Question

Suppose that Wall-E Corp. currently has the balance sheet shown below, and that sales for the year just ended were $6.3 million. The firm also has a profit margin of 30 percent, a retention ratio of 20 percent, and expects sales of $8.3 million next year. Fixed assets are currently fully utilized, and the nature of Wall-E’s fixed assets is such that they must be added in $1 million increments. Assets Liabilities and Equity Current assets $ 1,701,000 Current liabilities $ 1,890,000 Fixed assets 4,347,000 Long-term debt 1,850,000 Equity 2,308,000 Total assets $ 6,048,000 Total liabilities and equity $ 6,048,000 If current assets and current liabilities are expected to grow with sales, what amount of additional funds will Wall-E need from external sources to fund the expected growth?

Answer 1

Calculation of external finance needed(Assets are fully utilized)

The financing requirement is calculated based on percentage sales method.

(A).Required increase in assets=(Current total asset)* (percentage increase in sales)=A0*((S1-S0)/S0)

A0=Fixed assets in current period=$4,347,000

S0=Sales in current period

S1= Sales in next period

Current sales=$6.3 million

Increase in sales=S1-S0=($8.3 million-$6.3 million)/$6.3 million=2/6.3=0.31746

Required increase in fixed assets=$4,347,000*0.31746= $ 1,380,000

Fixed assets can be added in increment of $ 1 million

Hence increase in fixed assets required=$ 2million

(B).Spontaneous increase in Current assets=(Current assets)* 0.31746=1701000*0.31746=

$   540,000

Spontaneous increase in Current liabilities=(Current Liabilities)*0.31746=

1890000*0.31746= $ 600,000

Net decrease in working capital=(600000-540000)=-$60,000

(C)Increase in retained earning =(Profit margin)*(Sales)*(Retention ratio)

Retention Ratio=0.2

Profit margin=0.3

Increase in retained earning=0.3*8300000*0.2= $ 498,000

External Finance Required=(A)-(B)-(C)=$2,000,000-$60,000-$498,000= $ 1,442,000

External Finance Required

$        1,442,000