Question

AO Smith Corporation has total assets of $682 million. To support its growth in sales next year, it projects total assets will need to increase by 5% and its naturally occurring growth in financing resources (i.e., total liabilities and equity) will be 2%. Assuming funding deficits can be financed with external debt at 9%, by how much (in $ millions, rounded to one decimal place, e.g. $12.3) would interest expense be expected to jncrease due to the increased amount of external borrowing reeded?

Answer 1

AO Smith Corporation's interest expense is expected to increase by approximately $1.8 million due to a need for external borrowing to finance an asset increase necessary for projected sales growth.

Step-by-step explanation:

To calculate the increase in interest expense due to external borrowing for AO Smith Corporation, we'll start with their total assets of $682 million and determine the amount by which these assets need to increase to support next year's growth. Given that total assets need to increase by 5%, we calculate the dollar amount of this increase by multiplying $682 million by 5%, which equals $34.1 million. Financing resources are projected to grow naturally by 2%, contributing $13.64 million ($682 million x 2%).

The shortfall that needs to be financed externally is the difference between the asset increase and the natural financing increase, which is $34.1 million - $13.64 million = $20.46 million. To cover this shortfall, external debt at an interest rate of 9% will be incurred, leading to an additional interest expense calculated as $20.46 million x 9%, which equals approximately $1.8414 million. Therefore, AO Smith Corporation would expect their interest expense to increase by about $1.8 million due to external borrowing.