Rondolo, Inc. is currently operating at 84% of capacity. All costs and net working capital vary directly with sales. The tax rate, the proﬁt margin, and the dividend payout ratio will remain constant. How
Much additional debt is required if no new equity is raised and sales are projected to increase by
12%?($ in millions)
A) -$820.40
B) -$229.84
C) -$4.20
D) $349.20

Question

Rondolo, Inc. is currently operating at 84% of capacity. All costs and net working capital vary directly with sales. The tax rate, the proﬁt margin, and the dividend payout ratio will remain constant. How
Much additional debt is required if no new equity is raised and sales are projected to increase by
12%?($ in millions)
A) -$820.40 
B) -$229.84 
C) -$4.20 
D) $349.20

Quizplus · Accepted Answer

To solve this problem, we need to use the percent of sales method. The percent of sales method assumes that all costs (including net working capital) as well as the dividends paid vary proportionally with sales.

We are given that Rondolo, Inc. is operating at 84% of capacity, so we can assume that we have room to increase sales by 16% before we hit full capacity.

Using the percent of sales method, we can calculate the additional debt required as follows:

Increase in Sales = 12% x Current Sales 
= 0.12 x 100 
= $12 million

Increase in Total Assets = Increase in Sales / Capacity Utilization 
= $12 million / (1 - 0.84) 
= $75 million

Increase in Total Liabilities = Increase in Total Assets x Debt Ratio 
= $75 million x 0.4 
= $30 million

Increase in Total Debt = Increase in Total Liabilities - Increase in Net Working Capital 
= $30 million - (0.2 x $12 million) 
= $27.6 million

Since the question asks for additional debt required, we need to take the absolute value of the answer. Therefore, the answer is -$229.84 million.