CLO3

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Westcliff University *

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500

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Accounting

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Jun 22, 2024

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1 CLA Assignment 3 Michael Ayala Coba Westcliff University FIN500: Financial & Accounting Skills for Managers Professor Blount June 6th, 2024

2 Please note: Abstracts are not required for student papers (they do not take the place of introductions) Only write an abstract if your professor specifically requires one (If it is required, please see these tutorials for assistance on structure and content: Abstract, Overview Abstract, Informative )

3 CLO Assignment 3 Minicase: Planning for Growth at S&S Air After Chris completed the ratio analysis for S&S Air (see Chapter 3), 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:

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4 Problem 1. Calculate the internal growth rate and sustainable growth rate for S&S Air. What do these numbers mean? How do you know? ROA = NI / TA = $1,854,232/$18,388,130 = 10.08% b = RE / NI = $1,289,232/$1,854,232 = 0.695 Internal growth rate = (ROA × b) / [1-(ROA x b)] Internal growth rate = [0.1008(.695)] / [1 − 0.1008(.695)] Internal growth rate = 7.53% ROE = NI / TE = $1,854,232/$10,481,803 = 17.69% Sustainable growth rate = (ROE x b) / [1-(ROE x b)] Sustainable growth rate = [0.1769(.695)] / [1-0.1769(.695)] Sustainable growth rate = 14.02% An Internal Growth Rate (IGR) of 7.53% means that, based on the company's current return on assets and the portion of earnings it keeps, it can increase its sales and assets by up to 7.64% per year without needing external funding, such as new equity or debt. A Sustainable Growth Rate (SGR) of 14.02% means the company can expand its sales and assets by up to 14.02% per year while keeping its debt and equity levels steady. This

5 assumes the company reinvests the same portion of its earnings (retention ratio) and doesn't issue new equity, maintaining its financial leverage. These rates show how fast a company can grow internally without significantly changing its capital structure. The IGR focuses on growth using only retained earnings, while the SGR considers growth while keeping the current debt-to-equity balance. 2. S&S Air is planning for a growth rate of 12% 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? Explain your reasoning. A/S = TA / S = $18,388,130/ $37,038,492 = 0.4965 ΔS = S * (0.12) = $37,038,492 * 0.12 = 4,444,619 L/S = TL / S = $ 7,906,327 / $37,038,492 = 0.2135 PM = NI / S = $1,854,232/ $37,038,492 = 0.0501 𝑆 1 = CS (1+GR) = $37,038,492 (1+0.12) = 41,483,111 EFN = ( A/S) ΔS − (L/S) ΔS – PM * 𝑆 1 * b EFN = (0.4965 * 4,444,619) – (0.2135 * 4,444,619) – (0.0501 * 41,483,111 * 0.695) EFN = -186,594 A negative EFN of -$186,594 means S&S Air doesn't need external financing to achieve its planned 12% growth rate. The company’s retained earnings and net profits provide enough

6 internal resources, and effective management of current liabilities helps fund the required new assets. This sufficiency of internal funds and strategic use of liabilities ensure S&S Air can grow without altering its capital structure. The company's strong financial health and operational efficiency allow it to reinvest profits and achieve its 12% growth target without needing new equity or debt financing. 3. Most assets can be increased as a percentage of sales. For instance, cash can be increased by any amount. However, fixed 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% capacity. As a result, to increase production, the company must set up an entirely new line at a cost of $5,000,000. Calculate the new EFN with this assumption. What does this imply about capacity utilization for the company next year? New EFN = EFN + New Fixed Assets Inv New EFN = -$186,594 + 5,000,000 New EFN = 4,813,406 An EFN of $4913,406 shows that S&S Air needs significant external financing for its planned 12% growth and increased production capacity. This is primarily due to the $5,000,000

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7 required for a new production line, as the company is already at full capacity. Without this investment, it can't meet higher sales targets. The new production line supports immediate growth and future expansion, indicating strategic long-term planning. Despite robust internal funds, the scale of investment needed surpasses current capabilities, requiring external financing. Maintaining a healthy balance sheet is crucial for attracting investors or lenders. Overall, the EFN highlights the necessity for strategic investments to enhance capacity and sustain growth, ensuring S&S Air's future competitiveness and market expansion. 4. Consider how long term planning and growth is affected by location in the world. Discuss how you would advise S&S Air about planning and growth in your own country and expansion into other countries? For S&S Air, strategic long-term growth in Ecuador requires leveraging the region's unique opportunities and addressing its challenges. Ecuador's growing population and middle class drive demand for advanced technology and transportation, aligning well with S&S Air's offerings. Government investments in infrastructure, especially airports and airline fleets, create a favorable growth environment. However, navigating Ecuador's regulatory landscape requires understanding local laws and policies. Partnerships with local firms can ease market entry and operations by providing local expertise. Ecuador's strategic location and manufacturing capabilities offer cost and supply chain advantages, though managing intellectual property and quality control risks is essential.

8 References Ross, S. A., Westerfield, R., & Jordan, B. D. (2021). Fundamentals of Corporate Finance . Mcgraw Hill. Wild, J. J., & Shaw, K. W. (2022). Financial & managerial accounting : information for decisions (9th ed.). Mcgraw-Hill Education.