Chapter 4 Problem 10
2009 2010 2011 2012 2013 2014
Sales 477.84 491.62 706.52 792.01 876.52 1,088.46
Net income – 43.27 26.31 38.48 44.84 25.76
Total assets – 477.06 648.42 664.26 697.16 982.63
Equity – 346.32 426.01 465.85 432.91 553.27
Dividends – – – 0.80 1.65 2.22
a. Use the information below from Tournment Sporting Goods’s annual financial
statements to calculate the actual and sustainable growth rate for each year from 2010
– 2014.
b. Do you think Tournment Sporting Goods is having a problem financing its
growth? Is the increase in dividends a good idea for the company?
Tournment Sporting Goods ($ in thousands)
Chapter 4 Problem 10 Suggested Answers
2009 2010 2011 2012 2013 2014
Sales 477.84 491.62 706.52 792.01 876.52 1,088.46
Net income – 43.27 26.31 38.48 44.84 25.76
Total assets – 477.06 648.42 664.26 697.16 982.63
Equity – 346.32 426.01 465.85 432.91 553.27
Dividends – – – 0.80 1.65 2.22
a. Sustainable growth calculation:
Profit margin 8.80% 3.72% 4.86% 5.12% 2.37%
Retention ratio 1.00 1.00 0.98 0.96 0.91
Asset turnover 1.03 1.09 1.19 1.26 1.11
Financial leverage N/A 1.87 1.56 1.50 2.27
Sustainable growth (g*) N/A 7.60% 8.84% 9.27% 5.44%
Actual growth 2.88% 43.71% 12.10% 10.67% 24.18%
g*-g N/A –36.12% -3.26% -1.40% -18.74%
Tournament Sporting Goods ($ in thousands)
b. Tournament Sporting’s actual growth has exceeded its sustainable growth rate every year. The company has
facilitated its rapid growth by aggressively increasing its asset turnover and in 2014 financial leverage. The initiation
and increase in dividend payments, although modest, have exacerbated its sustainable growth challenges.
Chapter 4 Problem 11
Problem 15, part f. in Chapter 3 asks you to construct a five year financial projection for Aquatic Supplies beginning in 2015.
The five year projection appears below.
a. Calculate Aquatic Supplies’s sustainable and actual growth rates in these years.
b. What do these numbers suggest to you?
Aquatic Supplies Co. Five Year Projected Income Statements and Balance Sheets
2014 Assumptions 2015 2016 2017 2018 2019
Sales 582.762$ 12% 652.693 731.017 818.739 916.987 1,027.026
Cost of Goods Sold 240.828 39% 254.550 285.096 319.308 357.625 400.540
Gross Profit 341.934 398.143 445.920 499.431 559.362 626.486
Selling, General, & Administrative Exp. 257.507 49% 319.820 358.198 401.182 449.324 503.243
Operating Income Before Deprec. 84.427 78.323 87.722 98.249 110.038 123.243
Depreciation, Depletion, & Amortization 25.221 30% 29.371 32.896 36.843 41.264 46.216
Operating Profit 59.206 48.952 54.826 61.405 68.774 77.027
Interest Expense 16.430 initially constant
18.636 18.801 18.841 18.733 18.446
Pretax Income 42.776 30.316 36.025 42.564 50.041 58.581
Total Income Taxes 14.971 35% 10.611 12.609 14.897 17.514 20.503
Net income 27.805$ 19.705$ 23.416$ 27.667$ 32.527$ 38.078$
ASSETS
Cash & Equivalents 7.152$ 2% 13.054 14.620 16.375 18.340 20.541
Account Receivable 70.538 13% 84.850 95.032 106.436 119.208 133.513
Inventories 39.033 5% 32.635 36.551 40.937 45.849 51.351
Prepaid Expenses 9.339 no change 9.339 9.339 9.339 9.339 9.339
Other Current Assets 27.076 6% 39.162 43.861 49.124 55.019 61.622
Total Current Assets 153.138 179.039 199.403 222.211 247.756 276.366
Net Plant, Property & Equipment 81.648 15% 97.904 109.652 122.811 137.548 154.054
Intangibles 9.415 no change 9.415 9.415 9.415 9.415 9.415
Other Assets 24.642 5% 32.635 36.551 40.937 45.849 51.351
TOTAL ASSETS 268.843$ 318.993 355.022 395.374 440.568 491.186
LIABILITIES
Accounts Payable 36.951$ 6% 39.162 43.861 49.124 55.019 61.622
Accrued Expenses 31.206 5% 32.635 36.551 40.937 45.849 51.351
Other Current Liabilities 3.663 no change 3.663 3.663 3.663 3.663 3.663
