The Optimal Scam Company would like to see its sales grow at 20 percent for the foreseeable

future. Its financial statements for the current year are presented below.

Income Statement ($ millions) Balance Sheet ($ millions)

Sales 32.00 Current assets 16
Costs 28.97 Fixed assets 16
Gross profit 3.03 Total assets 32
Taxes 1.03
Net income 2.00 Current debt 10
Long-term debt 4
Dividends 1.40 Total debt 14
Retained earnings 0.60 Common stock 14
Ret. earnings 4
Total liabilities and equity 32

The current financial policy of the Optimal Scam Company includes

Dividend-payout ratio (d) = 70%

Debt-to-equity ratio (L) = 77.78%
Net profit margin (P) = 6.25%
Assets-sales ratio (T) =1

Determine Optimal Scam's need for external funds next year.

Construct a pro forma balance sheet for Optimal Scam.

Calculate the sustainable growth rate for the Optimal Scam Company.

How can Optimal Scam change its financial policy to achieve its growth objective?

a. Since you are making a projection for one year in the future it is reasonable to assume that
fixed costs do not change. Thus, if sales grow 20%, then net income will grow 20%.
Net income is $2,000,000(1.2) = $2,400,000.
Next determine total uses of funds
The increase in net working capital is the same as the growth rate since the current
assets and current liabilities will increase with sales
Net working capital = current assets current liabilities
NWC = 0.20 ($16,000,000 - $10,000,000) = $1,200,000
The increase in fixed assets is growth rate X existing fixed assets
INV = 0.20 ($16,000,000) = $3,200,000
Dividend = 0.70 ($2,400,000) = $1,680,000 (given the dividend payout ratio)
Total uses = NWC + INV + Dividend = $6,080,000
Operating sources = Net income = $2,400,000
New External Funds = Total uses - Operating sources
= $6,080,000 - 2,400,000 = $3,680,000

b. The total increase in assets is 6,400,000 (32,000,000X20%) . To maintain a debt equity

ratio of 77.78%. We get
D+E = 6,400,000
D/E = 0.7778. This gives us Equity = 6,400,000/1.7778 = 3,600,000
 Debt = 2,800,000.
Of this debt, increase in current liability is 2,000,000 (10,000,000X20%). Long term debt
has to be increased by 800,000
Retained earnings will increase by 2,400,000-1,680,000 = 720,000
Equity will increase by 3,600,000-720,000=2,880,000

Current assets (16,000,000X1.2) $19,200,000

Fixed assets (16,000,000 X 1.2) 19,200,000
Total assets $38,400,000

Current liabilities (10,000,000 X1.2) $12,000,000

Long-term debt $4,800,000
Total liabilities $16,800,000
Common stock $16,880,000
Accumulated retained earnings 4,720,000
Total equity $21,600,000
Total liabilities and equity $38,400,000

We can make the balance sheet based on our calculations above.

Pro Forma Balance Sheet
Optimal Scam Company
Current assets $19,200,000
Fixed assets 19,200,000
Total assets $38,400,000
Current liabilities $12,000,000
Long-term debt 4,800,000
Total liabilities $16,800,000
Common stock $16,880,000
Accumulated retained earnings 4,720,000
Total equity $21,600,000
Total liabilities and equity $38,400,000

S P(1 d)(1 L)
c. Sustainable growth
S T P(1 d)(1 L)

0.0625(.3)(1.7778)
0.0345 3.45%
1 0.0625(0.3)(1.7778)

Here P, d, T and L are as per the figures mentioned in the question.

d. The growth rate of 20% if much above the sustainable growth rate of 3.45%.
Cutting the dividend to zero will not be enough. It could only attain a 12.5% growth
rate by eliminating the dividend. Optimal Scam must increase its asset utilization
and/or its profit margin substantially to be able to achieve its objective growth rate.
Optimal could also increase its debt load; this action will increase ROE.