Question

For the next fiscal year, you forecast net profit of and ending assets of . Your firm’s payout ratio is . Your beginning shareholders’ equity is and your beginning total liabilities are . Your non-debt liabilities such as accounts payable are forecasted to increase by .

You begin with in debt. Ultimately, calculate the amount of new debt and new equity that has to be issued in new financing to maintain a constant debt to equity ratio. Answer the following questions to do so.
a) What is the initial debt ratio? % (Give answer as percentage to 2 decimal places)
b) What is total debt and equity at the end of next year (i.e. excluding non-debt and non-equity items)? $ (Give answer to nearest $)

Answer 1

To maintain a constant debt to equity ratio, we need to calculate the initial debt ratio and then determine the new debt and new equity required. The total debt and equity at the end of the next year can then be calculated by adding the new debt and new equity to the beginning debt and shareholders' equity respectively.

Step-by-step explanation:

To calculate the amount of new debt and new equity that needs to be issued to maintain a constant debt to equity ratio, we first need to determine the initial debt ratio. The initial debt ratio can be calculated by dividing the total debt by the sum of total debt and equity. In this case, the initial debt ratio would be calculated as follows: (beginning total liabilities + beginning debt) / (beginning total liabilities + beginning shareholders' equity + beginning debt).

Once we have the initial debt ratio, we can use it to determine the new debt and new equity required to maintain a constant debt to equity ratio. We can calculate the new debt by multiplying the forecasted net profit by the payout ratio and subtracting the increase in non-debt liabilities. The new equity can be calculated by subtracting the new debt from the forecasted ending assets and adding the beginning shareholders' equity. The total debt and equity at the end of the next year can be calculated by adding the new debt and new equity to the beginning debt and beginning shareholders' equity respectively.