Question

Mansfield Corporation had 20X1 sales of \(100 million. The balance sheet items that vary directly with sales and the profit margin are as follows:

	Percent
Cash	5%
Accounts receivable	15
Inventory	20
Net fixed assets	40
Accounts payable	15
Accruals	10
Profit margin after tax	10%

The dividend payout rate is 50 percent of earnings, and the balance in retained earnings at the end of 20X1 was \)33 million. Notes payable are currently \(7 million. Long-term bonds and common stock are constant at \)5 million and $10 million, respectively.

b. What will happen to external fund requirements if Mansfield Corporation reduces the payout ratio, grows at a slower rate, or suffers a decline in its profit margin? Discuss each of these separately.

Short answer

If Mansfield reduces the payout ratio, the company will retain more earnings and need less external funding. A slower growth rate means that less assets will have to be financed and in this case, less external funding would be needed. In addition, a declining profit margin will lower retained earnings and force Mansfield corporation to seek more external funds.

Step-by-step solution

Dividend payout ratio

Dividend payout ratio is defined as the ratio at which dividend is paid by an organization to their shareholders. Lesser dividend payout ratio means high retained earnings and if the company has high retained earning, then the company require less external funding.

Decline in profit margin

Profit margin is defined as the net income earned by the company on the gross revenue of the company. If the profit margin of the company decreases, it means company has less retained earnings. Hence, company require more external funding.

Slower growth rate

If the growth rate of the companies slows down, then it means company does not require assets to be financed, and hence, company require less external funding.