Question

3. Excess capacity adjustments

Water and Power Co. (W&P) currently has $540,000 in total assets and sales of $1,550,000. Half of W&P’s total assets come from net fixed assets, and the rest are current assets. The firm expects sales to grow by 22% in the next year. According to the AFN equation, the amount of additional assets required to support this level of sales is $_________

.

W&P was using its fixed assets at only 93% of capacity last year. How much sales could the firm have supported last year with its current level of fixed assets?

$1,416,667

$1,666,667

$1,916,667

$1,500,000

When you consider that W&P’s fixed assets were being underused, its target fixed assets to sales ratio should be

________%.

When you consider that W&P’s fixed assets were being underused, how much fixed assets must W&P raise to support its expected sales for next year?

$30,891

$36,342

$41,793

$32,708

Answer 1

Solution :-

(a)

According to the AFN equation, the amount of additional assets required to support this level of sales is =

= Current Level of Assets * %age increase in sales

= $540,000 * 0.22

= $118,800

(b)

Since fixed asset utilisation is 93% at 100% level total sales will be:

Total Fixed Asset = $ 540,000 / 2 = $270,000

Utilisation = $ 270,000 * 93% = $ 251,100

Current Level of Sales = $1,550,000

Total Sales at 100% Asset Utilisation = ( $1,550,000 / $251,100) * $270,000 = $ 1,666,667

Therefore, Correct Answer is (b)

(c)

Fixed Asset to Sales Ratio = Fixed Asset / Sales

Targeted Ratio = Fixed Assets / Targeted Sales

i.e., ( $270,000 / 1,666,667 ) * 100 = 16.20% (Approx)

(d)

Targeted Sales Level = $ 1,550,000 * (1 + 0.22) = $ 1,891,000

Current Fixed Asset Utilisation = $ 251,100

Total Fixed Assets required for additional sales = Current Asset Utilisation Ratio * Targeted Sales

i.e., ( $251,100 / $1,550,000) * $1,891,000 = $306,342

Hence, Additional fixed Asset Required are: $306,342 - $270,000 = $ 36,342

Therefore, Correct Answer is (d)

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