Style's Pro Forma Financial Statements Interest rate on new debt 2020 2020 10% Initially keep Interest = Constant and N/P = Constant Transfer cells Ds to Es Let's assume Assumed growth rate in (Sales, Op. Costs, Cash, A/R, Inv, Net PPE, A/P, Accruals) Dividend payout ratio 15% 45% LT Debt Constant DEMONSTRATE HOW GROWTH HAS FINANCIAL IMPLICATIONS Income Statement: 2019 Pro forma 2020 Equity Constant Let's forecast 2020 line items Sales $ 36,000 $ Op costs $ 32,440 $ Adjusted 41,400 $ 41,400 37,306 $ 37,306 Q1. What changed by the same percentage as Sales? 1 EBIT $ 3,560 $ 4,094 $ 4,094 2 Interest $ 560 $ 560 $ 780 3 EBT $ 3,000 $ 3,534 $ 3,314 4 Taxes (40%) $ 1,200 $ 1,414 $ Net inc $ 1,800 $ Divs (45%) Add to RE $ 810 $ 990 $ 2,120 $ 954.18 $ 1,166 $ 1,094 1,326 1,988 Q2. What are the funding sources? 1 2 3 4 895 Q3. HOW CAN WE ACCOUNT FOR ADDED INTEREST? 1) Estimate the following system of equations (NOTE: the following process assumes that all new funds are borrowed at the beginning of the yr) a) Additional interest = additional funds borrowed (AFN) x cost of new borrowing Balance Sheet: 2019 2020 Adjusted b) (1+g) x Total assets = (1+g) x (A/P + Accruals) + (N/P + AFN) + LT debt + common stock + (R/E + Addition to R/E) Assets: c) NI = (Sales Operating costs) x (1-T) - Interest x (1-T) Cash $ 1,080 $ A/R $ 6,480 $ Inv $ 9,000 $ 1,242 $ 7,452 $ 10,350 $ Cur assets $ 16,560 $ 19,044 $ Net PPE $ 12,600 $ 14,490 $ Total assets $ 29,160 $ 33,534 $ 1,242 7,452 10,350 19,044 14,490 33,534 d) Addition to R/E = NI x (1- dividend payout ratio) Liabilities & Equity: A/P $ 4,320 $ 4,968 $ 4,968 Where Accruals $ 2,880 $ 3,312 $ 3,312 N/P $ 2,100 $ 2,100 $ 4,300 Cur liabilities $ 9,300 $ 10,380 $ 12,580 LT debt $ 3,500 $ 3,500 $ 3,500 Common stock $ 3,500 $ 3,500 $ RE $ 12,860 $ Total L&E $ 29,160 $ 14,026 $ 31,406 $ 3,500 13,954 33,534 d In equation a), additional interest depends upon AFN (unknown). In equation b), we have 2 unknown variables, AFN and addition to R/E. Eq. d) shows that addition to R/E depends on NI (which is affected by how much interest is paid. So, substituting equation a) into c) (and therefore into equation d)), we can break this down into 2 equations and 2 unknowns (AFN and addition to R/E). Ultimately, we can define AFN (incorporating financing feedbacks) as: AFN = g(A* -L*) (EBIT)(1 + g)(1 T)(1 d) + I (1 T)(1 d) 1 i(1 T)(1 d) A* = assets that increase proportionally with sales L* = liabilities that increase proportionally with sales g= growth rate in sales EBIT operating income T = tax rate dividend payout ratio lo = interest expense (ignoring any additional financing) i=interest rate on additional funds borrowed AFN Assets - L&E $ 2,200 $ NOTES: Use Tools Solver (add-in) to set Difference cell equal to 0 by changing the AFN cell. Note that total interest relies on the amount of AFN, thus impacting addition to RE. Internal growth rate: Sustainable growth rate: 3.51% 6.44% NI b() TA Internal Growth rate NI Sustainable Growth Rate b(ROE) 1-b(ROE) 1 b Ratio of Liabilities to Equity 78.24% 79.20%