principles finance week 10

  1. Given the following information:
    Complete the following three problems.

    Total assets


    Debt (12% interest rate)




    Variable costs of production

    $14 per unit

    Fixed cost of production


    Units Sold


    Sales price

    $19.75 per unit

    What happens to operating income and net income if output is increased by 10 percent? Verify your answer.

  1. A firm needs $100 to start and has the following expectations:





    Tax rate

    33% of earnings

    • What are earnings if the owners invest the $100?
    • If the firm borrows $40 of the $100 at an interest rate of 10%, what are the firm’s net earnings?
    • What is the return on the owners’ investment in each case? Why do the returns differ?
    • If expenses rise to $194, what will be the returns in each case?
    • In which case did the returns decline more?
    • What generalization can you draw from the above?
  1. A firm with sales of $5,000 has the following balance sheet:

Assets, Liabilities and Equity as of xx/xx/xx


Liabilities and Equity

Accounts receivable


Accounts payable




Long-term debt










The firm earns 20 percent on sales and expects those sales to rise to $5,500. The increased sales may require additional financing. Accounts receivable and inventory will increase, and trade accounts will also spontaneously increase with the increase in sales. Management expects to distribute 75% of earnings.

  1. Determine the new balance sheet entries for those assets and liabilities that spontaneously change with the level of sales using the percent of sales technique. (Accounts receivable, inventory, and accounts payable vary with sales; the other entries do not). Round off to nearest percentage point, such as 22% or .22.
  2. Will the firm need external financing to achieve sales of $5,500?
  3. Construct the pro forma balance sheet for sales of $5,500. Any new financing should be obtained by issuing new long‑term debt. Any excess funds should be held in cash.
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