Question

External Funds Needed The Optical Scan Company has forecast a 20 percent sales growth rate for next year. The current financial statements are shown here: 3.8 Statement of Comprehensive Income Sales Costs Taxable income Taxes Net income $30,400,000 26,720,000 $ 3,680,000 1,288,000 $ 2,392,000 Dividends Addition to retained earnings $ 956,800 1,435,200 Statement of Financial Position Assets Liabilities and shareholder's equity Current assets 7,200,000 Short-term debt Fixed assets 17,600,000 Long-term debt Common stock $6,400,000 4,800,000 $3,200,000 10,400,000 $13,600,000 $24.800,000 Accumulated retained earnings Total equity Total liabilities and shareholders' equity Total assets a. Using the equation from the chapter, calculate the EFN for next year. b Construct the firm's pro forma statement of financial position for next year and $24,800,000 confirm the EFN that you calculated in (a). c. Calculate the sustainable growth rate for the company. d. Can Optical Scan eliminate the need for external funds by changing its dividend policy? What other options are available to the company to meet its growth objectives?

Answer 1

Requirement-(d): Forecasted Sales Retention Ratio Amount paid as dividends External Financing Needed (EFN) Balance that can be paid as dividends $36,480,000 $14,592,000 [Forecasted sales x (1-Retention Ratio) = $36,480,000 x (1-0.60) = $36,480,000 x 0.40-$14,952,000] $12,634,240 0.60 $1,957,760 As calculated in Requirement-(a) & (b)l Dividend payout ratio shall be Therefore, by changing its dividend policy from 0.40 to 0.35, Optimal Scan can eleminate External Financing Needed (EFN) Other ways (instead of changing dividend policy) through which EFN can be eleminated & growth can be achieved: 0.35 [Balance that can be paid as dividends/Forecasted sales $12,634,240/$36,480,000 0.35] By increasing Reducing its operating expenses -> By reducing its expense:s >By raising further common capital, etc.

Answer 2

a. The external finance needed is calculated as shown below:

Income Statement next year
Sales	3,6480,000
Costs	3,206,4000
Taxable Income	4,416,000
Taxes at 35%	1,545,600
Net Income	2,870,400
Dividends (40%)	1,148,160
In addition to retained earnings	1,722,240
Assets		Liabilities and Equity
Current Assets	8,640,000	Short term debt	7,680,000
Fixed Assets	21,120,000	Long term debt	4,800,000
		Common Stock	3,200,000
		Accumulated RE	12,122,240
Total Assets	29,760,000	Total Liability and Equity	27,802,240
		External Financing Needed (EFN)	1,957,760

External Financing needed (EFN) = $1,957,760

b. Proforma financial Statement

Income Statement next year
Sales	3,6480,000
Costs	3,206,4000
Taxable Income	4,416,000
Taxes at 35%	1,545,600
Net Income	2,870,400
Dividends (40%)	1,148,160
In addition to retained earnings	1,722,240
Assets		Liabilities and Equity
Current Assets	8,640,000	Short term debt	7,680,000
Fixed Assets	21,120,000	Long term debt	4,800,000
		Common Stock	3,200,000
		Accumulated RE	12,122,240
Total Assets	29,760,000	Total Liability and Equity	27,802,240
		External Financing Needed (EFN)	1,957,760

c. Sustainable growth rate = ROE * Retention Ratio

Retention Ratio = 60% =0.6

ROE = Net income/ total shareholders equity = 2,392,000/13,600,000 (Numbers from the given data and not the forecast)

ROE = 0.17588

Sustainable growth rate = 0.17588*0.6 = 0.1055

Sustainable growth rate = 10.55%

d. No, Optical Scan cannot eliminate the need for external funds by changing the dividend policy because the EFN is greater than the dividends paid out.

Options available are: Raise the external funds by raising more debt through a bond issue or an equity issue.