Cambridge Prep Shops, a national clothing chain, had sales of $200 million last year. The business has a steady net profit margin of 12 percent and a dividend payout ratio of 40 percent. The balance sheet for the end of last year is shown below.
End of Year
(In $ Millions)
Cash . $10
Accounts Receivable. 15
Plant and equipment.. 75
Total Assets $150
Liabilities and Stockholders' Equity
Accounts payable . $15
Accrued expenses 5
Other payables . 40
Common Stock . 30
Retained Earnings 60
Total liabilities and
stockholders' equity . $150
Cambridge's marketing staff tells the president that in this coming year there will be a large increase in the demand for tweed sport coats and various shoes. A sales increase of 15 percent is forecast for the Prep Shop. All balance sheet items are expected to maintain the same percent-of-sales relationships as last year, except for common stock and retained earnings. No change is scheduled in the number of common stock shares outstanding, and retained earnings will change as dictated by the profits and dividend policy of the firm. (Remember the net profit margin is 12 percent.)
a. Will external financing be required for the Prep Shop during the coming year?
b. What would be the need for external financing if the net profit margin went up to 14 percent and the dividend payout ratio was increased to 70 percent? Explain.
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