Problem solving

Test 2

1. Sustainable Growth Rate (Part A through D)

2. Weighted Average Cost of Capital (WACC)

3. External Financing Needed (EFN) – AutoCalc – percentage of sales method

4. External Financing Needed (EFN) – Direct Method (Part A and B)

5. External Financing Needed (EFN) – Excess Capacity (90%)

Test 2
o Submit on Canvas by 10:30 am, Tuesday, November 23, 2021.
o There is a penalty of 1point for every 1 minute that the submission is late.
o You may not work with (get help from/give help to) anyone else on this test.
Use ONE Excel workbook, but a separate sheet for each problem. You may work all parts of the same problem in one sheet (e.g. parts A through D of Question 1), and so on. So, as there are 5 questions on the test, your Excel workbook should have 5 sheets.
Show work clearly, else NO partial credit will be given.

Question 1 (25 Points)
A. Use the information below from Paxton Industries annual financial statements to calculate the actual and sustainable growth rate for each year from 2016 – 2020. (15 points)
B. Describe the company’s growth challenge, if any, over this period. (5 points)
C. Comment on the observed change in the company’s payout policy over the period in question. Does it make sense in the context of the company’s growth challenge? Explain. (2.5 points)
D. What are some recommendations you might provide management that will help to meet this growth challenge? (2.5 points)

Paxton Industries ($ in thousands)
2014 2015 2016 2017 2018 2019 2020
Equity – 377.49 464.35 507.78 471.87 603.06 680.72
Total assets – 520.00 706.78 724.04 759.90 1071.07 1423.35
Sales 597.30 585.03 861.95 950.41 1139.48 1360.58 1721.78
Net income – 51.92 31.57 46.18 53.81 30.91 38.26
Dividends – 0.00 0.00 1.20 1.88 2.56 3.04

Question 2 (20 points)

Dexter Corp has 9.4% coupon bonds outstanding that have a remaining maturity of 10 years. They pay interest semiannually, and are currently selling for $1075 for every $1000 of face value. The firm also has perpetual preferred stock outstanding. Each of the preferred shares has a par value of $100, and is currently trading for $80. Each carries a fixed annual dividend of $10. Dexter common stock is trading at $38.40 per share. Each share of common is expected to pay a dividend of $4.15 for the coming year (i.e. one year from today). Analysts expect Dexter earnings and per-share dividends to grow at a constant rate of 3.75% for the foreseeable future. Dexter stock is estimated to have a beta of 1.55. The estimated market risk premium is 7%, and the proxy for the risk-free rate is the 3.25% yield on US Treasury securities. Dexter faces a marginal tax rate of 28%. Its management has a policy of raising funds in the following market-value based proportions: Common Stock 25%; Debt 60%; and Preferred Stock 15%. Estimate Dexter Corp’s weighted average cost of capital (WACC).
Use the financials for Garland Company below to answer Questions 3—5
Garland Company
Balance Sheet, Year Ended Dec 31, 2020
Assets:
Cash and marketable securities $ 500,000
Accounts receivable 800,000
Inventories 1,350,000
Prepaid expenses 50,000
Total current assets $ 2,700,000
Gross Fixed Assets 5,000,000
Accumulated Depreciation 2,000,000
Net fixed assets $ 3,000,000
Total assets $ 5,700,000

Liabilities:
Accounts payable $ 475,000
Notes payable 900,000
Total current liabilities $ 1,375,000
Long-term debt 1,200,000
Owner’s equity 3,125,000
Total liabilities and owner’s equity $ 5,700,000

Garland Company
Income Statement, 2020
Net sales $ 8,000,000
Cost of Goods Sold 3,500,000
Selling and administrative expense 2,000,000
Depreciation expense 250,000
Interest expense 150,000
Earnings before taxes $ 2,100,000
Income taxes 700,000
Net income $ 1,400,000

Question 3 (25 points)
On account of its very recent entry into a lucrative market, Garland Company (whose financials are given above) projects an 18% increase in sales for next year (2020). NOTE: All numbers in the financials are in thousands of dollars. The company paid out $1.26 billion in dividends in 2020, and its payout ratio is constant. Current assets and net fixed assets, and all operating expenses, vary directly with sales. Accounts payables will also maintain their existing relationship to sales; the other liabilities, however, are not spontaneous. Management has decided that any required additional funding will be raised through long-term debt, on which it will pay an interest rate of 8.5%. Any short-term debt will be rolled over at the same interest rate as existed at the end of 2020. Long-term debt will increase by the full amount of any estimated EFN (i.e., no principal pay-down on existing debt is anticipated for next year, 2021). NOTE: This means that none of the existing debt will be paid down in 2021, and will be charged the same interest rate as it was charged in 2020. The tax rate for 2020 will apply for 2021 as well. NOTE: You need to figure the tax rate yourself, based on the financials provided.
Estimate the external financing needed (EFN) for 2021, based on the projected growth in sales, using the percentage of sales method. Make sure to set up an “assumptions box”, and automate the iterations (like we did in class) needed to estimate EFN.

Question 4
Refer to the information provided for Garland in Question 3.
A. Use the “direct estimation of EFN” formula to estimate the external financing needed to support the projected growth in 2021. Do NOT use the pro-forma financials to estimate the EFN. Show work clearly, please. (10 points)
B. The EFN “direct” formula has 3 parts. Explain what each part estimates (here, I am looking for the “concept” behind each part, not the number). ALSO, what are the assumptions implicit in your calculation of Garland’s EFN using the direct formula? Kindly be brief. (5 points)

Question 5
Suppose Garland Company (whose financials were provided above and used in Questions 3

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