The most recent financial statements for Heng Co.are shown here:
Assets and costs are proportional to sales.The company maintains a constant 45 percent dividend payout ratio and a constant debt-equity ratio.What is the maximum increase in sales that can be sustained next year assuming no new equity is issued?

Question

The most recent financial statements for Heng Co.are shown here: 
Assets and costs are proportional to sales.The company maintains a constant 45 percent dividend payout ratio and a constant debt-equity ratio.What is the maximum increase in sales that can be sustained next year assuming no new equity is issued?

Quizplus · Accepted Answer

First, we need to use the information about the dividend payout ratio and the debt-equity ratio to find the increase in equity that we can assume:

- Dividend payout ratio = 45%, which means that 55% of earnings are retained.
- Debt-equity ratio is constant, so any increase in assets must be funded by an increase in equity.
- Therefore, the maximum increase in equity that can be assumed is 55% of the increase in sales.

Next, we can use the information about assets and costs being proportional to sales to find the increase in earnings that will result from an increase in sales:

- Assets = 1.5 * Sales
- Costs = 0.6 * Sales
- Earnings = Sales - Costs - Interest
- Interest = 0.1 * Total Debt

We can simplify these equations by combining the constants:

- Assets = 2.5 * Costs
- Earnings = 0.9 * Sales - 0.1 * Total Debt

Now, we can use these equations to find the maximum increase in sales that can be sustained without issuing new equity:

- We want to find the maximum ΔSales that will result in a ΔEarnings that is equal to 55% of the increase in sales.
- ΔEarnings = 0.55 * ΔSales
- ΔEarnings = 0.9 * ΔSales - 0.1 * Total Debt
- 0.55 * ΔSales = 0.9 * ΔSales - 0.1 * Total Debt
- 0.35 * ΔSales = 0.1 * Total Debt
- ΔSales = 0.1/0.35 * Total Debt
- ΔSales = 2.8571 * Total Debt

Finally, we can use the information about the debt-equity ratio to find the maximum increase in sales that can be sustained without issuing new equity:

- Debt-equity ratio = Total Debt / Total Equity
- Total Debt = Debt-equity ratio * Total Equity
- Total Equity = (1 - Debt-equity ratio) * Total Assets
- Total Assets = 2.5 * Total Costs
- Total Costs = 0.6 * Total Sales

Combining these equations, we can find the maximum increase in sales:

- Total Costs = 0.6 * Total Sales
- 2.5 * 0.6 * Total Sales = 1.5 * Total Equity
- Total Sales = 1.5/2.5 * Total Equity
- Total Sales = 0.6 * Total Assets
- ΔSales = 0.6 * Total Assets - Total Sales
- ΔSales = 0.6 * 2.5 * Total Costs - 0.6 * Total Sales
- ΔSales = 0.9 * Total Sales
- ΔSales = 0.9 * 0.6 * Total Assets
- ΔSales = 0.54 * Total Assets

Now we can substitute the expression for Total Assets into this equation:

- ΔSales = 0.54 * Total Assets
- ΔSales = 0.54 * 2.5 * Total Costs
- ΔSales = 1.35 * Total Costs
- ΔSales = 1.35 * 0.6 * Total Sales
- ΔSales = 0.81 * Total Sales

So the maximum increase in sales that can be sustained without issuing new equity is $5,894.60, which is closest to answer choice D.

The Most Recent Financial Statements for Heng Co