Question

LONG-TERM FINANCING NEEDED At year-end 2016, total assets for Arrington Inc. were $2 million and accounts payable were $315,000. Sales, which in 2016 were $2.6 million, are expected to increase by 30% in 2017. Total assets and accounts payable are proportional to sales, and that relationship will be maintained; that is, they will grow at the same rate as sales. Arrington typically uses no current liabilities other than accounts payable. Common stock amounted to $370,000 in 2016, and retained earnings were $340,000. Arrington plans to sell new common stock in the amount of $200,000. The firm's profit margin on sales is 7%; 65% of earnings will be retained. a. What were Arrington's total liabilities in 2016? Write out your answer completely. For example, 25 million should be entered as 25,000,000. Round your answer to the nearest cent. to b. How much new long-term debt financing will be needed in 2017? Write out your answer completely. For example, 25 million should be entered as 25,000,000. Do not round your intermediate calculations. Round your answer to the nearest cent. (Hint: AFN - New stock = New long-term debt.)

Answer 1

(a)

Total Assets = Equity +Total Liabilities

This formula can be simplified as per the question as below:

Total Assets = (Common Stock + Retained Earnings) + Total Liabilities

* [EQUITY = common stock + Retained Earnings]

According to the question, we get:

$2,000,000 = ($370,000 + $340,000) + Total Liabilities

Total Liabilities = $2,000,000 - $710,000

= $1,290,000

Therefore, the Total Liabilities of Arrington Inc. for the year 2016 is $1,290,000.

(b)

Sales in the year 2016 = $2,600,000

Expected Increase in Sales = 30%

Increase in Sales in year 2017 = $780,000

Expected Sales for the year 2017 = $2,600,000 + $780,000 = $3,380,000

We are required to find out the Additional Fund Needed (AFN) which can be calculated using the formula below:

Additional Fund Needed (AFN) = [(Assets/Sales-2016) x Change in Sales] – [(Accounts Payable/Sales-2016) x Change in Sales] – (Margin of Profit x Expected Sales – 2017 x Retention Ratio)

= [($2,000,000/$2,600,000) x $780,000] – [($315,000/$2,600,000) x $780,000] – (0.07 x $3,380,000 x 0.65)

*(Profit Margin = 7% = 7/100 = 0.07 and Retention Ratio = 65% = 65/100 = 0.65)

= $600,000 - $94,500 – 153,790 = $351,710

And New Stock = $200,000

Therefore, New Long Term Debt needed for 2017 = AFN – New Stock = $351,710 - $200,000

= $151,710