Question

Goals for Sales and Income Growth

Sunset Corp. is a major regional retailer. The chief executive officer (CEO) is concerned with the slow growth both of sales and of net income and the subsequent effect on the trading price of the common stock. Selected financial data for the past three years follow.

Sunset Corp.
(in millions)
		2017		2016		2015
1. Sales		$100.0		$96.7		$93.3
2. Net income		3.0		2.9		2.8
3. Dividends declared and paid		1.2		1.2		1.2
December 31 balances:
4. Stockholders’ equity		40.0		38.2		36.5
5. Debt		10.0		10.2		10.2
Selected year-end financial ratios
Net income to sales		3.0%		3.0%		3.0%
Asset turnover		2 times		2 times		2 times
6. Return on stockholders’ equity*		7.5%		7.6%		7.7%
7. Debt to total assets		20.0%		21.1%		21.8%

*Based on year-end balances in stockholders’ equity.

The CEO believes that the price of the stock has been adversely affected by the downward trend of the return on equity, the relatively low dividend payout ratio, and the lack of dividend increases. To improve the price of the stock, he wants to improve the return on equity and dividends.

He believes that the company should be able to meet these objectives by (1) increasing sales and net income at an annual rate of 10% a year and (2) establishing a new dividend policy that calls for a dividend payout of 60% of earnings or $2,000,000, whichever is larger.

The 10% annual sales increase will be accomplished through a product enhancement program. The president believes that the present net income to sales ratio of 3% will be unchanged by the cost of this new program and any interest paid on new debt. He expects that the company can accomplish this sales and income growth while maintaining the current relationship of total assets to sales. Any capital that is needed to maintain this relationship and that is not generated internally would be acquired through long-term debt financing. The CEO hopes that debt would not exceed 25% of total liabilities and stockholders' equity.

Required:

1. Using the CEO's program, prepare a schedule that shows the appropriate data for the years 2018, 2019, and 2020 for the items numbered 1 through 7 on the preceding schedule. Use the year-end balance to calculate the return on stockholders' equity ratios. Enter dollar amounts in millions rounded to two decimal places, such as 250.35.

To enter ratios, round the answer to four decimal places before converting to a percentage and enter your percentage answer rounded to two decimal places. For example, .88349 would be rounded to .8835 and entered as 88.35.

Enter all amounts as positive numbers.

Sunset Corp.
Schedule of Financial data
For the Years 2020, 2019 and 2018
	2020	2019	2018
Sales	$	$	$
Net income	$	$	$
Dividends declared and paid	$	$	$
Stockholders' equity, December 31 balance	$	$	$
Debt, December 31 balance	$	$	$
Return on stockholders' equity	%	%	%
Debt to total assets	%	%	%

2. Can the CEO meet all of her requirements if a 10% per-year growth in income and sales is achieved? Explain your answer.

3. In order to increase the return on equity and support the increase in dividends, the company can do all of the following EXCEPT

reduce dividend payments.

reduce its asset base, thus improving asset turnover.

improve sales of higher margin product lines.

reduce variable and fixed costs.

Answer 1

Ans.1) The following table was prepared keeping in mind the conditions laid out in the question:-

Ans.2) The CEO cannot meet all her requirements if 10% increasein sales is to be achieved. The reasons for this are:

a) The total asset turnover ratio needs to be 2 times.

b) The capex needed is only to be funded through long term debt issue.

Ans.3) This seems to be an MCQ - reduce divdend payment.

Also if equity is raised for capex and all other conditions are kept same we can meet CEO expectations as shown in this table: