Northern Pacific Heating and Cooling Inc. has a 6-month backlog of orders for it

Question

Northern Pacific Heating and Cooling Inc. has a 6-month backlog of orders for its patented solar heating system. To meet this demand, management plans to expand production capacity by 25% with a $20 million investment in plant and machinery. The firm wants to maintain a 35% debt-to-total-assets ratio in its capital structure. It also wants to maintain its past dividend policy of distributing 50% of last year's net income. In 2012, net income was $5 million. How much external equity must Northern Pacific seek at the beginning of 2013 to expand capacity as desired? Assume the firm uses only debt and common equity in its capital structure. Write out your answer completely. For example, 25 million should be entered as 25,000,000. Round your answer to the nearest cent.

$  

Please show calculation. Thanks!

Explanation / Answer

How much external equity must Northern Pacific seek at the beginning of 2013 to expand capacity as desired?

Caital budget for expansion = $20 million

Given 35% debt-to-total-assets ratio which means

Equity Part of investment = $20millions x 65% = $13 millions

Given, past dividend policy of distributing 50% of last year's net income.

Hence Amount left for Capital Investments = Net Income - Dividends = $5 millions x 50% = 2.5 millions

Hence, Amount Left for Capital Investments = 2.5 millions = $2500000

Hence, External Equity finance required = $13 - $2.5 = $10.5 millions

Hence, External finance requied = $10500000

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