Question

In 2019, Weihan’s soft-drink company had market capitalization of $100000 and the number of shares was 100. The market-to-book ratio was 8, debt-equity ratio was 1, profit margin was 0.3, total asset turnover was 0.7, and dividend payout ratio was 0.7. Among the total liabilities, all of them are current liabilities (so there is no long-term debt). Assume the total sales will grow 15% in 2020. Assume the retention ratio and profit margin in 2020 will be the same as the corresponding levels in 2019. Also, assume that total assets and current liabilities will change in the same speed as total sales.

What would be the External Financing Needed (EFN) in 2020, given the predicted sales growth rate of 15%?

Answer 1

2019 figures calculations

Market Value/Book Value=8

100000/BV=8

BV of equity =100000/8=

12500

Debt/Equity=1

Debt/12500=1

So, debt=Current liabilities= 12500

Total asset turnover=0.7

ie.Sales/ Total assets=0.7

Total assets=Debt+Equity

ie. 12500+12500= 25000

So, sales,2019= 25000*0.7=

17500

Profit margin=30%*sales

Now, the external financing needed=

EFN=Required Increase in assets-Increase in spontaneous liabilities-Increase in Retained Earnings

ie.(2019 assets*0.15)-(2019 current liabilities*0.15)-(2019 sales*1.15 *Profit margin*Retention ratio)

ie.(25000*0.15)-(12500*0.15)-(17500*1.15*30%*(1-0.70))=

63.75

so, the answer is EFN= $ 63.75