Question

Owen’s Electronics has nine operating plants in seven southwestern states. Sales for last year were $100 million, and the balance sheet at year-end is similar in percentage of sales to that of previous years (and this will continue in the future). All assets (including fixed assets) and current liabilities will vary directly with sales. The firm is working at full capacity.

Balance Sheet (in $ millions)
Assets			Liabilities and Stockholders' Equity
Cash	$	6	Accounts payable	$	19
Accounts receivable		24	Accrued wages		6
Inventory		27	Accrued taxes		12
Current assets	$	57	Current liabilities	$	37
Fixed assets		44	Notes payable		14
			Common stock		19
			Retained earnings		31
Total assets	$	101	Total liabilities and stockholders' equity	$	101

Owen’s Electronics has an aftertax profit margin of 9 percent and a dividend payout ratio of 40 percent.

If sales grow by 15 percent next year, determine how many dollars of new funds are needed to finance the growth. (Do not round intermediate calculations. Enter your answer in dollars, not millions, (e.g., $1,234,567).)

I’m getting 15,520,000 but I don’t think it’s right :-(

Answer 1

Sometimes the firm can use percentage of sales method to forecast its financial needs in the future. It helps the firm to predict a rough estimate of the extra / additional funds needed in the future course of business in order to achieve the desired level of sales growth. In this method all the business accounts that are directly correlated to the sales growth are calculated as percentage of sales (like cost of goods sold, inventory, cash in hand etc). However, this percentage of sales method can be only applied to those items that are closely correlated with sales. Other items like fixed assets, debt, notes payable, retained earnings, common stock are not directly correlated to sales, so their future value cannot be predicted with this method.

The basic premise of this method to calculate the additional funds needed is that the additional increase in the sales level is asscociated with a spontaneous increase in assets like plant & machinery, inventories, accounts receivables etc. This increase in assets is however, offset partly, by the spontaneous increase in current liabilities like accounts payables, accrued wages & taxes etc. & partly by the increase in retained earnings.

The additonal / extra funds needed can be calculated with the help of the following formula under the percentage of sales mathod :-

AFN = Increase in Spontaneous Assets - Increase in Spontaneous Liabilities - Increase in retained earnings

Or,

where, AFN = Additional funds needed or the required new funds

A / S = Proportion of spontaneous assets to sales

L / S = Proportion of spontaneous liabilities to sales

PM = Profit Margin

b = retention ratio = 1 - dividend payout ratio

S₁ = New sales level

= Change in Sales
i.e.{ S₁ - S₀ = } where, S₀ = last year sales level

Now, when the plant is working at full capacity :-

Spontaneous Assets = Current Assets + Fixed Assets

Spontaneous Liabilities = Accounts Payable + Accrued Wages + Accrued Taxes

From the above given formula, we get the following data :-

S₀ = $100 million

Sales grwoth in the next year = 15%

Therefore, = 15% of $100 million

or, = 0.15 * $100,000,000 = $15,000,000

Therefore, new sales level = $100,000,000 + $15,000,000 = $115,000,000

After tax Profit margin or PM = 9% or, 0.09

Dividend payout ratio = 40% or, 0.40

Therefore, b = retention ratio = (1- payout ratio) = (1- 0.40) = 0.60

Total Assets = Current Assets + Fixed Assets = $101 million

Total Current Liabilities = Accounts payable + Accrued wages + Accrued Taxes = $37 million

Now by applying the above formula :-

we get, the required new funds can be calculated as below :-

AFN or RNF (in dollars) = 101 /100 (15,000,000) - 37 /100 (15,000,000) - 0.09 * 0.60 * 115,000,000

Or, RNF = (1.01 * 15,000,000) - (0.37 * 15,000,000) - 6,210,000

Or, RNF = (15,150,000 - 5,550,000 - 6,210,000)

Or, RNF = 3,390,000

Therefore, the dollar value of the new funds needed to finance the increased sales growth is = $3,390,000.