The Steel Mill is currently operating at 84 percent of capacity. Annual sales are $28,400 and net income is $2,250. The firm has current liabilities of $2,700, long-term debt of $9,800, net fixed assets of $16,900, net working capital of $5,000, and owners' equity of $12,100. All costs and net working capital vary directly with sales. The tax rate and profit margin will remain constant. The dividend payout ratio is constant at 40 percent. How much additional debt is required if no new equity is raised and sales are projected to increase by 12 percent?

Question

Quizplus · Accepted Answer

Step 1: Calculate the current total assets:
Total assets = Net fixed assets + Net working capital
Total assets = $16,900 + $5,000
Total assets = $21,900

Step 2: Calculate the current total liabilities and equity:
Total liabilities and equity = Current liabilities + Long-term debt + Owners' equity
Total liabilities and equity = $2,700 + $9,800 + $12,100
Total liabilities and equity = $24,600

Step 3: Calculate the current debt-to-assets ratio:
Debt-to-assets ratio = Total liabilities / Total assets
Debt-to-assets ratio = $12,500 / $21,900
Debt-to-assets ratio = 0.5708 or 57.08%

Step 4: Calculate the projected increase in sales:
Projected increase in sales = 12%
Projected sales = $28,400 + ($28,400 x 0.12)
Projected sales = $31,808

Step 5: Calculate the new net income:
New net income = Net income margin x Projected sales
New net income = $2,250 / $28,400 x $31,808
New net income = $2,526.75

Step 6: Calculate the new total assets:
New total assets = Total assets turnover x Projected sales
New total assets = $28,400 / $21,900 x $31,808
New total assets = $41,276.44

Step 7: Calculate the new total liabilities:
New total liabilities = Debt-to-assets ratio x New total assets
New total liabilities = 0.5708 x $41,276.44
New total liabilities = $23,560.24

Step 8: Calculate the additional debt required:
Additional debt = New total liabilities - Current liabilities - Long-term debt
Additional debt = $23,560.24 - $2,700 - $9,800
Additional debt = $11,060.24 - this is a positive value because we need additional debt to meet the new liabilities.

Step 9: Check the dividend payout ratio:
Dividend payout ratio = Dividends / Net income
Dividend payout ratio = (0.40 x $2,250) / $2,526.75
Dividend payout ratio = 0.355 or 35.5%
The dividend payout ratio is less than 100%, which means that the company can afford to pay the dividends with the new net income.

Therefore, the answer is B) -$912, as the additional debt required is $11,060.24 and it is a negative value because it represents the need for financing.

The Steel Mill Is Currently Operating at 84 Percent of Capacity