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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937
Textbook Problem
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EXTERNAL EQUITY FINANCING Coastal Carolina Heating and Cooling Inc. has a 6-month backlog of orders for its patented solar heating system. To meet this demand, management plans to expand production capacity by 45% with a $20 million investment in plant and machinery. The firm wants to maintain a 35% debt level in its capital structure. It also wants to maintain its past dividend policy of distributing 55% of last year’s net income. In 2016, net income was $5 million. How much external equity must Coastal Carolina seek at the beginning of 2017 to expand capacity as desired? Assume that the firm uses only debt and common equity in its capital structure.

Summary Introduction

To calculate: Amount of external equity CC seeks at the beginning to expand its capacity as desire.

Introduction:

External Equity Financing:

When a firm requires funds and it obtains them externally then this will be termed as external equity financing. It is also termed as selling of ownership interest to acquire funds for business.

Explanation

Calculate total value equity required.

Given,

Cost of project is $20,000,000.

Percentage of debt in capital is 35%.

Formula to calculate equity required,

Equityrequired=Costofproject×(1%debtincapital)

Substitute $20,000,000 for project cost and 35% for % debt in capital.

Equityrequired=$20,000,000×(135%)=$20,000,000×0.65=$13,000,000

Hence, total value of equity required for the new project is $13,000,000.

Calculate total earnings retained.

Given,

Net income is $5,000,000.

Payout ratio is 55%.

Formula to calculate total earnings retained,

Totalearningsretained=NetIncome×(1Payoutratio)

Substitute $5,000,000 for net income and 55% for payout ratio

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