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CHAPTER 4 - 16
So the EFN is:
25. First, we need to calculate full capacity sales, which is:
The fixed assets required at full capacity sales is the full capacity ratio times the projected sales
level:
26. The D/E ratio of the company is:
CHAPTER 4 - 17
The pro forma balance sheet with the new long-term debt will be:
FLEURY INC.
Pro Forma Balance Sheet
Assets Liabilities and Owners’ Equity
The funds raised by the debt issue can be put into an excess cash account to make the balance sheet
balance. The excess debt will be:
CHAPTER 4 - 18
FLEURY INC.
Pro Forma Balance Sheet
The excess cash has an opportunity cost that we discussed earlier. Increasing fixed assets would also
not be a good idea since the company already has enough fixed assets. A likely scenario would be the
repurchase of debt and equity in its current capital structure weights. The company’s debt-assets and
equity assets are:
CHAPTER 4 - 19
FLEURY INC.
Pro Forma Balance Sheet
Assets Liabilities and Owners’ Equity
27. The pro forma income statements for all three growth rates will be:
FLEURY INC.
Pro Forma Income Statement
We will calculate the EFN for the 15 percent growth rate first. Assuming the payout ratio is constant,
the dividends paid will be:
CHAPTER 4 - 20
The new retained earnings on the pro forma balance sheet will be:
The pro forma balance sheet will look like this:
15% Sales Growth:
FLEURY INC.
Pro Forma Balance Sheet
Assets Liabilities and Owners’ Equity
So the EFN is:
At a 20 percent growth rate, and assuming the payout ratio is constant, the dividends paid will be:
CHAPTER 4 - 21
The pro forma balance sheet will look like this:
20% Sales Growth:
FLEURY INC.
Pro Forma Balance Sheet
Assets Liabilities and Owners’ Equity
So the EFN is:
At a 25 percent growth rate, and assuming the payout ratio is constant, the dividends paid will be:
CHAPTER 4 - 22
25% Sales Growth:
FLEURY INC.
Pro Forma Balance Sheet
Assets Liabilities and Owners’ Equity
So the EFN is:
28. The pro forma income statements for all three growth rates will be:
FLEURY INC.
Pro Forma Income Statement
At a 30 percent growth rate, and assuming the payout ratio is constant, the dividends paid will be:
CHAPTER 4 - 23
FLEURY INC.
Pro Forma Balance Sheet
Assets Liabilities and Owners’ Equity
So the excess debt raised is:
At a 35 percent growth rate, and assuming the payout ratio is constant, the dividends paid will be:
CHAPTER 4 - 24
And the addition to retained earnings will be:
CHAPTER 4 - 25
FLEURY INC.
Pro Forma Balance Sheet
Assets Liabilities and Owners’ Equity
29. We need the ROE to calculate the sustainable growth rate. The ROE is:
CHAPTER 4 - 26
30. We know that EFN is:
31. We start with the EFN equation we derived in Problem 30 and set it equal to zero:
CHAPTER 4 - 27
To derive the sustainable growth rate, we must realize that to maintain a constant D/E ratio with no
external equity financing, EFN must equal the addition to retained earnings times the D/E ratio:
32. In the following derivations, the subscript “E” refers to end of period numbers, and the subscript “B”
refers to beginning of period numbers. TE is total equity and TA is total assets.
CHAPTER 4 - 28
We multiply this equation by:
