Question

5. A software startup, Lutoj, Inc., is developing a new smart home software product. Lutoj believes revenue must reach $5 million in Year 3 for the product to be viable. Lutoj’s operating margin (EBIT/Sales) is 20%, the tax rate is 30, and asset turnover is 5X. The founders have a total of $200,000 for initial equity funding. Assume Lutoj will pay no dividend. (15 points) a. With no other financing, will the $200,000 of founder investment be sufficient to achieve the Year 3 sales target? If not, what level of initial equity investment would be required?

Answer 1

Answer and Explanation:

A. Given asset turnover =5 (there's an error in the question of 5X)

Net Sales = 5 million dollars

Asset turnover is given by Net Sales/Total assets invested

Asset turnover = Net sales/total assets invested

We substitute values in the equation:

5= $5000000/total assets invested

= total assets invested=$5000000/5

Total assets invested =$1000000

Therefore to reach net sales of $5000000, there needs to be an initial investment of $1000000 not $200000

B. Given that initial investment required = $1000000

And investment available for equity now=$200000

Debt required for additional financing to reach initial investment requirement

=$1000000-$200000

=$800000 debt