A new software start-up, Lutoj, Inc., is developing a new smart home software product. Lutoj believes sales 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 $200,000 between them for initial equity funding. Assume Lutoj will pay no dividend.
a. With no other financing, will the $200,000 of founder investment be sufficient to achieve the Year 3 sales target?
b. Assume Lutoj cannot raise additional equity, but will use debt to achieve the scale necessary to reach the Year 3 sales target. How much debt will initially be required (leverage factor)