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Internal growth rate / EFN

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Planning for Growth at S&S Air
After Chris completed the ratio analysis for S&S Air, Mark and Todd approached him about planning for next year's sales. The company had historically used little planning for investment needs. As a result, the company experienced some challenging times because of cash flow problems. The lack of planning resulted in missed sales, as well as periods when Mark and Todd were unable to draw salaries. To this end, they would like Chris to prepare a financial plan for the next year so the company can begin to address any outside investment requirements. The income statement and balance sheet are shown here:

S&S Air, Inc.
2006 Income Statement
Sales $ 21,785,300
Cost of goods sold 15,874,700
Other expenses 2,762,500
Depreciation 976,200
EBIT $ 2,171,900
Interest 341,600
Taxable income $ 1,830,300
Taxes (40%) 732,120
Net income $ 1,098,180
Dividends $439,272
Add to retained earnings 658,908

S&S Air, Inc.
2006 Balance Sheet
Assets Liabilities and Equity
Current assets Current liabilities
Cash $ 315,000 Accounts payable $ 635,000
Accounts receivable 506,000 Notes payable 1,450,000
Inventory 740,800 Total current liabilities $ 2,085,000

Total current assets $ 1,561,800
Long-term debt $ 3,800,000
Fixed assets
Net plant and equipment $ 11,516,000 Shareholder equity
Common stock $ 250,000
Retained earnings 6,942,800
Total equity $ 7,192,800
Total assets $ 13,077,800 Total liabilities and equity $13,077,800

1. Calculate the internal growth rate and sustainable growth rate for S&S Air. What do these numbers mean?
2. S&S Air is planning for a growth rate of 12 percent next year. Calculate the EFN for the company assuming the company is operating at full capacity. Can the company's sales increase at this growth rate?
3. Most assets can be increased as a percentage of sales. For instance, cash can be increased by any amount. However, fi xed assets must be increased in specific amounts because it is impossible, as a practical matter, to buy part of a new plant or machine. In this case, a company has a "staircase" or "lumpy" fixed cost structure. Assume S&S Air is currently producing at 100 percent capacity. As a result, to increase production, the company must set up an entirely new line at a cost of $4,000,000. Calculate the new EFN with this assumption. What does this imply about capacity utilization for the company next year?

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Solution Summary

The solution explains the calculation of internal growth rate and EFN