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In: Finance

At year-end 2014, total assets for Microloft Inc. were $1.4 million and accounts payable were $380,000....

At year-end 2014, total assets for Microloft Inc. were $1.4 million and accounts payable were $380,000. Sales, which in 2014 were $2.7 million, are expected to increase by 25% in 2015. 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. Microloft typically uses no current liabilities other than accounts payable. Common stock amounted to $435,000 in 2014, and retained earnings were $290,000. Microloft plans to sell new common stock in the amount of $85,000. The firm’s profit margin on sales is 6%; 60% of earnings will be retained. How much new long-term debt financing will be needed in 2015 (Hint: AFN – New stock equals new long-term debt)

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Expert Solution

Answer:

Current Sales = $2,700,000
Total Assets = $1,400,000
Profit Margin = 6.00%
Retention Ratio = 60%

Spontaneous Current Liabilities = Accounts Payable
Spontaneous Current Liabilities = $380,000

Expected Sales = $2,700,000 * 1.25
Expected Sales = $3,375,000

Addition to Retained Earnings = Sales * Profit Margin * Retention Ratio
Addition to Retained Earnings = $3,375,000 * 6.00% * 60%
Addition to Retained Earnings = $121,500

Increase in Total Assets = $1,400,000 * 0.25
Increase in Total Assets = $350,000

Increase in Spontaneous Current Liabilities = $380,000 * 0.25
Increase in Spontaneous Current Liabilities = $95,000

Additional Fund Needed = Increase in Total Assets - Increase in Spontaneous Current Liabilities - Addition to Retained Earnings
Additional Fund Needed = $350,000 - $95,000 - $121,500
Additional Fund Needed = $133,500

Therefore, an amount of $133,500 would be financed through long term debt.


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