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    Optimal Scam

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    Muaaz Butt
    The Optimal Scam Company wants to grow sales by 20% annually but its current financial policies will not support that level of growth. It needs to raise $3.68 million in external funds to support a 20% sales increase. A pro forma balance sheet was constructed maintaining its debt to equity ratio to show how the company's assets and liabilities would change with 20% growth. Its sustainable growth rate is calculated to be 3.45% based on its current financial ratios, well below the desired 20% growth. To achieve its sales growth target, Optimal Scam will need to change its financial policies such as cutting or eliminating dividends, increasing asset utilization, raising profit margins, or taking on more debt.

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    Optimal Scam

    Uploaded by

    Muaaz Butt
    187 views2 pages
    The Optimal Scam Company wants to grow sales by 20% annually but its current financial policies will not support that level of growth. It needs to raise $3.68 million in external funds to support a 20% sales increase. A pro forma balance sheet was constructed maintaining its debt to equity ratio to show how the company's assets and liabilities would change with 20% growth. Its sustainable growth rate is calculated to be 3.45% based on its current financial ratios, well below the desired 20% growth. To achieve its sales growth target, Optimal Scam will need to change its financial policies such as cutting or eliminating dividends, increasing asset utilization, raising profit margins, or taking on more debt.

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    The Optimal Scam Company wants to grow sales by 20% annually but its current financial policies will not support that level of growth. It needs to raise $3.68 million in external funds to support a 20% sales increase. A pro forma balance sheet was constructed maintaining its debt to equity ratio to show how the company's assets and liabilities would change with 20% growth. Its sustainable growth rate is calculated to be 3.45% based on its current financial ratios, well below the desired 20% growth. To achieve its sales growth target, Optimal Scam will need to change its financial policies such as cutting or eliminating dividends, increasing asset utilization, raising profit margins, or taking on more debt.

    Copyright:

    © All Rights Reserved
    Download as DOC, PDF, TXT or read online from Scribd
    Download as doc, pdf, or txt
    187 views2 pages

    Optimal Scam

    Uploaded by

    Muaaz Butt
    The Optimal Scam Company wants to grow sales by 20% annually but its current financial policies will not support that level of growth. It needs to raise $3.68 million in external funds to support a 20% sales increase. A pro forma balance sheet was constructed maintaining its debt to equity ratio to show how the company's assets and liabilities would change with 20% growth. Its sustainable growth rate is calculated to be 3.45% based on its current financial ratios, well below the desired 20% growth. To achieve its sales growth target, Optimal Scam will need to change its financial policies such as cutting or eliminating dividends, increasing asset utilization, raising profit margins, or taking on more debt.

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    The Optimal Scam Company would like to see its sales grow at 20 percent for the foreseeable

    future. Its financial statements for the current year are presented below.

    Income Statement ($ millions) Balance Sheet ($ millions)


    Sales 32.00 Current assets 16
    Costs 28.97 Fixed assets 16
    Gross profit 3.03 Total assets 32
    Taxes 1.03
    Net income 2.00 Current debt 10
    Long-term debt 4
    Dividends 1.40 Total debt 14
    Retained earnings 0.60 Common stock 14
    Ret. earnings 4
    Total liabilities and equity 32

    The current financial policy of the Optimal Scam Company includes

    Dividend-payout ratio (d) = 70%


    Debt-to-equity ratio (L) = 77.78%
    Net profit margin (P) = 6.25%
    Assets-sales ratio (T) =1

    Determine Optimal Scam's need for external funds next year.

    Construct a pro forma balance sheet for Optimal Scam.

    Calculate the sustainable growth rate for the Optimal Scam Company.

    How can Optimal Scam change its financial policy to achieve its growth objective?

    a. Since you are making a projection for one year in the future it is reasonable to assume that
    fixed costs do not change. Thus, if sales grow 20%, then net income will grow 20%.
    Net income is $2,000,000(1.2) = $2,400,000.
    Next determine total uses of funds
    The increase in net working capital is the same as the growth rate since the current
    assets and current liabilities will increase with sales
    Net working capital = current assets current liabilities
    NWC = 0.20 ($16,000,000 - $10,000,000) = $1,200,000
    The increase in fixed assets is growth rate X existing fixed assets
    INV = 0.20 ($16,000,000) = $3,200,000
    Dividend = 0.70 ($2,400,000) = $1,680,000 (given the dividend payout ratio)
    Total uses = NWC + INV + Dividend = $6,080,000
    Operating sources = Net income = $2,400,000
    New External Funds = Total uses - Operating sources
    = $6,080,000 - 2,400,000 = $3,680,000

    b. The total increase in assets is 6,400,000 (32,000,000X20%) . To maintain a debt equity


    ratio of 77.78%. We get
    D+E = 6,400,000
    D/E = 0.7778. This gives us Equity = 6,400,000/1.7778 = 3,600,000
    Debt = 2,800,000.
    Of this debt, increase in current liability is 2,000,000 (10,000,000X20%). Long term debt
    has to be increased by 800,000
    Retained earnings will increase by 2,400,000-1,680,000 = 720,000
    Equity will increase by 3,600,000-720,000=2,880,000

    Current assets (16,000,000X1.2) $19,200,000


    Fixed assets (16,000,000 X 1.2) 19,200,000
    Total assets $38,400,000

    Current liabilities (10,000,000 X1.2) $12,000,000


    Long-term debt $4,800,000
    Total liabilities $16,800,000
    Common stock $16,880,000
    Accumulated retained earnings 4,720,000
    Total equity $21,600,000
    Total liabilities and equity $38,400,000

    We can make the balance sheet based on our calculations above.


    Pro Forma Balance Sheet
    Optimal Scam Company
    Current assets $19,200,000
    Fixed assets 19,200,000
    Total assets $38,400,000
    Current liabilities $12,000,000
    Long-term debt 4,800,000
    Total liabilities $16,800,000
    Common stock $16,880,000
    Accumulated retained earnings 4,720,000
    Total equity $21,600,000
    Total liabilities and equity $38,400,000

    S P(1 d)(1 L)
    c. Sustainable growth
    S T P(1 d)(1 L)

    0.0625(.3)(1.7778)
    0.0345 3.45%
    1 0.0625(0.3)(1.7778)

    Here P, d, T and L are as per the figures mentioned in the question.

    d. The growth rate of 20% if much above the sustainable growth rate of 3.45%.
    Cutting the dividend to zero will not be enough. It could only attain a 12.5% growth
    rate by eliminating the dividend. Optimal Scam must increase its asset utilization
    and/or its profit margin substantially to be able to achieve its objective growth rate.
    Optimal could also increase its debt load; this action will increase ROE.

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