Northern Pacific Heating and Cooling Inc. has a 6-month backlogof orders for its

Question

Northern Pacific Heating and Cooling Inc. has a 6-month backlogof orders for its patented solar heating system. To meet thisdemand, management plans to expand production capacity by 40percent with a $10 million investment in plant and machinery. Thefirm wants to maintain a 40 percent debt-to-total-assets ratio inits capital structure; it also wants to maintain its past dividendpolicy of distributing 45 percent of last year’s net income.In 2005, net income was $5 million. How much external equity mustNorthern Pacific seek at the beginning of 2006 to expand capacityas desired? Assume the firm uses only debt and common equity in itscapital structure.

Explanation / Answer

Desired Investment 10000000 ( A ) Debt 4000000 ( B ) Net Income 5000000 Dividends Paid ( Net Income * 45% ) 2250000 Retained Earnings 2750000 ( C ) DesiredEquity 3250000 ( A ) - ( B ) - ( C)

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