Question

To please be done in excel: ABC Pty(Ltd) is a manufacturing company that has been listed on the Stock Exchange for the last 15 years. Approximately 35 percent of its sales are to government and 65 percent to private customers. The company has been growing erratically in recent years, but in real terms at a rate on average equal to that of the economy as a whole. Recent analyst’s reports suggest that the firm’s rate of growth might increase significantly in the near to mid future because of the government’s accelerated infrastructure investment program. However, ABC management believes that the analysts are overoptimistic in this regard and are worried about the effects of increased inflationary pressures. The company’s shares, which are largely institutionally held, are currently selling at 14 times earnings. The industry average PE ratio is 12. The company’s Return on Equity (ROE) was 17% p.a. compared to the industry average of 23%. The company’s most recent total dividend payout was $5m which represented a dividend cover of 2.5 times (the industry average is 2 times). The company has assets of $200 million and a debt to capital ratio of 20 percent (the industry average is 22 percent). ABC is budgeting for growth in the next 12m and needs an additional $25 million in capital over and above additions to retained earnings to support its projected level of business activties. a. Identify the stage of this company’s lifecycle and identify the normal sources of funding for such a stage. b. Calculate the company’s current Debt/Equity (D/E) ratio. What would it the new D/E ratio be if it raises debt to finance its growth?

Answer 1

1)

From the moment you make the decision to set up a business, you’re in the “business lifecycle.” This will see you journey from idea to startup, and if successful, through to the growth and maturity phases.

Currently the company is in growth and establishment phase of it’s lifecycle.

If you’re at this stage, your business should now be generating a consistent source of income and regularly taking on new customers. Cash flow should start to improve as recurring revenues help to cover ongoing expenses, and you should be looking forward to seeing your profits improve slowly and steadily.

The biggest challenge for entrepreneurs in this stage is dividing time between a whole new range of demands requiring your attention– managing increasing levels of revenue, attending to customers, dealing with the competition, accommodating an expanding workforce, etc.

Source of Funding: - For growth and establishment phase

1. Issue of fresh capital.
2. Issue of fresh debt.
3. Loan /Borrowings from market.
4. Venture Capital.

2)

Dividend paid = 5,000,000

Dividend covered = 2.5 times

Earning attributable to equity holders = 5,000,000*2.5= 12,500,000

Dividend pay-out ratio = 5/12.5*100 = 40%

P/E ratio of Company = 14 times

Market Share capital = Earnings attributable to equity holders * P/E ratio

= 12,500,000 * 14 = 175 million

Here, net profit= Earnings available for equity share holders

ROE = 17% p.a.

ROE = Net profit / book value of Share capital

• book value of Share capital = 12.5 million/ 17% = $73.529 million

Total assets =200 million

Debt-capital ratio = 20%

Therefore Debt = 40 million

Equity = $73.529 million

Retained Earnings = (200-40-73.529)= $86.471 million

1. Current Debt Equity Ratio            = Debt/ Equity *100

                                                                = (40/ 160)*100

                                                                = 25%

1. New D/E ratio be if it raises debt to finance its growth:-

New Debt = 40+25= 65

Equity = 160

Debt Equity Ratio             = (65/160)*100

                                                = 40.625%