*****REPOST-RECEIVED WRONG ASNWER********** Sales and costs are projected to gro

Question

*****REPOST-RECEIVED WRONG ASNWER**********

  

  

Sales and costs are projected to grow at 40% a year for at least the next 4 years. Both current assets and accounts payable are projected to rise in proportion to sales. The firm is currently operating at 70% capacity, so it plans to increase fixed assets in proportion to sales. Interest expense will equal 10% of long-term debt outstanding at the start of the year. The firm will maintain a dividend payout ratio of 0.60.

What is the required external financing over the next year? (Negative amounts should be indicated by a minus sign.)

66,600 is not correct.

Sales $ 250,000 Costs 175,000 EBIT $ 75,000 Interest expense 15,000 Taxable income $ 60,000 Taxes (at 35%) 21,000 Net income $ 39,000 Dividends $ 23,400 Addition to retained earnings 15,600

Explanation / Answer

Proportion of fixed assets to sales = Fixed assets / Sales = 190000 / 250000 = 0.76

New sales = 250000 + 40% x 250000 = 350000

Now, fixed assets increase in proportion to sales, i.e., 0.76 will be maintained.

New Fixed assets = 350000 x 0.76 = 266000

New Financing needed = 266000 - 190000 = 76000

Next, we project the retained earnings next year -

External Financing needed = New financing needed - Retained earnings = 76000 - 23400 = 52600

With the given info, this seems to be the correct answer. But, in case you consider the existing retained earnings of $60000, the company won't require any external financing.

Sales 350000 Costs (175000 + 40% x 175000) 245000 EBIT 105000 Interest Expense (10% x 150000) 15000 Taxable Income 90000 Taxes @35% 31500 Net Income 58500 Dividend (58500 x 0.60) 35100 Retained earnings 23400

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