Conn Man’s Shops, a national clothing chain, had sales of \(350 million last year. The business has a steady net profit margin of 9 percent and a dividend payout ratio of 25 percent. The balance sheet for the end of last year is shown next. The firm’s marketing staff has told the president that in the coming year

there will be a large increase in the demand for overcoats and wool slacks. A

sales increase of 20 percent is forecast for the company.

BALANCE SHEET End of year (in \) million)
Assets		Liabilities and Stockholder’s equity
Cash	\(25	Accounts payable	\)64
Accounts receivable	40	Accrued expenses	31
Inventory	82	Other payables	45
Plant and equipment	133	Common stock	50
		Retained earnings	90
Total assets	\(280	Total liabilities and stockholder’s equity	\)280

All balance sheet items are expected to maintain the same percent-of-sales relationships as last year,* except for common stock and retained earnings. No change is scheduled in the number of common stock shares outstanding, and retained earnings will change as dictated by the profits and dividend policy of the firm. (Remember the net profit margin is 9 percent.)

b. What would be the need for external financing if the net profit margin went up to 10.5 percent and the dividend payout ratio was increased to 60 percent? Explain.

Step by step solution

01

Change in sales

$\begin{array}{rcl}\mathrm{Change}\mathrm{in}\mathrm{sales}& =& \mathrm{Existing}\mathrm{sales}\times \mathrm{Growth}\mathrm{ratio}\\ & =& \$350\mathrm{million}\times 20\%\\ & =& \$70\mathrm{million}\end{array}$

02

Assets to sales ratio

$\begin{array}{rcl}\mathrm{Assets}\mathrm{to}\mathrm{sales}\mathrm{ratio}& =& \frac{\mathrm{Total}\mathrm{assets}}{\mathrm{Sales}}\\ & =& \frac{\$280\mathrm{million}}{\$350\mathrm{million}}\\ & =& 0.80\end{array}$

03

Liabilities to sales ratio

$\begin{array}{rcl}\mathrm{Liabilities}\mathrm{to}\mathrm{sales}\mathrm{ratio}& =& \frac{\mathrm{Liabilities}}{\mathrm{Sales}}\\ & =& \frac{\left(\$64+\$31+\$45\right)\mathrm{million}}{\$350\mathrm{million}}\\ & =& 0.40\end{array}$

04

New sales level

$\begin{array}{rcl}\mathrm{New}\mathrm{sales}\mathrm{level}& =& \mathrm{Existing}\mathrm{sales}+\mathrm{Increase}\mathrm{in}\mathrm{sales}\\ & =& \$350\mathrm{million}+\$70\mathrm{million}\\ & =& \$420\mathrm{million}\end{array}$

05

Required new funds

$\begin{array}{rcl}\mathrm{Required}\mathrm{new}\mathrm{funds}& =& \left(\mathrm{Assets}\mathrm{to}\mathrm{sales}\mathrm{ratio}\times \mathrm{Change}\mathrm{in}\mathrm{sales}\right)-\left(\mathrm{Liabilities}\mathrm{to}\mathrm{sales}\mathrm{ratio}\times \mathrm{Change}\mathrm{in}\mathrm{sales}\right)-\left(\mathrm{Profit}\mathrm{margin}\times \mathrm{New}\mathrm{sales}\mathrm{level}\right)\left(1-\mathrm{Dividend}\mathrm{payout}\mathrm{ratio}\right)\\ & =& \left(0.80\times \$70\mathrm{million}\right)-\left(0.40\times \$70\mathrm{million}\right)-\left(0.105\times \$420\mathrm{million}\right)\left(1-0.60\right)\\ & =& \$56\mathrm{million}-\$28\mathrm{million}-\$17.64\mathrm{million}\\ & =& \$10.36\mathrm{million}\end{array}$

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