Question

CCC currently has sales of $22,000,000 and projects sales of $27,500,000 for next year. The firm's current assets equal $8,000,000 while its fixed assets are $9,000,000. The best estimate is that current assets will rise directly with sales while fixed assets will rise by $200,000. The firm presently has $4,000,000 in accounts payable, $2,000,000 in long-term debt, and $11,000,000 in common equity. All current liabilities are expected to change directly with sales. CCC plans to pay $700,000 in dividends next year and has a 5.0% net profit margin. Assuming the increase in fixed assets will occur, what is the most sales could equal next year without using discretionary sources of funds? (Round your answer to the nearest dollar.) $28,961,483 $26,127,655 $23,517,241 $20,763,372 $22,157,474

Answer 1

The company does not want to use discretionary sources of funds - implying they want to finance the fixed asset and working capital (accounts receivable and payable) requirements internally and no additional funds (in the form of equity/debt) is needed.

We have the equation:

Additional Funds Requirement = Increase in Fixed Assets + Increase in Current Assets - Increase in Current Liabilities - Increase in Retained Earnings

a. Additional Funds Requirement (in the form of equity & long term debt) = 0

b. Increase in Fixed Assets = $200,000 (given in question)

c. Increase in Current Assets:

Current assets now = $8,000,000 (given in question)

Current asset next year rises directly with sales. Thus the change in sales will equal change in currrent assets. Lets assume the change in sales be X

Increase in Current asset next year = $8,000,000*X

d. Increase in Current Liabilities:

Current Liabilities now = $4,000,000 (given in question)

Current Liabilities next year rises directly with sales. Thus the change in sales will equal change in currrent Liabilities. Lets assume the change in sales be X

Increase in Current Liabilities next year = $4,000,000*X

e. Increase in Retained Earnings:

Retained Earnings = Net Profit Margin - Dividends declared

Net profit margin = Sales * Net profit margin % = $22,000,000*(1+X)*5% = $1,100,000+$1,100,000X

(Sales in current year given in question = $22,000,000 and sales next year = $22,000,000*(1+X) as X is the change in sales assumed. Net Profit Margin of 5% given in the question).

Dividends declared = $700,000 (given in question)

Increase in Retained Earnings = $1,100,000+$1,100,000X -$700,000 = $400,000+$1,100,000X

Applying the above values in equation:

Additional Funds Requirement = Increase in Fixed Assets + Increase in Current Assets - Increase in Current Liabilities - Increase in Retained Earnings

0 = $200,000+$8,000,000*X-$4,000,000*X-($400,000+$1,100,000*X)

=$200,000+$4,000,000*X-$400,000-$1,100,000*X

= -$200000 = $2900000*X

X = -$200,000/$2,900,000 = -6.89655% (negative implies sales to grow as this is used to fund the increase in asset requirements).

Thus, sales has to be grow by 6.89655% next year for financing the increase in assets and working capital without using discretionary sources of funds.

Hence sales required next year = Current year sales * (1+6.89655%)

= $22,000,000*(1+6.89655%) = $23,517,241 (3rd option).