Pickup Industries has a proﬁt margin of 15% and a dividend payout of 40%. Last year's sales were $600 million and total assets were $400 million. None of the liabilities vary directly with sales, but
Assets and costs do. If the sales growth rate for Pickup is 20%, how much external ﬁnancing is
Needed?
A) $5.2 million
B) $13.1 million
C) $15.2 million
D) $21.3 million
E) $26.0 million

Question

Quizplus · Accepted Answer

First, we need to calculate the net income:

Net Income = Profit Margin x Sales

Net Income = 0.15 x $600 million

Net Income = $90 million

Next, we need to calculate the dividend payment:

Dividend Payment = Dividend Payout Ratio x Net Income

Dividend Payment = 0.4 x $90 million

Dividend Payment = $36 million

We can use the formula for the sustainable growth rate to calculate the maximum amount of growth Pickup Industries can achieve without external financing:

Sustainable Growth Rate = Retention Ratio x Return on Assets

Retention Ratio = 1 - Dividend Payout Ratio

Retention Ratio = 1 - 0.4

Retention Ratio = 0.6

Return on Assets = Net Income / Total Assets

Return on Assets = $90 million / $400 million

Return on Assets = 0.225

Sustainable Growth Rate = 0.6 x 0.225

Sustainable Growth Rate = 0.135 or 13.5%

Since the sales growth rate is higher than the sustainable growth rate, external financing is needed. To calculate the amount of external financing needed, we use the formula:

External Financing Needed = Increase in Assets - Increase in Liabilities - Retained Earnings

Since liabilities do not vary with sales, the increase in liabilities is 0.

The increase in assets is:

Increase in Assets = Sales Growth Rate x Total Assets

Increase in Assets = 0.2 x $400 million

Increase in Assets = $80 million

Retained Earnings = Net Income - Dividend Payment

Retained Earnings = $90 million - $36 million

Retained Earnings = $54 million

External Financing Needed = $80 million - $0 - $54 million

External Financing Needed = $26 million

Therefore, the external financing needed is $26 million, which is answer choice C.

Pickup Industries Has a Proﬁt Margin of 15% and a Dividend