Question

Suppose that Wind Em Corp. currently has the balance sheet shown below, and that sales for the year just ended were $7.8 million. The firm also has a profit margin of 30 percent, a retention ratio of 15 percent, and expects sales of $8.8 million next year.

Assets					Liabilities and Equity
Current assets	$	2,624,000			Current liabilities	$	3,622,320
Fixed assets		5,800,000			Long-term debt		1,900,000
					Equity		2,901,680
Total assets	$	8,424,000			Total liabilities and equity	$	8,424,000

If all assets and current liabilities are expected to grow with sales, what amount of additional funds will Wind Em need from external sources to fund the expected growth? (Enter your answer in dollars not in millions.)  

Answer 1

Current year's sales Next year's sales Increase % in sales $7.8 $8.8 1 2.82% million million [($8.8m - $7.8m) / $8.8m] It is given that all assets and current liabilities are expected to grow with sales, therefore, all assets and liabilities shall be increased by 12.82% Next year's sales Net profit margin % Increase in profit Retention ratio Increase in equity from sales $8,800,000 30% $2,640,000 ($8800000 x 30%] 15% $396,000 ($2640000 x 15%] Increase in total assets Less: Increase in liabilities Increase in shareholders' equity $1,080,000 ($8424000 x 12.82%] $707,990 [($3,622,320 + $1,900,000) x 12.82%] $372,010.26 [$1080000 - $707989.743589744] So, External Financing Needed $23,990 [If rounded off to zero decimal place] -$23,989.74 ($372010.26 - $396000]

Alternatively, EFN can be calculated using formula: EFN = (S) - So) - (5. – S.)=(PM/S.XD) where • So = Current Sales, $7,800,000 (Ref: Income Statement] • S1 = Forecasted Sales = So(1 + g). $8,800,000 [$7800000 X (1+12.82%) • g = the forecasted growth rate is Sales, 12.82% • A* = Assets (at time 0) which vary directly with Sales, $8,424,000 [= Total Assets as firm operates at full capacity] • L*6 = Liabilities (at time 0) which vary directly with Sales, $5,522,320 [= Current liabilities + Long-term debt as firm operates at full capacity] • PM = Profit Margin = (Net Income) (Sales), and 30.00% . b = Retention Ratio = (Addition to Retained Earnings) (Net Income) 15.00% External Financing Needed (EFN) -$23,989.74 --> $23,990 [If rounded off to zero decimal place) {[($8,424,000 / $7,800,000) x ($8,800,000-$7,800,000)] - ($5,522,320 / $7,800,000) x ($8,800,000-$7,800,000)] - [30% x $7,800,000 x 15%] =-$23,989.74}