Question

Tobin Supplies Company expects sales next year to be \(500,000. Inventory and accounts receivable will increase \)90,000 to accommodate this sales level. The company has a steady profit margin of 12 percent with a 40 percent dividend pay-out. How much external financing will Tobin Supplies Company have to seek? Assume there is no increase in liabilities other than that which will occur with the external financing.

Short answer

The external financing that the company has to seek is $54,000.

Step-by-step solution

Information given in the question

The following information is provided:

Expected sales = $500,000

Expected increase in inventory and accounts receivables = $90,000

Profit margin = 12%

Dividend pay-out = 40%

 Net income calculation

$$\begin{gathered} \mathbf{Net}\mathbf{income}\mathbf{=}\mathbf{Expected}\mathbf{sales}\mathbf{\times }\mathbf{Profit}\mathbf{}\mathbf{margin} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{\$}\mathbf{500}\mathbf{,}\mathbf{00}\mathbf{}\mathbf{\times }\mathbf{12}\mathbf{\%} \\ \mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{}\mathbf{=}\mathbf{\$}\mathbf{60}\mathbf{,}\mathbf{000} \end{gathered}$$

Dividend pay-out calculation

$$\begin{gathered} \mathbf{Dividend}\mathbf{}\mathbf{pay}\mathbf{}\mathbf{out}\mathbf{=}\mathbf{Net}\mathbf{}\mathbf{income}\mathbf{\times }\mathbf{Dividend}\mathbf{}\mathbf{pay}\mathbf{-}\mathbf{out}\mathbf{}\mathbf{percentage} \\ \mathbf{=}\mathbf{\$}\mathbf{60}\mathbf{,}\mathbf{000}\mathbf{}\mathbf{\times }\mathbf{40}\mathbf{\%} \\ \mathbf{=}\mathbf{\$}\mathbf{24}\mathbf{,}\mathbf{000} \end{gathered}$$

Addition made to retained earnings

$$\begin{gathered} \mathbf{Addition}\mathbf{}\mathbf{to}\mathbf{}\mathbf{retained}\mathbf{}\mathbf{earnings}\mathbf{=}\mathbf{Net}\mathbf{}\mathbf{income}\mathbf{-}\mathbf{Dividend}\mathbf{}\mathbf{pay}\mathbf{-}\mathbf{out}\mathbf{} \\ \mathbf{=}\mathbf{\$}\mathbf{60}\mathbf{,}\mathbf{000}\mathbf{}\mathbf{-}\mathbf{\$}\mathbf{24}\mathbf{,}\mathbf{000} \\ \mathbf{=}\mathbf{\$}\mathbf{36}\mathbf{,}\mathbf{000} \end{gathered}$$

External fund needed

The external fund needed is $54,000.

$$\begin{gathered} \mathbf{External}\mathbf{}\mathbf{funds}\mathbf{}\mathbf{needed}\mathbf{=}\mathbf{Increase}\mathbf{}\mathbf{in}\mathbf{}\mathbf{assets}\mathbf{}\mathbf{-}\mathbf{Addition}\mathbf{}\mathbf{to}\mathbf{}\mathbf{retained}\mathbf{}\mathbf{earnings} \\ \mathbf{=}\mathbf{\$}\mathbf{90}\mathbf{,}\mathbf{000}\mathbf{}\mathbf{-}\mathbf{\$}\mathbf{36}\mathbf{,}\mathbf{000} \\ \mathbf{=}\mathbf{\$}\mathbf{54}\mathbf{,}\mathbf{000} \end{gathered}$$