Question

Coastal Carolina Heating and Cooling Inc. has a 6-month backlog of orders for its patented solar heating system. To meet this demand, management plans to expand production capacity by 45% with a $20 million investment in plant and machinery. The firm wants to maintain a 35% debt level in its capital structure. It also wants to maintain its past dividend policy of distributing 55% of last year’s net income. In 2018, net income was $5 million. How much external equity must Coastal Carolina seek at the beginning of 2019 to expand capacity as desired? Assume that the firm uses only debt and common equity in its capital structure.

Answer 1

$12500000 external equity is needed

Explanation:

The given data:

Production capacity to be maintained : 45%, investment = $20 million, debt level to be maintained = 35%, dividend distributing = 55%, net income = $5 million

INVESTMENT IN PLANT MACHINARY

= $20000000

NET INCOME OF YEAR 2018 = $5000000

RETAINED EARNNING AFTER DIVIDEND

$=\ 5000000-(\ 5000000 * 55 \%)$

= $2250000

DEBT FINANCING

$=\ 15000000 * 35 \%$

= $5250000

EXTERNAL EQUITY NEEDED

= TOTAL INVESTMENT - DEBT FINANCING - RETAINED EARNNINGS

$=\ 20000000-\ 5250000-\ 2250000$

= $12500000