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Alternative Example 8

Rising Star Inc. forecasts sales increases of $250,000, $275,000, and $300,000 over the next three years. It estimates net working capital needs based on percentages of the sales increases: cash requirements at 5%, inventory at 7%, receivables at 10%, and payables at 8%. The forecasted increase in net working capital over the three years is $35,000 in year 1, $38,500 in year 2, and $42,000 in year 3.

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69 views4 pages

Alternative Example 8

Rising Star Inc. forecasts sales increases of $250,000, $275,000, and $300,000 over the next three years. It estimates net working capital needs based on percentages of the sales increases: cash requirements at 5%, inventory at 7%, receivables at 10%, and payables at 8%. The forecasted increase in net working capital over the three years is $35,000 in year 1, $38,500 in year 2, and $42,000 in year 3.

Uploaded by

attique
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Q3 Part

• Problem
• Rising Star Inc is forecasting that their sales will increase by
$250,000 next year, $275,000 the following year, and
$300,000 in the third year. The company estimates that
additional cash requirements will be 5% of the change in
sales, inventory will increase by 7% of the change in sales,
receivables will increase by 10% of the change in sales, and
payables will increase by 8% of the increase in sales.
Forecast the increase in net working capital for Rising Star
over the next three years.
Alternative Example 8.4 (cont’d)
• Solution
• The required increase in net working capital is shown below:

Year
0 1 2 3
Sales Forecast (increase) $250,000 $275,000 $300,000
Net Working Capital Forecast
Cash Requirements (5% of sales) $12,500 $13,750 $15,000
Inventory (7% of sales) $17,500 $19,250 $21,000
Receivables (10% of sales) $25,000 $27,500 $30,000
Payables (8% of sales) $20,000 $22,000 $24,000
Net Working Capital $35,000 $38,500 $42,000
Q3 Part B
Warren Supply Inc. is evaluating its capital budget. The company finances with debt and common equity, but because of market
conditions, wants to avoid issuing any new common stock during the coming year. It is forecasting an EPS of $3.00 for the coming
year on its 500,000 outstanding shares of stock. Its capital budget is forecasted at $800,000, and it is committed to maintaining a
$2.00 dividend per share. Given these constraints, what percentage of the capital budget must be financed with debt?
Q3 Part B
Answer:37.5%
Explanation: Given:
Earnings per share, EPS = $3.00 Outstanding shares of stock = 500,000
Capital budget = $800,000
Dividend per share = $2.00 Now,
The  total earning of the Warren Supply Inc. = EPS × Outstanding shares or
Total earning of the Warren Supply Inc. = $3.00 × 500,000 = $1,500,000
Total Dividends paid = Dividend per share × Outstanding shares
or Total Dividends paid = $2.00 × 500,000 = $1,000,000
Therefore, the total retained earnings = Total earning - Total Dividends paid or the total retained earnings
= $1,500,000 - $1,000,000  = $500,000
Thus, the capital budget that must be financed with debt= Forecasted capital budget - Total retained earning
= $800,000 - $500,000= $300,000
Hence, the percentage of capital budget that must be financed with debt=  
on substituting the respective values,
we get= Percentage of capital budget that must be financed with debt = 37.5%Read more

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