Question

The financial statements for the year ended June 30, 2017, are given for Morgan Construction Ltd. The company's revenues are projected to grow at a rate of 19 percent next year. The company currently pays 75 percent of its income as dividends every year. In addition, the company plans to expand production capacity by expanding the current facility and acquiring additional equipment. This will cost the company $10 million (above normal asset growth). Also assume that equity accounts do not vary directly with sales but change when retained earnings change or new equity is issued. Based on that projection, a pro forma balance sheet and an income statement for the 2017-2018 fiscal year is given. The company's long-term debt-to-equity ratio is approximately 90 percent, and its equity-to-total assets ratio is about 43 percent. The company wishes to increase its equity-to-total assets ratio to at least 50 percent. It is willing to reduce its payout ratio but will retain no more than 40 percent of its retained earnings. The company will raise any additional funds needed including funds for expansion in new equity. No new long-term debt will be issued. Morgan Construction Ltd Pro Forma Balance Sheet for Year Ended June 30, 2018 2017 2018 2017 2018 Cash $3,349,239 $3,985,594 Accounts payable $9,041,679 $10,759,598 Accounts receivable 5,830,754 6,938,597 Notes payable 4,857,496 5,780,420 Inventories 22,267,674 26,498,532 Total current assets $31,447,667 $37,422,724 Total current liabilities $13,899,175 $16,540,018 Net fixed assets 43,362,482 51,601,354 Long-term debt 29,731,406 49,182,419 Addition to fixed assets 10,000,000 Ordinary shares 19,987,500 19,987,500 Other assets 1,748,906 2,081,198 Retained earnings 12,940,974 15,395,339 Total assets $76,559,055 $101,105,276 Total liabilities & equity $76,559,055 $101,105,276 Morgan Construction Ltd Pro Forma Income Statement Year Ended June 30, 2018 2017 2018 Revenues $193,212,500 $229,922,875 Costs 145,265,625 172,866,094 EBITDA $47,946,875 $57,056,781 Depreciation 23,318,750 27,749,313 EBIT $24,628,125 $29,307,468 Interest 11,935,869 14,203,684 EBT $12,692,256 $15,103,784 Tax (35%) 4,442,290 5,286,325 Profit $8,249,966 $9,817,459 (Round dollar amounts to the closest dollar, and percent amounts to two decimals e.g 5.25%. Omit (%), ($), and () signs in answer.) a. Morgan's EFN is $ b. Morgan's internal growth rate is %. C. Morgan's sustainable growth rate is %. d. Morgan must issue $ in new equity. e. Morgan's new equity ratio is % and the debt-to-equity ratio is 96.

Answer 1

Answer:

Part (a)

EFN = Increase in assets - increase in accounts payable - Retained earning for the year 2018

= (101,105,276 - 76,559,055) - (10,759,598 - 9,041,679) - Profit in 2018 x Max retention ratio

= 22,828,302 - 9,817,459 x 40%

= 18,901,318

Part (b)

b = retention ratio = 40%

ROA = Profit / total assets = 9,817,459 / 101,105,276 = 9.71%

Hence, internal growth rate = ROA x b / (1 - ROA x b) = 9.71% x 40% / (1 - 9.71% x 40%) = 4.04%

Part (c)

ROE = ROA x A/E = 9.71% x 1/50% = 19.42%

Hence, the sustainable growth rate = ROE x b / (1 - ROE x b) = 19.42% x 40% / (1 - 19.42% x 40%) = 8.42%

Part (d)

Morgan will fund the entire EFN by equity. Hence, Morgan must issue $ 18,901,318 in new equity.

Part (e)

Total equity will then be = ordinary shares + retained earnings till 2017 + earnings retained in year 2018 + fresh equity = 19,987,500 + 9,817,459 x 40% + 18,901,318 = 42,815,802

Hence, new equity ratio = Equity / total assets = 42,815,802 / 101,105,276 = 42.35%

and debt to equity ratio = total liabilities / equity = (total assets - total equity) / equity = 1/42.35% - 1 = 1.36