15-5 External Equity Financing: Northern Pacific 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 40% with a $10 million investment
in plant and machinery. The firm wants to maintain a 40% debt to total assets ratio in its
capital structure. It also wants to maintain its past dividend policy of distributing 45% of
last years net income. In 2008, net income was $5 million. How much external equity
must Northern Pacific seek at the beginning of 2009 to expand capacity as desired?
Assume that the firm uses only debt and common equity in its capital structure.

Retained earnings = Net income (1 – Payout ratio)

= $5,000,000(0.55) = $2,750,000.

External equity needed:

Total equity required = (New investment)(1 – Debt ratio)
= $10,000,000(0.60) = $6,000,000.

New external equity needed = $6,000,000 – $2,750,000 = $3,250,000.

16-2 Receivables investment: Lamar Lumber Co. has sales of $10 million per year, all on
credit terms calling for payment within 30 days; and its accounts receivables are $2
million. What is Lamar’s DSO what would it be if all customers paid on time, and how
much capital would be released if lamar could take action that led to on time payments?
( Assume all customers pay on time and DSO =30 days)

Sales = $10,000,000; A/R = $2,000,000; DSO = ?

Receivable s
DSO = Sales/365
$2,000,000
= $10,000,000 /365

= 73 days.

If all customers paid on time (assuming that it makes no sense for customers to pay
earlier than 30 days), then the firm’s DSO = 30 days. If customers paid on time, the
firm’s A/R = 30  $10,000,000/365 = $821,917.81.

Cash freed up = $2,000,000 – $821,917.81 = $1,178,082.19.