Question

Piedomont Products LTD (PPL) has current sales of $60 million. sales are expected to grow to $80 million next year. PPL currently has accounts receivables of $9 million, inventories of $15 million and net fixed assets of $24 million. These assets are expected to grow at the same rate as sales over the next year. Accounts payable are expected to increase from their current level of $15 million to a new level of $19 million next year. PPL wants to increase its cash balance at the end of next year by $3 million over its current cash balance (of $2 million). Earnings after taxes next year are forecasted to be $12 million. PPL plans to pay $2 million cash dividend. PPL intends to use 10% debt in its capital structure and the marginal tax rate is 30 percent

a. How much external financing is required by PPL next year?
b. What is PPL’s sustainable growth rate.

Answer 1

Fig. in mlns.	Current	Expected		Increase
A/R	9	9/60*80=	12	3
Inv.	15	15/60*80=	20	5
Net F/A	24	24/60*80=	32	8
Cash	2	3	3	1
Increase in assets	50		67	17
A/P	15		19	4
Increase in liabilities				4

a.External financing needed(EFN) by PPL next year =

Required increase in assets-Reqd. increase in spontaneous liabilities-Reqd. increase in Retained Earnings

17-4-10=

3

Balance sheet (Current)
Assets	50	A/P	15
		Equity(Bal.fig.)	35
Total	50	Total	50
Balance sheet (projected)
Assets	67	A/P	19
		Equity(35+10)	45
		Debt(bal.fig.)	3
Total	67	Total	67

b.PPL’s sustainable growth rate

SGR=ROE*RR

SGR=Return On Equity*Retention Ratio

ie.SGR=(Net income/Total equity)*((Net Income- Dividends)/Net Income)

ie.(12/45)*((12-2)/12)=

22.22%

NOTE: Since $ 12 mlns. Is given as after-tax income, it is after deducting interest on debt, 3*10%=0.3 mlns.