The Steel Mill is currently operating at 84 percent of capacity. Annual sales are $28,400 and net income is $2,250. The firm has current liabilities of $2,700, long-term debt of $9,800, net fixed assets of $16,900, net working capital of $5,000, and owners' equity of $12,100. All costs and net working capital vary directly with sales. The tax rate and profit margin will remain constant. The dividend payout ratio is constant at 40 percent. How much additional debt is required if no new equity is raised and sales are projected to increase by 12 percent?

Since there is no new equity being raised, the additional financing required to sustain business operations would be done by taking on higher debt. To calculate how much debt would be required, we need to use a formula that gives us the amount of External Financing Needs.

The formula is simple to use and requires us to factor in the following variables.

The increase in assets required with respect to the change in sales
The increase in liabilities required with respect to the change in sales
The increase in unappropriated profit (retained earnings) required

The formula to calculate the first point is given by dividing last year's assets with last year's sales and multiplying it by the change in sales.

The formula to calculate the second point is by dividing last year's liabilities by last year's sales and multiplying it by the change in sales.

The formula to calculate the third point is multiplying the profit margin by the forecasted sales and the dividend payout ratio.

Lets look at all the values for the required variables below:

Total Assets last Year : $24,600
Total Sales Last Year : $28,400
Total Current Liabilities last year: $2,700
Profit Margin : 8%
Forecasted Sales: $31,808
Dividend Payout Ratio: 40%
Change in Sales : $3,408
Current Liabilities: $2,700 (we will not use total liabilities. Since long term debt does not vary with change in sales, we will exclude long term debt)

We know the values to points 2, 3, 6, and 8 since these are given in the equation. We will calculate the rest of the values required below.

(1) Total Assets last year: Total Equity + Long Term Debt + Current Liabilities. Therefore, Assets = 12,100+2,700+9,800 = 24,600

(4) Profit Margin = Net Income/Sales = 2,250/28,400 = 8%

(5) Forecasted Sales = Sales last year x Increase in Sales = $28,400 x 1.12 = $31,808

(7) Change in sales = Forecasted Sales - Last Year Sales = 3,408

Formula for External Financing Need:

(Assets/Sales x Change in sales) - (Liabilities/Sales x Change in Sales) - (Profit Margin x Forecasted Sales x Dividend Payout Ratio)

Now, lets plug in the values:

(24,600/28,400 x 3,408) - (2,700/28,400 x 3,408) - (8% x 31,808 x 40%)

2,952 - 324 - 1,017.86 = 1,610.14

So, additional debt required is $1,610.14