{iv -6w Datarable .:r.:tt t at?.;,4../,,:.,t .::.:::tt.,a .r'L::l;.:!l;::lilll!i;1111': ).. a:,..:af:aa 1r,i'.al : :: 4.1, :.:,' :.t: :.:.\ :r.r:l:lt:aL.ar,.:,')r,,i tattt::,,:::a Current assets Net fixed assets Total $12,090,000 17,730,000 $29,820,000 Current assets Net frxed assets Total Accounts payable $2,030,000 Accounts payable Accrued expenses 1,980,000 Accrued expenses Notes payable 1,410,000 Notes payable Current liabilities Long-term debt Total liabilities Common stock (par) Paid-in capital Retained earnings $5,420,000 6,450,000 $l1,870,000 930,000 2,080,000 14,940,000 Current liabilities Long-term debt Total liabilities Common stock (par) Paid-in capital Retained earnings $24,180,000 35,460,000 $59,640,000 $4,060,000 3,960,000 1,410,000 $9,430,000 6,450,000 s15,890,000 930,000 2,080,000 14,940,000 Common equity $17,950,000 Common equity $ 17,950,000 Total $29,820,000 Projected sources of financing $33,830,000 Discretionary financing needs Total financing needs: Total assets Page I Qu6floJ $ Sales 45,708,000 (22,815,000) Variable costs $ Revenue before fixed costs Fixed costs 22,893,000 , $ EBIT (9,230,000) 13,663,000 (1,393,000) Interest expense $ Earnings before taxes 12,270,000 (6,135,000) Taxes (50Yo) $ Net income Page I 6.135,000 ( nvx',, Pl7-l (similar to). a.efr.rJ (Ffuancial forecasting) Zapateru Enterprises is evaluating its financing requirements for the coming year. The frm has only been in business for one year, but its CFO predicts that the firm's operating expenses, current assets, net fixed assets, and current liabilities will remain at their currentproportion ofsales. ^ / Last year iapateruhad@miflion in sales wi.t! net income of ${mi[ion. The firm arrticipates that next yef,fs sales will reach $ffi6mi11ion with o"fircrm" risrng to-ry#million. Given its present high rate of growth, the firm retains all of its earnings to help defray the cost of new invesffients. The firm's balance sheet for the year just ended is as followt, i,H};. Estimate Zapatera's total financing requirements (total assets) and its net funding requirernents (discretionary financingneeded) far2014. Nofe: Use the percentage of sales given in Zapatera Enterprises' balance sheet for 201 3. The 2014 retained earnings are $[. (Round to the nearest dollar.) Complete the pro fonna balance sheet for 2014 below: (Round to the nearest dollar.) T.apater a Enterpris es, In c. tzlSlltl Pro forma Balance Sheet Currentassets $l I Net fixed assets Total Liabilities and Owners' Equif Accounts payable Long-term debt Total liabilities Common stock Paid-in capital Retained eamings Common equity t"trt *E Zapatera's total financing requirements (total assets) for 2014 *" $[. (Round to the nearest dollar.) Zapatera-snet funding requirements (discretionary financing needed) for the nearest dollar.) Page I Z}l4rre $[. (Round to Data Table Zapatcra Enterprlses, Int. Current assets 3,300,000 Net fixed assets 6,000,000 9,300,000 Total Liabilities and Owners- Equif Accounts payable 3,500,000 29.81% Long-term debt l,90o,ooo NAU Commoa stock l,3oo,oo0 NAU Paid-in capital 2,200,000 NAA Total liabilities 400,000 Retained earnings Commoncquity 3,900,000 Total NAe. This figure does not vary directly with sale,s and is assumed for purposes of forec'asting n€xt yeads financing requirements. Page I to remain cmstant ToN Qm-ltct.l (Leverage and EPS) You have developed the following pro forma income statement for your corporation: im,. It represents the most recent year's operations, which snded yesterday. Your zupervisor in the controller's office has just handed you a memorandum asking for written responses to the following questions: .