The company forecasts that its sales will increase by 8 percent in 2005 and its operating costs will increase in proportion to sales. The company's interest expense is expected to remain at $150 million, and the tax rate will remain at 40 percent. The company plans to pay out 70 percent of its net income as dividends, the other 30 percent will be additions to retained earnings. What is the forecasted addition to retained earnings for 2005?

Complete Question:

Luemas Corporation recently reported the following income statement for 2004 (numbers are in millions of dollars):

Sales                                                                           $12,500

Total operating costs                                                (5,700)

EBIT                                                                        $6,800

Interest                                                                       (150)

Earnings before tax (EBT)                                         $6,650

Taxes (40%)                                                                  (2,660)

Net income available to common shareholders      $3,990

The company forecasts that its sales will increase by 8 percent in 2005 and its operating costs will increase in proportion to sales. The company's interest expense is expected to remain at $150 million, and the tax rate will remain at 40 percent. The company plans to pay out 70 percent of its net income as dividends, the other 30 percent will be additions to retained earnings. What is the forecasted addition to retained earnings for 2005?

$1295

Explanation:

The simple way to solve it is increasing the above income statement sales and operating cost by 8% increment and then deducting fixed expenses.

So

Sales $12,500 * (1 + 8%)                                               $13,500

Total operating costs $5,700 * (1 + 8%)                 (6,156)

EBIT                                                                         $7,344

Interest                                                                       (150)

Earnings before tax (EBT)                                         $7,194

Taxes (40%)                                                                 (2,878)

Net income available to common shareholders       $4,316

Now 70% would be paid out and the remainder 30% will be added to retained earnings for 2005.

So

30% of Profit after tax = $4,316 * 30% = $1295

This is the share of profit that the company will retain and is the addition to the retained earnings.