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. balance sheet (in $ millions) assets liabilities and stockholders' equity cash $ 11 accounts payable $ 24 accounts receivable 29 accrued wages 11 inventory 32 accrued taxes 17 current assets $ 72 current liabilities $ 52 fixed assets 49 notes payable 19 common stock 24 retained earnings 26 total assets $ 121 total liabilities and stockholders' equity $ 121 owen's has an aftertax profit margin of 9 percent and a dividend payout ratio of 30 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

Answer 1

Answer: Owen's Electronics will need $9.375 million to finance a 25% growth in sales.

We use the following formula to determine the quantum of External Financing Needed (EFN) to fuel additional growth, since the company is functioning at full capacity.

$\mathbf{EFN = \frac{A^{*}_{0}}{S_{0}}(S_{1} - S_{0}) - \frac{L^{*}_{0}}{S_{0}}(S_{1} - S_{0}) - (NPM)(S_{1})(b)}$

where

$S_{0}$  is current sales

$S_{1}$  is projected increase in sales

${A^{*}_{0}$  refers to Assets that vary directly with sales at time 0.

$L^{*}_{0}$ refers only to those liabilities that change directly with sales

NPM refers to the after tax (net) profit margin

b refers to retention ratio. This is also calculated as $b = 1 - Dividend Payout Ratio$

We have:

Last year's sales                                              $100 million

Projected Growth rate in sales                                   25%

Next Year's Sales                                    $100*1.25 = 125 million$

Total Assets                                                     $121 million

Current Liabilities                                            $52 million

We take only Current liabilities into account as the question states that all current liabilities vary with sales

Net Profit Margin                                                          9%

Dividend Payout Ratio                                                30%

Retention Ratio                                       $0.70 (1-0.3)$

Substituting the values in the formula above we get,

$\mathbf{EFN = \frac{121}{100}(125 - 100) - \frac{52}{100}(125 - 100) - (0.09)(125)(0.70)}$

$\mathbf{EFN = 1.21(25) - 0.52(25) - (0.09)(125)(0.70)}$

$EFN = 30.25 - 13 - 7.875$

$\mathbf{EFN = 9.375}$