The most recent financial statements for REM Co. are shown below. Assets and costs are proportional to sales. Debt is not. A dividend of $90 was paid, and REM wishes to maintain a constant payout to net income. Next year's sales are projected to be $480. What is external funds needed (EFN)?

Question

The most recent financial statements for REM Co. are shown below.  Assets and costs are proportional to sales. Debt is not. A dividend of $90 was paid, and REM wishes to maintain a constant payout to net income. Next year's sales are projected to be $480. What is external funds needed (EFN)?

Quizplus · Accepted Answer

To calculate EFN, we need to use the following formula:
EFN = (A*/S)*ΔS - (L*/S)*ΔS - MS1*(1 - Payout ratio)*ΔS
Where A* is the assets-to-sales ratio, L* is the spontaneous liabilities-to-sales ratio, and MS1 is the initial profit margin.

First, we need to calculate the assets-to-sales ratio:
A/S = Total assets / Sales = $960 / $400 = 2.4
We are told that assets and costs are proportional to sales, so we can assume that A/S will remain constant, even with the increase in sales. Therefore, A*/S = 2.4.

Next, we need to calculate the spontaneous liabilities-to-sales ratio:
L*/S = (Accounts payable + Accrued expenses) / Sales = ($120 + $60) / $400 = 0.45
Like A/S, we can assume that L*/S will remain constant, so we can use this value for next year's calculations.

We are told that debt is not proportional to sales, so we do not need to consider any changes to the debt level.

Finally, we need to calculate the initial profit margin:
Profit margin = Net income / Sales = $120 / $400 = 0.3
MS1 = 0.3

Now we can calculate EFN:
EFN = (A*/S)*ΔS - (L*/S)*ΔS - MS1*(1 - Payout ratio)*ΔS
EFN = (2.4)*($480 - $400) - (0.45)*($480 - $400) - (0.3)*(1 - 90/120)*($480 - $400)
EFN = $168

Therefore, the external funds needed are $168. The correct answer is D.

The Most Recent Financial Statements for REM Co