Learning objective: Apply the percent of sales method to creating pro forma income statement and balance sheet.

Due date: March 13th, 11:59 pm on Blackboard Percent of sales method

• The first step in to express the balance of an accounting item in the income statement or balance sheet as a percent of current sales revenue. Then multiply that percentage by the projected sales revenue to arrive the projected amount for an accounting item in the coming year. For example, IMCs costs except depreciation were $56,800, which accounted for 94.67% of current years sales revenue ($56,800/$60,000 = 94.67%). The projected costs except depreciation for the upcoming year will be 94.67% x $75,000 (the projected sales revenue) = $71,000.

• Some of the accounting items expressed as a percentage of sales are meaningless. This is because either the balance of the accounting item remains unchanged or its proportional change does not correspond to the percentage change in sales. We put a n.a. in the percentage column.

• We assume that IMC dividend payout ratio remains unchanged for the coming year. Given the $117 dividends and net income of $390 from the income statement, we know that its dividend payout ratio is cash dividend / net income = $117/$390 = 30%. This implies that IMCs retention ratio is 70%, as the sum of the dividend payout and retention ratios equals to 100%.

• The textbook provides the formula for the projected retained earnings. The projected retained earnings

  = The retained earnings from the past year + projected net income projected cash dividends to be paid

  Therefore, you will use the dividend payout ratio in the calculations.

• You will find that the pro forma balance sheet is imbalanced as total assets are not equal to total

  liabilities and stockholders equity. If the projected total assets exceed projected total liabilities and stockholders equity, this indicates that external financing is needed. Please compute the needed amount from external financing.

  Explanations for each item have been inserted as notes in the Excel file.

International Motor Corporation Income Statement in millions) For the year of 2019 International Motor Corporation Pro forma Income Statement (in millions) For the year of 2020 Percentage of Sales $ $ $ $ 5 Sales 6 Costs except depreciation 7 EBITDA 8 Depreciation 9 EBIT 10 Interest expense 11 Pretax income 12 Income taxes (35%) 13 Net income 14 Dividends 15 Addition to retained earnings 60,000.00 56,800.00 3,200.00 1,200.00 2,000.00 1,400.00 600.00 210.00 390.00 Sales Costs except depreciation EBITDA Depreciation EBIT Interest expense Pretax income Income taxes (35%) Net income $ n.a. $1,400.00 na. na na. 117.00 273.00 16