%) | $58226 | $70,809 |
Net income | $108,134 | $131,503 |
Hence, the income increased at the rate of 20%.
Dividend and addition to retained earnings for the rate of 20% sales growth:
Hence, dividend and addition to retained earnings is $43,396 and $88,107.
Pro forma balance sheet after adjusting 20% of growth rate
Pro forma balance sheet | |||
Assets |
Amount ($) | Liabilities |
Amount ($) |
Current assets: | Current liabilities: | ||
Cash | $29,136 | Accounts payable | $78,240 |
Accounts receivable | $44,484 | Notes payable | $16,320 |
Inventory | $100,080 | ||
Total | $173,700 | Total | $94,560 |
Fixed assets: | Long-term debt | $155,000 | |
Net plant and equipment | $475,800 | Owner's equity: | |
Common stock and paid in surplus | $130,000 | ||
Retained earnings | $262,837 | ||
Total owner’s equity | $392,837 | ||
Total | $649,500 | Total | $642,397 |
The external financing needed is determined by the difference of the total assets and the total liabilities and owner’s equity.
Hence, external financing needed at the rate of 20% growth rate is $7,103.
Pro forma income statement at 25% growth rate
Pro forma income statement | ||
Particulars |
Current Year Amount ($) |
Amount ($) (25%) |
Sales | $891,600 | $1,114,500 |
Costs | $693,600 | $867,000 |
Other expenses | $18,240 | $22,800 |
EBIT | $179,760 | $224,700 |
Interest paid | $13,400 | $13,400 |
Taxable income | $166,360 | $211,300 |
Taxes (35%) | $58226 | $73,955 |
Net income | $108,134 | $137,345 |
Dividend and addition to retained earnings for the rate of 25% sales growth:
Hence, dividend and retained earnings is $45,324 and $92,021.
Pro forma balance sheet after adjusting 25% of growth rate
Pro forma balance sheet | |||
Assets |
Amount ($) | Liabilities |
Amount ($) |
Current assets: | Current liabilities: | ||
Cash | $30,350 | Accounts payable | $81,500 |
Accounts receivable | $46,338 | Notes payable | $16,320 |
Inventory | $104,250 | ||
Total | $180,938 | Total | $97,820 |
Fixed assets: | Long-term debt | $155,000 | |
Net plant and equipment | $495,625 | Owner's equity: | |
Common stock and paid in surplus | $130,000 | ||
Retained earnings | $266,751 | ||
Total owner’s equity | $396,751 | ||
Total | $676,563 | Total | $649,571 |
The external financing needed is determined by the difference of the total assets and the total liabilities and owner’s equity.
Hence, external financing needed at the rate of 25% growth rate is $26,992.
To discuss: The relationship between external financing and growth rate.
Explanation of Solution
The relationship of external financing and growth rate is a primary element in the area of financial planning.
- The firm maintains 100% capacity utilization to make the things easy and simple.
- When growth rate is at 15% the EFN is negative, this shows the company has more funds.
- When growth rate at 20% and 25% the EFN is positive, this indicates the company needs additional financing for the upcoming period.
To determine: The rate at which EFN is zero.
Explanation of Solution
The rate at which external financing needed is zero at 15% growth rate. As the difference of total assets and total liabilities of external financing needed at the rate of 15% growth rate is -$12,785 this shows that EFN is zero since it exceeds the liabilities.
To discuss: Reason for the difference of internal growth using graphical method and equation method.
Explanation of Solution
The (ROA x b) is the element which is used throughout the text. This is based on the ROA using ending balance sheet numbers of assets and beginning balance sheet number of assets whereas the internal growth rate and ROA calculated by the equations on a abbreviated form is based on the assets which will not exists once the net income earned.
Thus, the rate 15% at which the company external financing needed is negative. Negative external financing needed indicates that the company has more funds which can be used to reduce current liabilities, debts etc. Thus, these are the graphical relationship between external financing needed and growth rates.
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