External Financing Needed & Sustainable Growth Rate
Use ONE Excel workbook, but a separate sheet for each problem. You may work all parts of the same problem in one sheet (e.g. parts A through D of Question 1), and so on.
Show work clearly, else NO partial credit will be given.
Question 1
A. Use the information below from Paxton Industries’ annual financial statements to calculate the actual and sustainable growth rate for each year from 2016 – 2020.
B. Describe the company’s growth challenge, if any, over this period.
C. Comment on the observed change in the company’s payout policy over the period in question. Does it make sense in the context of the company’s growth challenge? Explain.
D. What are some recommendations you might provide management that will help to meet this growth challenge?
Paxton Industries ($ in thousands)
2014 2015 2016 2017 2018 2019 2020
Equity – 377.49 464.35 507.78 471.87 603.06 680.72
Total assets – 520.00 706.78 724.04 759.90 1071.07 1423.35
Sales 597.30 585.03 861.95 950.41 1139.48 1360.58 1721.78
Net income – 51.92 31.57 46.18 53.81 30.91 38.26
Dividends – 0.00 0.00 1.20 1.88 2.56 3.04
Use the financials for Garland Company below to answer Questions 2
Garland Company
Balance Sheet, Year Ended Dec 31, 2020
Assets:
Cash and marketable securities $ 500,000
Accounts receivable 800,000
Inventories 1,350,000
Prepaid expenses 50,000
Total current assets $ 2,700,000
Gross Fixed Assets 5,000,000
Accumulated Depreciation 2,000,000
Net fixed assets $ 3,000,000
Total assets $ 5,700,000
Liabilities:
Accounts payable $ 475,000
Notes payable 900,000
Total current liabilities $ 1,375,000
Long-term debt 1,200,000
Owner’s equity 3,125,000
Total liabilities and owner’s equity $ 5,700,000
Garland Company
Income Statement, 2020
Net sales $ 8,000,000
Cost of Goods Sold 3,500,000
Selling and administrative expense 2,000,000
Depreciation expense 250,000
Interest expense 150,000
Earnings before taxes $ 2,100,000
Income taxes 700,000
Net income $ 1,400,000
Question 2
On account of its very recent entry into a lucrative market, Garland Company (whose financials are given above) projects an 18% increase in sales for next year (2020). NOTE: All numbers in the financials are in thousands of dollars. The company paid out $1.26 billion in dividends in 2020, and its payout ratio is constant. Current assets and net fixed assets, and all operating expenses, vary directly with sales. Accounts payables will also maintain their existing relationship to sales; the other liabilities, however, are not spontaneous. Management has decided that any required additional funding will be raised through long-term debt, on which it will pay an interest rate of 8.5%. Any short-term debt will be rolled over at the same interest rate as existed at the end of 2020. Long-term debt will increase by the full amount of any estimated EFN (i.e., no principal pay-down on existing debt is anticipated for next year, 2021). NOTE: This means that none of the existing debt will be paid down in 2021, and will be charged the same interest rate as it was charged in 2020. The tax rate for 2020 will apply for 2021 as well. NOTE: You need to figure the tax rate yourself, based on the financials provided.
Estimate the external financing needed (EFN) for 2021, based on the projected growth in sales, using the percentage of sales method (Auto-Calc). Make sure to set up an “assumptions box”, and automate the iterations needed to estimate EFN. Use the pro-forma financials to estimate the EFN. Do NOT use the “direct formula.”
