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Upton Computers makes bulk purchases of small computers, stock them in conveniently located warehouses, and ship them to its chain of retail stores
Upton Computers makes bulk purchases of small computers, stock them in conveniently located warehouses, and ship them to its chain of retail stores. Upton's balance sheet as of December 31, 2004, is shown here (millions):
Cash $3.5 Accounts payable $9.0
Receivable 26.0 Notes Payable $18.0
Inventories 58.0 Accruals 8.5
Total Current Assets 87.5 Total Current liabilities 35.5
Net Fixed Assets 35.0 Mortgage Loan 6.0
Common Stock 15.0
Retained Earnings 66.0
Total Assets $122.5 Total liabilities and equity 122.5
Sales for 2004 were $350 million, while net income for the year was $10.5 million. Upton paid dividends of $4.2 million to common stockholders. The firm is operating at full capacity. Assume that all the ratios remain constant.
A. If sales are projected to increase by 70 million, or 20 percent, during 2005, use the Additional Funds Needed equation to determine Upton's projected external capital requirements.
B. Construct Upton's pro forma balance sheet for December 31, 2005. Assume that all external capital requirements are met by bank loans and are reflected in notes payable. Assume Upton's profit margin and dividend payout ratio remain constant.
Expert Solution
Funds are spontaneously generated if a liability account increases spontaneously (automatically) as sales increase. An increase in a liability account is a source of funds, thus funds have been generated. Two examples of spontaneous liability accounts are accounts payable and accrued wages.
Additional funds needed (AFN) are those funds required from external sources to increase the firm's assets to support a sales increase. A sales increase will normally require an increase in assets. However, some of this increase is usually offset by a spontaneous increase in liabilities as well as by earnings retained in the firm. Those funds that are required but not generated internally must be obtained from external sources. Although most firms' forecasts of capital requirements are made by constructing pro forma income statements and balance sheets.
Additional funds need= Increase in assets-Increase in spontaneous liabilities-increase in retained earnings.
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