Question

Consider the balance sheet of Wikileaks Industries as shown below. Because Wikileaks has $900,000 of retained earnings, do you think that the company would be able to pay cash to buy an asset with a cost of $300,000? Why or why not? Give logical arguments to support your answer. (minimum 250 words)

Cash	$     50,000	Accounts payable	$   100,000
Inventory	200,000	Accruals	100,000
Accounts receivable	250,000	Total CL	$   200,000
Total CA	$   500,000	Debt	100,000
Net fixed assets	$   900,000	Common stock	200,000
	_________	Retained earnings	900,000
Total assets	$1,400,000	Total L & E	$1,400,000

Answer 1

Ans -

Because Wikileaks has $900,000 of retained earnings, do you think that the company would be able to pay cash to buy an asset with a cost of $300,000?

Ans - No

Explanation - Company can't finance full asset worth $300,000 using cash balance as they have only $50,000 in cash balance. Also, company shouldn't use complete $50,000 to buy assets as this will create further liquidity issues as keeping Zero cash balance is not good for company. So, it would be advised to take a loan to finance new asset,

Retained earnings is used to finance fixed assets for future expansion, to finance working capital which is used to manage Inventory and Accounts Receivable and Retained earnings is also used to pay off debts. However, in the gives balance sheet it is seems like company has used most of their retained earnings to finance Net Fixed Assets which is standing at $900,000, used in Working Capital or they have used retained earnings to pay off their debts as company is having only $100,000 as debt. Company with $900,000 of Net Fixed Assets balance and only $100,000 debt balance shows that most of existing fixed assets is financed used retained earnings so company don't have further availability of retained earnings in the form of cash to finance full new assets.

Though company don't have sufficient cash balance to pay cash to buy assets costing $300,000 however company is having healthy balance sheet and required ratios to measure health of the company, ratios like Current Ratio, Quick Ratio or Debt to Equity Ratio are very good. So looking at company balance sheet, company can get easy loan to finance cost of new assets and company can opt out that option.