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 $20 million investment in new machinery. Gardial plans to maintain its current 30% 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 30% 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 :- External equity needed : $8,400,000

Calculation :-

Given,

Investment in new machinery : $ 20,000,000

Debt-to-total asset ratio : 30%

Then, Equity-to-asset ratio : 70%

So, Equity needed : ( 20,000,000 * 70% ) = $14,000,000

Net income : $8,000,000

Dividend payout : 30%

Then, Dividend paid : (8,000,000 * 30%) = $2,400,000

And, Retained Earnings : ( 8,000,000 - 2,400,000 ) = $5,600,000

So, External equity needed: ( 14,000,000 - 5,600,000) = $8,400,000