-. a. If sales should increase by 30 percent, by what percent would earnings before interest and taxes and net income increase? b. If sales should decrease by 30 percent, by what percent would earnings before interest and taxes and net income decrease? c. If the firm were to reduce its reliance on debt financing such that interest expense were cut in half, how would this affect your answers to parts a and b? STEP 1: Picture the Problem Finaneial leverage has the effect of magnifying the effects of changes in the firm's eamings in response to changes in the fir:n's sales and operating income. STEP 2: Decide on a Solution Strategy We can calculate earnings before interest and taxes and net income under different scenarios by completing the following income staternent: Sales Variable costs Revenue before fixed costs Fixed costs EBIT Interest expense Earnings before taxes Taxes (50%) Net income a. If sales should increase by 30Yo, by what percent would earnings before interest and taxes and net income increase? STEP 3: Solve We complete the company's income statementunder a30Yo sales increase scenario: Sales Variable costs $ 59,491,900 (29,694,600) Page 1 $ Revenue before fixed costs 29,797,300 (9,213,000) Fixed costs s EBIT 20,584,300 (1,362,000) Interest expense $ Earnings before taxes 19,222,300 (9,61I,150) Taxes (50%) $ Net income 9.611.150 The percentage change in earnings before interest and taxes is: Percentage Change in Earnings Before hrterest: $20,584,300 - $ 13,708,000 :0.5015:50.16% $13,708,000 The percentage change in net income is: Percentage Change in Net b. If sales should decrease decrease? STEP tVe by Income: 30Yo, $9,61 1,150 - $6,173,000 $6,173,000 : 0.5570 = 55.70o/" by what percent would earnings before interest and taxes and net income 3: Solve complete the companls inconne statement under a 3}ort sales deqrease scenario: Sales $ (15,989,400) Variable costs Revenue before fixed costs $ $ $ 5,469,700 (2,734,95O\ Taxes (50olo) Net income 6,831,700 (1,362,000) Interest expense Earnings before taxes 16,044,700 (9,213,000) Fixed costs EBIT 32,A34.J0A $ 2,734.8sA Page2 Percentage Change in Earnings Before $6,831 ,700 - $ 13,709,000 _ Interest: $13J0g60 -: - 0"5016: - 50"16% The percentage change in net income is: Percentage Change in Net Income : 92,7 34,850 - $6, I 73,000 $6,173,000 : -0.5570: -55.70o/o c. If the firm were to reduce its reliance on debt financing such tlat interest expense were cut in half, how would this affect your answers to parts a and b? STEP 3: Solve We complete the company's income statement under a3oo/o sales increase and 50% interest expense decrease scenario: $ Sales Variable costs 59,491,900 Q9,694,600) Revenue before fixed costs g 29,797,300 (9,213,000) Fixed costs $ EBIT 20,584,300 (681,000) Interest expense Ea:nings before taxes $ 19,903,300 (9,951,650) Taxes (50olo) $ Net income 9.951.650 The percentage change in earnings before interest and taxes is: Percentage Change in Earnings Before s20,584,300 - $13,709,000 _ :0.5016: 50.16% Interest $l3J0gp00 The percentage change in net income is: Percentage Change in Net We complete tle Sales Variable costs $9,951,650 - $6,173,000 _ : 0.6121 : 6l.2lYa Income: S6J?3$00 company's income statement under a30Yq sales decrease and 50olo expense decrease scenario: s 32,034,100 (15,999,400) Page 3 Revenue before fixed costs costs EBIT lnterest expense Eamings before taxes Taxes (sOYr) Net income $ 16,044,700 (9,213,000) Fixed $ 6,831,700 (681,000) S 6,150,700 (3,075,350) $ 3,075.350 The percentage chaoge in earnings before interest and taxes is: _ $6,831,700-$13,708,000 PercentageChangeinEarningsBeforetrnterest: $13J0gp00 : -0.5016: - 5A.l6Y. The percentage change in net income is: _ STEP - $6,173,000 : S6J?3S00 -0.5018: $3,075,350 PercentageChangeinNetlncome: -50.18o/o 4: Analyze If sales increase 3OYo, and assuming that variable costs remain at$22,842,000 / $45,763,000:49.91368573% of sales, then we find that net income rises 55.70%, while EBIT rises 50.16%. The effect on net income is magnified, since the interest charges incurred by the firm do not rise as EBIT rises. We see these effects in reverse when sales fall by 30%. The larger effect on net income is an example of the leverage effect. If the firm reduces its leverage, it will change this leverage effect. The effects on EBIT are unaffected, of course, but now lve see that net income rises 61.21% (more than the initial 55.70yo) when sales rise by 3oo/o, and falls 50.18% (less than the initial 55.7$yo) when sales fall30Yo. With lower interest charges, more of the firm's operating cash flows flow through to the equityholders. Data Table $ Sales (22,942,000\ Variable costs Revenue before fixed costs $ 22,921,000 (9,213,000) Fixed costs $ EBIT 13,708,000 (1,362,000) Interest expense Earnings before 45,763,000 taxes Page4 $ 12,346,000 Taxes (50%) (6,173,000) $ Net income Page 5 6.173.000