Question

Assume sales for Peach Street Industries are expected to increase by 7.00% from 2015 to 2016. Peach Street is operating at full capacity currently and expected assets-to-sales and spontaneous liabilities-to-sales to remain the same. Additionally, the firm is looking to maintain their 2015 net profit margin and dividend payout ratios for 2016. The firm’s tax rate is 36.00% and selected income statement and balance sheet information for 2015 is provided below:

Entry	Value	Entry	Value
Current Assets	$800.00	Sales	$2,500.00
Net Fixed Assets (NFA)	$700.00	Operating Costs	$2,030.00
Total Assets	$1,500.00	Depreciation	$90.00
Accounts Payable and Accruals	$30.00	Interest Expense	$69.00
Notes Payable	$180.00	Dividends Paid	$93.30
Long term debt	$510.00
Total Equity	$780.00

what is the firm's payout ratio?

what is the firm's net income for 2015?

How much in additional funds (external capital) will Peach Street Industries need in 2016 to support their projected growth in sales? (i.e., calculate the firm’s additional funds needed --AFN)

The firm is projecting sales growth of 10% from 2015 to 2016. If the firm did not have access to or did not want to use external capital sources to grow sales, what is the maximum rate of sales growth (self-sustaining growth rate) could the firm could achieve under these conditions?

Answer 1

Solution:

Net Income:

Contribution = Sales - Operating Costs = 2500 - 2030 = 470

Earnings after interest = 470 - 69 = 401

Earnings after depreciation = 401 - 90 = 311

PAT or Earnings after Tax or Net Income = 311 * (1 - 36%) = 199.04

Dividend Payout ratio

DPR= Dividends Paid / Net Income = 93.30 / 199.04 = .468

Additional Funds Needed

AFN = Current level of assets X Percentage change in sales - (Current level of liab X Percentage change in sales ) - New level of sales X Profit Margin X retention rate

AFN = 1500 X 10% - (510 + 180 + 30 ) X 10 % - 2500 X 1.10 X (199.04 / 2500) X (1 - .468) {RR = 1 - DPR}

= 150 - 72 - 2750 X .079616 X 0.532

= 150 - 72- 116.47

= -38.47 i.e. no additional funds are needed by the firm to support the sales growth

Self Sustaining growth rate

SSR = ROE X Retention rate = (Net Income / Average Shareholder's Equity ) X (1 - DPR)

= (199.04 / 780 ) * (1 - .468 )

= .255 * .532 = .1356 or 13.56 %