Question 1) In November of each year the CFO of Barker Electronics begins the financial forecasting process to determine the firm's projected needs for new financing during the coming year. Barker is a small electronics manufacturing company located in Moline, Illinois, which is best known as the home of the John Deere Company. The CFO begins the process with the most recent year's income statement, projects sales growth for the coming year, and then estimates net income and finally the additional earnings he can expect to retain and reinvest in the firm. The firm's income statement for 2007 follows
(in $000 ):
Sales $ 1,500
Cost of goods sold (1,050)
Gross Profit $ 450
Operating costs (225)
Depreciation expense (50)
Net operating profit $ 175
Interest Expense (10)
Earnings before taxes $ 165
Taxes (58)
Net Income $ 107
Dividends $ 20
Addition to retained earnings 87
The electronics business has been growing rapidly over the past 18 months as the economy recovers, and the CFO estimates that sales will expand by 20 percent in the next year. In addition, he estimates the following relationships between each of the income statement expense items and sales:
COGS/sales 70%
Operating expenses/sales 15%
Depreciation expense ($000) $ 50
Interest Expense ($000) $ 10
Tax rate 35%
Note that for the coming year both depreciation expense and interest expense are projected to remain the same as in 2007:
A) Estimate Barker's net income for 2008 and its addition to retained earnings under the assumption that the firm leaves its dividends paid at the 2007 level.
B) Reevaluate Barker's net income and addition to retained earnings where sales grow at 40 percent over the coming year. However, this scenario requires the addition of new plant and equipment in the amount of $100,000, which increases annual depreciation to $ 58,000 per year, and interest expense rises to $ 15,000.