Goldilochs Inc. reported sales of $8 million and net income of $1.5 million. The firm has $10.5 million in total assets. The firm's chief financial officer is projecting a 25% increase in sales. The firm has $1.25 million in accounts payable and $1,500,000 in long-term debt (bonds). The firm currently pays out 20% of its net income to shareholders. Assuming that all assets and spontaneous liabilities are expected to grow with sales, how much in additional funds will Goldilochs need from external sources to fund the expected growth?
A) $902,700
B) $812,500
C) $821,000
D) $746,600

Question

Quizplus · Accepted Answer

First, calculate the firm's current financial ratios:

- Profit margin = net income/sales = $1.5 million/$8 million = 0.1875
- Asset turnover = sales/total assets = $8 million/$10.5 million = 0.76
- Return on assets (ROA) = profit margin x asset turnover = 0.1875 x 0.76 = 0.1425
- Debt ratio = total liabilities/total assets = ($1.25 million + $1,500,000)/$10.5 million = 0.2381

Next, use the projected sales increase to forecast the firm's financial statements:

- Projected sales = $8 million x 1.25 = $10 million
- Projected net income = $10 million x 0.1875 = $1.875 million
- Projected dividends = $1.875 million x 0.2 = $375,000
- Projected total assets = $10.5 million x 1.25 = $13.125 million
- Projected accounts payable = $1.25 million x 1.25 = $1.5625 million
- Projected long-term debt = $1,500,000 (assumed to remain constant)
- Projected total liabilities = $1.5625 million + $1,500,000 = $3.0625 million
- Projected equity = $13.125 million - $3.0625 million = $10.0625 million

Finally, calculate the additional funds needed (AFN) to support the growth:

- AFN = (A*/S0)ΔS - (L*/S0)ΔS - MS1(RR)

Where:

- A* = projected total assets
- S0 = current sales
- L* = projected total liabilities
- ΔS = change in sales
- MS1 = retention ratio = 1 - dividend payout ratio = 1 - 0.2 = 0.8
- RR = projected ROA x (1 - retention ratio) = 0.1425 x (1 - 0.8) = 0.0285

Plugging in the numbers:

- AFN = ($13.125 million/$8 million)($2 million - $8 million) - ($3.0625 million/$8 million)($2 million - $8 million) - $10.5 million(0.0285) 
- AFN = -$500,000 - (-$191,667) - $299,833 
- AFN = $812,500

Therefore, Goldilochs will need $812,500 in additional funds from external sources to fund the expected growth. The answer is B.