Question

Cryo-vac expects sales to increase 20% next year from the current level of $5,000,000. The firm has current assets of $1,000,000 and fixed assets of $1,500,000. Cryo-vac has current liabilities of $750,000 of which $300,000 are in notes payable. What additional financing will Cryo-vac need to support the expected sales increase if its profit margin is 8% and the firm expects to pay out $200,000 in dividends? An increase in net fixed assets of $300,000 will be required.
Assuming the (current assets) and (current liabilities- notes payable) will grow at the same rate as the sales.

change in current asset = ??
change in fixed asset = ??
change in (current liability - notes payable) = ??
net income = ??
addition to retained earnings = net income - dividend = ??
additional financing =
change in current asset
+ change in fixed asset
- change in (current liabilities - notes payable)
- addition to retained earnings

Answer 1

Answer:

Consider the following calculations

Explanation:

Current Sales Level = $ 5000000 and Expected Sales Growth Rate = 20 %

Next Year Sales = 5000000 x 1.2 = $ 6000000

Expected Profit Margin = 8% and Expected Profit = 0.08 x 6000000 = $ 480000

Expected Dividend Payout = $ 200000

Increase in Retained Earnings = Expected Profit - Expected Dividend Payout = 480000 - 200000 = $ 280000

An increase in retained earnings such as the aforementioned unbalances the asset, liability, equity equation and hence, some of the asset-liability items need to change so as to rebalance the equation. The items that usually change are the current assets, fixed assets, and current liabilities except for the current portion of the firm's long-term debt as the same is a function of the firm's financing activities, whereas increment in the sale and consequent increment in other balance sheet items are operating activities.

Further, it is assumed that the current assets and current liabilities less notes payable (it is a short-term financing instrument and hence remains unchanged) all increase at the same rate as sales increment. Fixed Assets although increase to support higher sales level, but are part of the firm's investing activities and hence do not bear a direct proportional relationship with the increase in sales.

Change in Current Asset = (1.08 x 1000000) - 1000000 = $ 80000

Change in Fixed Assets = 300000 (already mentioned)

Change in Current Liabilities less Notes Payable = (750000 - 300000) x 1.08 - (750000 - 300000) = $ 36000

Therefore, Additional Financing Required = Change in Current Assets + Change in Fixed Assets - Change in Current Liabilities less Notes Payable - Increment in Retained Earnings = 80000 + 300000 - 36000 - 280000 = $ 64000