Total Current Liabilities 71.820 75.459 84.075 93.724 104.532 116.636
Long Term Debt 157.720 initially constant
186.363 188.010 188.414 187.327 184.462
Accrued wages 21.418 3% 19.581 21.930 24.562 27.510 30.811
Total Liabilities 250.958 281.403 294.015 306.701 319.368 331.908
EQUITY
Common Stock 1.702 no change 1.702 1.702 1.702 1.702 1.702
Capital Surplus 55.513 no change 55.513 55.513 55.513 55.513 55.513
Retained Earnings 118.729
no dividends paid
so all income is
retained
138.434 161.851 189.517 222.044 260.122
Less: Treasury Stock 158.059 no change 158.059 158.059 158.059 158.059 158.059
TOTAL EQUITY 17.885 37.590 61.007 88.673 121.200 159.278
TOTAL LIABILITIES & EQUITY 268.843$ 318.993$ 355.022$ 395.374$ 440.568$ 491.186$
Chapter 4 Problem 11 Suggested Answers
Suggested Answers
a. Sustainable Growth Anlysis
2015 2016 2017 2018 2019
Profit margin 3.02% 3.20% 3.38% 3.55% 3.71%
Retention ratio 1.00 1.00 1.00 1.00 1.00
Asset turnover 2.05 2.06 2.07 2.08 2.09
Financial leverage 17.84 9.44 6.48 4.97 4.05
Sustainable growth rate 110% 62% 45% 37% 31%
Actual growth rate 12% 12% 12% 12% 12%
Sustainable – actual growth rate 98% 50% 33% 25% 19%
b. Interpretation
Aquatic Supplies’ projected actual growth rate is well below its sustainable growth rate, although the latter is trending toward the former
for the forecast period. A mildly improving profit margin, together with complete retention of earnings, has increased equity over the period.
Meanwhile, debt levels are not projected to increase appreciably; hence, the company’s leverage measures are decreasing. The company
is generating more cash than needed in the business and should develop a plan to productively deploy the extra cash.
Chapter 4 Problem 12
Instructions:
Use the pro forma financial statements to answer the questions below. Change the assumptions in the assumptio ns box as needed to answer the questio ns. In addition to the assumptions listed on the spreadsheet, also assume that all ass et accounts will grow at the same rate as sales, and that no new equity will b e issued in 2014.
Questions:
Actual Projected Actual Projected a. Enter a formula for external funding required in the first green box. How much external financing does Ottawa need in 2014?
2013 2014 2013 2014 b. Given your answer from (a), do you expect the sustainable growth rate to be greater than, less than, or equal to the sales growth rate for 2014? Enter a formula for the sustainable growth rate in the second green box. What is Ottawa’s sustainable growth rate?
Sales 3,500$ 4,025$ Cash 150$ 173$ c. At what rate does the actual s ales growth rate equal the sustainable growth rate? How muc h external financ ing is required at this growth rate? (This can be determined by trial and error.)
COGS 2,775 3,019 Accounts receivable 540 621 d. Return the sales growth rate to 15%. S uppose Ottawa wants to solve the financing shortfall by increasing profit margin. How low would the ratio of COGS/Sales have to go in order to make up the shortfall? With COGS/Sales at this lower level, what is the sustainable growth rate? (Hint: The Goal Seek tool can help you find this q uickly. C onsult Excel Help if you are unfamiliar with the Goal Seek tool.)
Operating expense 360 403 Inventory 1,050 1,208 e. Return COGS/Sales to 75%. Now suppose Ottawa wants to solve the shortfall by increasing the retention ratio. How low would the dividend payout ratio have to be in order to eliminate the financing shortfall?
EBIT 365 604 Total current assets 1,740 2,001 f. Return the dividend payout ratio to 40%. Now suppose Ottawa wants to make up any financing shortfall with increased debt. How high would the debt/equity ratio have to be to make up the difference?
