Goals for Sales and Income Growth
Sunrise Corp. is a major regional retailer. The chief executive officer (CEO) is concerned with the slow growth both of sales and of net income and the subsequent effect on the trading price of the common stock. Selected financial data for the past three years follow.
Sunrise Corp. (in millions)
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2014
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2013
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2012
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1. Sales
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$200.0
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$192.5
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$187.0
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|
2. Net income
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6.0
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5.8
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5.6
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|
3. Dividends declared and paid
December 31 balances:
4. Owners' equity
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2.5
70.0
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2.5
66.5
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2.5
63.2
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5. Debt
Selected year-end financial ratios
Net income to sales
|
30.0
3.0%
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29.8
3.0%
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30.3
3.0%
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|
Asset turnover
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2 times
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2 times
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2 times
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|
6. Return on owners' equity*
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8.6%
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8.7%
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8.9%
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|
7. Debt to total assets
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30.0%
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30.9%
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32.4%
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|
*Based on year-end balances in owners' equity.
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|
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The CEO believes that the price of the stock has been adversely affected by the downward trend of the return on equity, the relatively low dividend payout ratio, and the lack of dividend increases. To improve the price of the stock, she wants to improve the return on equity and dividends.
She believes that the company should be able to meet these objectives by (1) increasing sales and net income at an annual rate of 10% a year and (2) establishing a new dividend policy that calls for a dividend payout of 50% of earnings or $3,000,000, whichever is larger.
The 10% annual sales increase will be accomplished through a new promotional program. The president believes that the present net income to sales ratio of 3% will be unchanged by the cost of this new program and any interest paid on new debt. She expects that the company can accomplish this sales and income growth while maintaining the current relationship of total assets to sales. Any capital that is needed to maintain this relationship and that is not generated inter- nally would be acquired through long-term debt financing. The CEO hopes that debt would not exceed 35% of total liabilities and owners' equity.
Required
1. Using the CEO's program, prepare a schedule that shows the appropriate data for the years 2015, 2016, and 2017 for the items numbered 1 through 7 on the preceding schedule.
2. Can the CEO meet all of her requirements if a 10% per-year growth in income and sales is achieved? Explain your answer.
3. What alternative actions should the CEO consider to improve the return on equity and to support increased dividend payments?
4. Explain the reasons that the CEO might have for wanting to limit debt to 35% of total liabil- ities and owners' equity.