Question

Suppose that Wall-E Corp. currently has the balance sheet shown below, and that sales for the year just ended were $7.5 million. The firm also has a profit margin of 30 percent, a retention ratio of 20 percent, and expects sales of $9.5 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	$	2,400,000		Current liabilities	$	2,325,000
Fixed assets		5,550,000		Long-term debt		1,750,000
				Equity		3,875,000
Total assets	$	7,950,000		Total liabilities and equity	$	7,950,000

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

Current Working Capital = Current assets – Current liabilities
Current Working Capital = 2,400,000 – 2,325,000
Current Working Capital = 75000

Fixed Asset Turnover = Turnover / Fixed Asset
Fixed Asset Turnover = 7500000 / 5,550,000
Fixed Asset Turnover = 1.35

Current Sales = 7,500,000
Net Income = 30%*7,500,000 = 2250000
Income Retained = 20% * 2250000 = 450000

Growth in Sales = 9,500,000 – 7,500,000 = 2000000
Growth in Sales = 26.67%
Funds Needed for Working Capital = 26.67% * 75000 = 20000

Funds needed for fixed Asset = Additional Sales / Fixed Asset Turnover
Funds needed for fixed Asset = 2,000,000 / 1.35
Funds needed for fixed Asset = 1,480,000
As fixed assets must be added in $1 million increments
So, Funds needed for fixed Asset = 2,000,000

Total Funds Needed = 20000 + 2,000,000 = 2020000
Internal Sources = Retained Profit = 450000
External Sources = 2020000 – 450000

External Sources =1,570,000