Interest expense 68 80 Prop erty, plant, & equipment 1,578 1,815
EBT 297 524 Total assets 3,318 3,816
Tax 102 183
Net inco me 195$ 341$ Total debt 1,106 1,208
Sharehold ers’ equity 2,212 2,416
Total liabilities & equity 3,318$ 3,625$
Sales growth rate 15.0%
COGS/sales 75.0% Extern al funding required
Oper. Exp./sales 10.0% Sustainable growth rate
Dividend payout ratio 40.0%
Tax rate 35.0%
Interest rate on debt 7.2%
Total debt/equity 50.0%
g. Given the above options, and any other options that you can find , make a
recommendation for a reasonable and practical solution to Ottawa’s financ ing
shortfall. Your solution can involve changing multiple variables.
Assumptions for 2014
Ottawa Corporatio n
Financial Statements, 2013 and Projected 2014 ($ millions)
INCOME STATEMENT
BALANCE SHEET
Chapter 4 Problem 12 Suggested Answers
Instructions:
Use the pro forma financial statements to answer the questions below. Change the assumptions in the assumptions box as needed to answer the questions. In addition to the assumptions listed on the spreadsheet, also assume that all asset accounts will grow at the same rate as sales, and that no new equity will be issued in 2014.
Actual Projected Actual Projec ted Questions:
2013 2014 2013 2014 a. Enter a formula for external funding required in the first green box. How much external financing do es Ottawa need in 2014?
Sales 3,500$ 4,025$ Cash 150$ 173$ $191 milli on
COGS 2,775 3,019 Accounts receivable 540 621 b. Given your answer from (a), do you expect the sustainabl e growth rate to be greater than, less than, or equal to the sales growth rate for 2014? Enter a formula for the sustainable growth rate in the second green box. What is Ottawa’s sustainable growth rate?
Operating expense 360 403 Inventory 1,050 1 ,208 Since external financing required is positive, we ’d expect g* to be less than the actual sales growth rate.
EBIT 365 604 Total curre nt assets 1,740 2 ,001 9.2%
Interest expense 68 80
Property, plant, & equipment
1,578 1 ,815
c. At what rate does the actual sales growth rate equal the sustainable growth rate? How much external financing is required at this growt h rate ? (This can be determined by trial and error.)
EBT 297 524 Total assets 3,318 3,816 8.65%
Tax 102 183 By definition, external financing required is approximately 0 when g*=g.
Net income 195$ 341$ Tot al debt 1,106 1 ,208 d. Return the sales growth rate to 15%. Suppose Ottawa wants to solve the financing shortfall by increasing pr ofit margin. How low would the ratio of COGS/Sales have to go in order to make up the shortfall? With COGS/Sales at this lower level, what is the sustainable growth rate? (Hint: The Goal Seek tool can help you find this quickly. Consult Excel Help if you are unfamiliar wit h the Goal Seek too l.)
Shareholders’ equity 2,212 2,416 66.9%
Total liabilities & equity 3,318$ 3,6 25$ e. Return COGS/ Sales to 75%. Now suppose Ottawa wants to solve the shortfall by increasing the retention ratio. How low would the dividend payout ratio have to be in order to eliminate the financing shortfall?
Sales growth rate 15.0% 2.6%
COGS/sales 7 5.0% Extern al funding re quired 191 f. Return the dividend payout ratio to 40%. Now suppos e Ottawa wants to make up any financing shortfall with increased debt. How high would the debt/equity ratio have to be to make up the difference ?
Oper. Exp./sales 10.0% Su stainable gr owth rate 9.2% 57.9%
Dividend payout ratio 4 0.0%
g. Given the above options, and any other options t hat you can find, make a recommendation for a reaso nable and practical so lution to Ottawa’s financing shortfall. Your solution can involve changing multiple variabl es.
Tax r ate 3 5.0% There are many options you could consider. Cutting COGS/Sales ve ry far is difficult. Cutting divi dends is easy to do, but is unpopular with shareholders. Reasonable options would include small improvements in COGS/Sales or operating expense/Sales, increasing debt, cutting back on capital expenditures (reduce PP&E), or using current assets more e fficiently. Reducing sales growth is also an option, but it comes at the expense of profits. One possible so lution (of many) would be the following:
Interest rate on debt 7.2% Increase debt/e quity to 53%.
Total debt/equity 50.0% Reduce capital expenditures by 50.
Reduce operating expense/sales to 9%.
Cut COGS/sales to 74 %.
Keep accounts receivable at a maximum of 600.
Ottawa Corporation
Financial Statements, 2013 and Projected 2014 ($ millions)
INCOME STATEMENT
BALANCE SHEET
Assumptions for 2014