Question

Use the below information to answer the following question.

Income Statement
For the Year
Sales $42,700
Cost of goods sold 29,250
Depreciation 3,750

Earnings before interest and taxes $ 9,700
Interest paid 1,360

Taxable income $ 8,340
Taxes 2,840

Net income $ 5,500

Dividends $1,925


Balance Sheet
End-of-Year
Cash $1,320
Accounts receivable 3,780
Inventory 10,200


Total current assets $15,300
Net fixed assets 33,600


Total assets $48,900


Accounts payable $ 3,650
Long-term debt 18,100
Common stock ($1 par value) 15,000
Retained earnings 12,150


Total Liab. & Equity $48,900

What are the pro forma retained earnings for next year if this firm grows at a rate of 3.6 percent and both the profit margin and the dividend payout ratio remain constant?

Answer 1

To calculate the pro forma retained earnings for next year, you grow the current net income and dividends by the growth rate of 3.6% and subtract the grown dividend from the grown net income, then add it to the current retained earnings, resulting in $15,852.70.

Step-by-step explanation:

The pro forma retained earnings for next year can be calculated using the growth rate and keeping the profit margin and dividend payout ratio constant. To begin with, we calculate the net income growth by applying the 3.6% growth rate to the current net income:

Net income growth = $5,500 * (1 + 3.6%) = $5,500 * 1.036 = $5,698.

We then calculate the dividends that will be paid out using the given dividend payout ratio. Since there is no change in the ratio, the dividends can be grown at the same rate:

Dividends growth = $1,925 * (1 + 3.6%) = $1,925 * 1.036 = $1,995.30.

Finally, we find the new retained earnings by adding the retained earnings of this year to the growth in net income subtracting the growth in dividends paid:

Pro forma retained earnings = $12,150 + ($5,698 - $1,995.30) = $12,150 + $3,702.70 = $15,852.70.