Question

A firm has $40 million in sales last year. Its asset to sales ratio is .4 and its net profit margin of .07. The firm plans to maintain its current retention ratio is .6; its payables amount to $400,000 million, and it does not have any bank loans as notes payable. If 20% increase in sales is anticipated, how much additional financing is required?        

Answer 1

Required Additional Financing can be computed by calculating the net increase in assets

Additional funds required = (Increase in assets) - (Increase in Liabilities) - (Increase in Retined Earnings)

Calculating Assets:

Assets to sales ratio = 0.4; total assets for current year = 0.4*40 Million = $ 16Million

Current sales = $40 Million; Anticipated increase in sales = 20%

Anticipated sales = (1+0.20) * (40 Million) = $48 Million

Total assets with anticipated sales = (0.40 * 48 Million) = $ 19.2 Million

Increase in assets = (19.2 - 16) Million = $3.2 Million

Total Liabilities = $400,000 (I am taking it was wrongly mentioned in the question as 400,000 million instead of 400,000)

Total Liabilities with the anticipated sales increase = (400,000) * (1.20) [sales growth is 20%; payables increase on an propotional basis)

= $480,000

Increase in Liabilities = (480,000 - 400,000) = $80,000 = $0.08 Million

Calculating Retained Earnings:

Net Profit margin = 0.07 Net Profit last year = (40 * 0.07) = $ 2.8Million

retention ratio = 0.6 Retained Earnings = (0.6 * 2.8 Million) = $ 1.68 Million

Net Profit with anticipated sales = (0.07 * 48)= $ 3.36 Million

Current retention ratio = 0.6, which will be maintained.

Therefore retained earnings = (0.6 * Net Profit) = (0.6* 3.36 Million) = $ 2.016 Million

Increase in retained earnings = ($ 2.016 - $1.68) Million = $0.336 Million

Additional funds required = (Increase in assets) - (Increase in Liabilities) - (Increase in Retined Earnings)

= $ (3.2 - 0.08 - 0.336) Million

= $2.784 Million