Telford Engineers Limited, a medium-sized manufacturer of automobile components, has decided to modernize its factory by incorporating a number of robots. These will cost $20 million and will reduce operating costs by $6 million a year for their estimated useful life of 10 years starting next year (Year 10). To finance this plan the business can raise $20 million by either:
issuing 20 million common shares at $1 each, or issuing long-term bonds at 14% interest a year, with capital repayments of $3 million a year commencing at the end of Year 11.
Assumptions for Year 10: the corporate tax rate is 30%;? sales revenue and operating profit will remain unchanged except for the $6 million cost savings; and? Telford Engineers will pay the same dividend per share in Year 10 and in Year 9.
Prepare, for each financing arrangement, Telford Engineers' pro forma income statement including the addition to retained earnings for the year ending December 31, Year 10, and the pro forma long-term debt and shareholders' equity portion of the balance sheet only on that date.
Year 6 Year 7 Year 8 Year 9 Year10
Current assets55675755
Non-current assets48516564
Total assets103118122119
Current liabilities
Bank overdraft5068
Accounts payable20272518
Total current liabilities25273126
Long-term liabilities30303030
Total liabilities55576156
Shareholders' equity
Common shares20202020
Retained earnings28414143
Shareholders' equity48616163
Total liabilities and shareholders' equity103118122119
Other information:
Number of shares issued80808080
Market share price$1.50$2.00$1.00$1.45
Summary Income Statements
Including Addition to Retained Earnings
For the years ended December 31
($ millions)
Year 6Year 7 Year 8 Year 9
Sales 152170 110 145
EBIT 2840 7 15
Interest expense4345
Earnings before taxes2437310
Tax expense121604
Net income122136
Less: Dividends paid6834
Addition to retained earnings61302
Issuing Long-Term Bonds Option:
Summary of the Balance Sheet
As at December 31 Pro Forma
($ millions)
Year 6Year 7Year 8Year 9Year 10
Current assets55675755
Non-current assets48516564
Total assets103118122119
Current liabilities
Bank overdraft5068
Accounts payable20272518
Total current liabilities25273126
Long-term liabilities303030300
Total liabilities55576156Total long-term liabilities0
Shareholders' equity
Common shares20202020
Retained earnings28414143
Shareholders' equity486161630
Total liabilities and shareholders' equity103118122119Long-term debt and shareholders' equity0
Other information:
Number of shares issued80808080
Market share price$1.50$2.00$1.00$1.45
Summary Income Statements
Including Addition to Retained Earnings
For the years ended December 31Pro Forma
($ millions)
Year 6Year 7Year 8Year 9Year 10
Sales152170110145
EBIT2840715
Interest expense4345
Earnings before taxes24373100
Tax expense121604
Net income1221360
Less: Dividends paid6834
Addition to retained earnings613020
issuing 20 million common shares at $1 each, or issuing long-term bonds at 14% interest a year, with capital repayments of $3 million a year commencing at the end of Year 11.
Assumptions for Year 10: the corporate tax rate is 30%;? sales revenue and operating profit will remain unchanged except for the $6 million cost savings; and? Telford Engineers will pay the same dividend per share in Year 10 and in Year 9.
Prepare, for each financing arrangement, Telford Engineers' pro forma income statement including the addition to retained earnings for the year ending December 31, Year 10, and the pro forma long-term debt and shareholders' equity portion of the balance sheet only on that date.
Year 6 Year 7 Year 8 Year 9 Year10
Current assets55675755
Non-current assets48516564
Total assets103118122119
Current liabilities
Bank overdraft5068
Accounts payable20272518
Total current liabilities25273126
Long-term liabilities30303030
Total liabilities55576156
Shareholders' equity
Common shares20202020
Retained earnings28414143
Shareholders' equity48616163
Total liabilities and shareholders' equity103118122119
Other information:
Number of shares issued80808080
Market share price$1.50$2.00$1.00$1.45
Summary Income Statements
Including Addition to Retained Earnings
For the years ended December 31
($ millions)
Year 6Year 7 Year 8 Year 9
Sales 152170 110 145
EBIT 2840 7 15
Interest expense4345
Earnings before taxes2437310
Tax expense121604
Net income122136
Less: Dividends paid6834
Addition to retained earnings61302
Issuing Long-Term Bonds Option:
Summary of the Balance Sheet
As at December 31 Pro Forma
($ millions)
Year 6Year 7Year 8Year 9Year 10
Current assets55675755
Non-current assets48516564
Total assets103118122119
Current liabilities
Bank overdraft5068
Accounts payable20272518
Total current liabilities25273126
Long-term liabilities303030300
Total liabilities55576156Total long-term liabilities0
Shareholders' equity
Common shares20202020
Retained earnings28414143
Shareholders' equity486161630
Total liabilities and shareholders' equity103118122119Long-term debt and shareholders' equity0
Other information:
Number of shares issued80808080
Market share price$1.50$2.00$1.00$1.45
Summary Income Statements
Including Addition to Retained Earnings
For the years ended December 31Pro Forma
($ millions)
Year 6Year 7Year 8Year 9Year 10
Sales152170110145
EBIT2840715
Interest expense4345
Earnings before taxes24373100
Tax expense121604
Net income1221360
Less: Dividends paid6834
Addition to retained earnings613020