Owen\'s Electronics has nine operating plants in seven southwestern states. Sale
ID: 2612435 • Letter: O
Question
Owen's Electronics has nine operating plants in seven southwestern states. Sales for last year were $100 million, and the balance sheet at year-end is similar in percentage of sales to that of previous years (and this will continue in the future). All assets (including fixed assets) and current liabilities will vary directly with sales. The firm is working at full capacity. Owen's has an aftertax profit margin of 10 percent and a dividend payout ratio of 40 percent. If sales grow by 25 percent next year, determine how many dollars of new funds are needed to finance the growth. (Do not round intermediate calculations. Enter your answer in millions, (e.g., $1,234,567).)Explanation / Answer
ANSWER is $30,000,000.
Next Year Balance Sheet amounts as per Sales Growth estimate of 25% and as per % of Current Assets, Fixed Assets and Current Liabilities amounts on annual next year sales, are as follows:
Next Year Retained Earnings working as follows:
Next Year Sales growth= 25%
Next year Sales= 100(1+0.25)= $125 million
After-Tax Profit margin= 10% of Annual Sales ====> After-Tax Profit for next year= $125 million * 0.10
= $12.50 million
Dividend Payout ratio given= 40%; Thus Retained Earnings ratio= 100% - 40%= 60% = 0.60
Thus, Retaiend Earnings in the Balance Sheet at the end of next year= (0.60 * $12.50 million) + Existing $25 million = $7.50 million + $25 million= $32.50 million
Thus, external funding in the form of additional amount of Notes Payable required to fund next year's business growth= Balance Sheet Total $156.25 million - Current Liabilities - Common Stock - Retained Earnings
= $30 million= $30,000,000. ................... ANSWER
Also, as per Corporate Finance formula of Sustainable Growth rate, we have:
SGR= Retrun on Equity% * (1- Dividend-Payout ratio)
Thus, in this case, as per given information, SGR= [(10% PAT on $100 mn Yearly Sales) / ($50 mn of Common Stock plus Retained Earnings)] * (1 - 0.40)= [$10 mn / $50 mn] * 0.60= 0.20 * 0.60 = 0.12
==> 12% of SGR in Annual Sales of business in future
The sustainable growth rate (SGR) is a company's maximum growth rate in sales using internal financial resources and without having to increase debt or issue new equity
In this case, growth rate in Annual Sales for next year = 25% which is substantially higher than SGR of 12%, which makes it obvious that the company will definitely need to either issue additional new equity or increase its debt (i.e. borrow additional debt) for supporting this higher growth in its business next year.
In this case, as per given conditions, company will need to issue additional Notes Payable of $30,000,000 i.e. external financing...
Assets Amounts in $ Liabilities Amount in $ Current Assets (0.75*125)= 93.75 Current Liabilities (0.55*125)= 68.75 Fixed Assets (0.50*125)= 62.50 Notes Payable 30.00 Common Stock 25.00 Retained Earnings =25.00 + 7.50= 32.50 Total 156.25 Total 156.25Related Questions
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