Question

Gardial GreenLights, a manufacturer of energy-efficient lighting solutions, has had such success with its new products that it is planning to substantially expand its manufacturing capacity with a $10 million investment in new machinery. Gardial plans to maintain its current 35% debt-to-total-assets ratio for its capital structure and to maintain its dividend policy in which at the end of each year it distributes 55% of the year's net income. This year's net income was $8 million. How much external equity must Gardial seek now to expand as planned? Enter your answer in millions. For example, an answer of $1.23 million should be entered as 1.23, not 1,230,000. Round your answer to two decimal places.

Answer 1

Answer : Calculation of Amount of External Equity :

Given Debt to Total Asset Ratio = 35 % or 0.35

Equity to total Asset Ratio = 1-0.35 = 0.65 or 65%

Given Investment in new machinery ( Total Assets) = $ 10,000,000

Equity to Total Asset Ratio = Equity / Total Assets

0.65 = Equity / 10,000,000

Therefore Equity Needed = 6,500,000

Given Net Income = $ 8,000,000

Dividend Payout = 55%

Therefore Dividend Paid = 8,000,000 * 55%

= 4,400,000

Retained Earnings = Net Income - Dividend Paid

= 8,000,000 - 4,400,000

= 3,600,000

Therefore External Equity Needed = Total Equity Needed - Retained Earning

= 6,500,000 - 3,600,000

= $2,900,000 or $2.9 million