Oats 'R' Us
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Growing Pains - External Financing
Case 4 Growing Pains
"We must plan for the future," said Vicky. "I think we've been
playing it by ear for too long." Mason immediately called the treasurer,
Jim Moroney. "Jim, I need to know how much additional funding we are
going to need for the next year," said Mason. "The growth rate of
revenues should be between 25% and 40%. I would really appreciate if
you can have the forecast on my desk by early next week."
Jim knew that his fishing plans for the weekend had better be put
aside since it was going to be a long and busy weekend for him. He
immediately asked the accounting department to give him the last three
years' financial statements (see Tables 1 and 2) and got right to work!
I attached the financial statements.
Need to see and understand each calculation and show all work
2. If Oats 'R' Us is operating its fixed assets at full capacity,
what growth rate can it support without the need for any
additional external financing?
3. Oats 'R' Us has a flexible credit line with the Midway Bank.
If Mason decides to keep the debt-equity ratio constant, up to
what rate of growth in revenue can the firm support? What
assumptions are necessary when calculating this rate of
growth? Are these assumptions realistic in the case of Oats
'R' Us? Please explain.
4. Initially Jim assumes that the firm is operating at full
capacity. How much additional financing will it need to
support revenue growth rates ranging from 25% to 40% per
year?
5. After conducting an interview with the production manager,
Jim realizes that Oats 'R' Us is operating its plant at 90%
capacity, how much additional financing will it need to
support growth rates ranging from 25% to 40%?
6. What are some actions that Mason can take in order to
alleviate some of the need for external financing? Analyze
the feasibility and implications of each suggested action.
7. How critical is the financial condition of Oats 'R' Us? Is
Vicky justified in being concerned about the need for
financial planning? Explain why.
8. Given that Mason prefers not to deviate from the firm's 2004
debt-equity ratio, what will the firm's pro-forma income
statement and balance sheet look like under the scenario of
40% growth in revenue for 2005 (ignore feedback effects).
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Please see the attached files.
2. If Oats 'R' Us is operating its fixed assets at full capacity, what growth rate can it support without the need for any additional external financing?
This is the internal growth rate and is calculated as
IGR = ROE x (1 - Dividend Payout Ratio) x (Book Value of Equity)/(Total Assets)
ROE = Net Income/Equity = 219,900/(155,560+322,404)=46%
Dividend Payout Ratio = Dividends/Net income = 87,960/219,900=40%
Book Value of Equity = 477,964
Total Assets = 1,206,916
IGR = 46% X(1-40%) X (477,964/1,206,916) = 10.9%
3. Oats 'R' Us has a flexible credit line with the Midway Bank. If Mason decides to keep the debt-equity ratio constant, up to what rate of growth in revenue can the firm support? What assumptions are necessary when calculating this rate of growth? Are these assumptions realistic in the case of Oats 'R' Us? Please explain.
This is the sustainable growth rate and is given as
SGR = ROE x (1 - Dividend Payout Ratio)/((ROEX(1-Dividend Payout ratio))
SGR = 46% X (1-40%)/(46% X (1-40%))=38.12%.
The assumptions in the SGR are
Debt to Equity ratio remains constant. That is, the firm's debt will increase by the same percentage as equity.
No new equity is issued.
Asset Turnover Ratio will be the same from this year to next year. That is, the amount of assets needed to support a dollar of sales next year will be the same as this year.
All other liability accounts (i.e., besides debt) will increase at a rate equal to the growth rate of common equity.
The assumptions are not realistic. If the firm is operating at capacity, then assets will increase faster than the sales initially and the asset turnover ratio may fall.
The assumption of no new equity can be maintained
The other liability accounts are more dependent on sales rather than the common equity and so they growth rate may be ...
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