*Pharma Biotech is interested in developing an initial “big picture” of the size of financing that might be needed to support its rapid growth objectives for 2014 and 2015.*

* *

*Calculate the following financial ratios (as covered in Chapter 5) for Pharma Biotech for 2013: (a) net profit margin, (b) sales-to-total-assets ratio, (c) equity multiplier, and (d) total-debt-to-total-assets. Apply the return on assets and return on equity models. Discuss your observations.*

- Net profit margin:

= Net Profit / Sales

= 960/15,000

= 0.0640

= 6.40%

- Sales-to-total-assets:

= Sales / Total Assets

= 15,000/12,000

= 1.2500

- Equity multiplier:

= Total Assets / Owners Equity

= Total Assets / (Assets – (Total Current Liabs + Long Term Debt))

= 12,000/5,200

= 2.3077 times

Total common equity =2,400 + 2,800 = 5,200

- Total-debt-to-total assets:

= Total Debt / Total Assets

= (Total Current Liabs + Long Term Debt) / 12000

= (4,600 + 2,200)/12,000

= 6,800/12,000

= 0.5667

= 56.67%

See previous workings for the ROA and ROE calculations.

ROA Model = 6.40% * 1.2500 = 8.00% [check: 960/12,000 = 8.00%]

ROE Model = 6.40% * 1.2500 * 2.3077 = 18.46% [check: 960/5,200 = 18.46%]

Therefore, we can claim that Pharma Biotech’s net profit margin is less than double digits. With a bit of luck the venture grows the net profit margin might increase through the spreading of fixed costs. Sales-to-total-assets is greater than 1.00 times. Fast growth high tech firms could be expected to ameliorate this ratio as sales augment over time. Through the use of financial leverage, the 8.00% ROA has improved to an 18.46% ROE.

*Estimate Pharma’s sustainable sales growth rate based on its 2013 financial statements. [Hint: You need to estimate the beginning of period stockholders’ equity based on the information provided.] What financial policy change might Pharma Biotech make to improve its sustainable growth rate? Show your calculations.*

Beginning stockholders’ equity

= ending stockholders’ equity – added 2013 retained earnings

= (2,400 + 2,800) – 576

= 5,200 – 576

= 4,624

Growth equals:

= ROE x (1 – dividend-payout ratio) (The DPR is on the income statement at 40%)

= ((Net Income/Sales) * (Sales/Total Assets) * (Total Assets/Stockholders Equity)) * (1 – 0.40)

= ((960/15,000) * (15,000/12,000) * (12,000/4,624)) * (1 – 0.40)

= (0.064 * 1.2500 * 2.5952) * 0.6

= 0.1246

= 12.46%

Thus, the payment of cash dividends at a 40% of net income rate limits Pharma Biotech from being capable of growth more quickly without having to issue more equity capital. For instance, a policy of no cash dividends payout can result in a higher sustainable sales growth rate of: 20.76%

Growth = 0.064 x 1.2500 x 2.5952 x 1.00 = 0.2076 = 20.76%

*Estimate the additional funds needed (AFN) for 2014, using the formula or equation method presented in the chapter.*

2014 sales

= 15,000 * 1.50 = 22,500 (2013 sales plus a 50% increase)

Change in sales

= 22,500 – 15,000

= 7,500

Retention Rate (RR)

= 1 – Dividend Payout Ratio

= 1 – 0.40

= 0.60

AFN 2014

= Required Increase In Assets – Spontaneously Generated Funds – Increase In Retained Earnings

= ((Total Assets/Sales) * Change In Sales)) – (((Accounts Payable + Accrued Liabilities)/Sales) * (Change In Sales)) – ((2014 Sales) * (Net Income/Sales) * (RR))

= ($12,000/$15,000) * $7,500 – (($1,600 + $1,200)/$15,000) * $7,500) – $22,500 * ($960/$15,000) * 0.60

= 0.8000($7,500) – 0.1867($7,500) – $22,500(0.0640)*(0.60)

= $6,000 – $1,400 – $864

= $3,736

*Also, estimate the AFN using the equation method for Pharma Biotech for 2015. What will be the cumulative AFN for the two-year period?*

2014 Sales

= 22,500 (from Part C)

2015 Sales

= 22,500 * 1.80 (80% on top of 2014 sales)

= 40,500

Change in Sales

= 40,500 – 22,500

= 18,000

2014 Net Profit

= 22,500 * 0.064

= 1,440

2014 Total Assets

= 12,000 x 1.50

= 18,000

2014 Non-Interest Bbearing Current Lliabilities

= (Accounts Payable + Accrued Liabilities * 1.5)

= (1,600 + 1,200) * 1.50

= 4,200

AFN 2015

= Required Increase In Assets – Spontaneously Generated Funds – Increase In Retained Earnings

= ((Total Assets/Sales) * Change In Sales)) – (((Accounts Payable + Accrued Liabilities)/Sales) * (Change In Sales)) – ((2015 Sales) * (Net Income/Sales) * (RR))

= ((18,000/22,500) * 18,000) – ((4,200/22,500) * 18,000)) – 40,500 * ((1,440/22,500) * (1 – 0.40))

= 0.80(18,000) -0.1867(18,000) – 2,592(0.6)

= 14,400 – 3,361 – 1,555

= 9,484

Cumulative two-year (2014 & 2015) AFN

= $3,736 + $9,484

= $13,220

Total Net Sales

= $22,500 + $40,500

= $63,000

Total change in Net Sales

= $40,500 – $15,000

= $25,500

Total AFN

= 0.8000*($25,500) – 0.1867*($25,500) – $63,000*(0.0640)*(0.60)

= $20,400 – $4,761 – $2,419

= $13,220