Question

Strategic Growth Planning Sailing into the Sunset Burial Monument Co., Inc. wishes to expand their market territory and has sought counsel from you as to their fiscal capacity to sponsor their growth opportunities. As it presently stands, they have been generating a "bottom-line" profit of approximately 5%, for the past five years, but their forecasts for the oncoming year, put this performance at 6%. While management is cognizant that shareholders would love the best of both worlds, dividends as well as growth, they feel that any dividend distributions of less than 40% would be imprudent. Last year, the firm was able to produce an "asset turnover" of only 1/hx, but associated the poor turnover to a piece of equipment purchased in late December of last year. Management forecasts that the asset turnover, this year, is targeted at 2x!! Last, their bond covenant precludes all forms of debt in excess of 60% of the firm's assets. To what extent would you suggest that Sailing into the Sunset Burial Monument Co., Inc. plans its next year's sales, given that the sales for the year, just ended, were $10,000,000. And what would you forecast as their target profit? If Sailing into the Sunset Burial Monument Co., Inc. had wished to expand its market by an additional $3,000,000 over the prior year, would they be able to accomplish this goal, with a view toward a more conservative dividend policy? If so, how??

Answer 1

Company has been generating a bottom line profit of 5% for past five years.

Bottom line profit=total revenue - total expenses (including taxes and operating expenses)

dividend distribution of 40% is prudent. such that at least 40% of profits should be distributed among the shareholder while remaining can be used to expand business equity through retained earnings.

Asset turnover last year=total revenue / average assets[(assets at beginning + assets at the end)/2]

1.5x=total revenue / average assets

total revenue = 1.5x * average assets

The sales for the current year = $10,000,000

average assets=total revenue/1.5=$6666667

therefore,the asset turnover ratio for the coming year = 2

hence, the forecasted total revenue for the coming year if average assets remains same over the year = average assets * 2 =2 * 6666667=$13333333

The estimated target profit if the forecast sales is $13333333 = 6% * 13333333=$800000

They would be able to expand their market by $3000000 if the company obtains a asset turnover ratio of more 1.5 times of average assets.

without purchasing additional assets they would be able to earn $13333333 if their assets turnover ratio is 2.

Hence, No need to approach more conservative dividend policy. but, if somehow the bond covenant allows to preclude debt less than 60% of assets then asset turnover ratio will decrease therefore, to increase the sales turnover, company needs more retained earnings hence, the company can decrease the amount to distribute to shareholder with view of increasing the retained earning.