Goldilochs Inc. reported sales of $8 million and net income of $2 million. The firm has a total asset turnover of 1.2. The firm's chief financial officer is projecting a $6 million increase in sales and that spontaneous liabilities will increase by $1 million automatically. The firm currently pays out 50% of its net income to shareholders. Assuming that all assets and current liabilities are expected to grow with sales, how much in additional funds will Goldilochs need from external sources to fund the expected growth?

Question

Quizplus · Accepted Answer

First, we need to calculate the new net income after the projected increase in sales and spontaneous liabilities:

New Sales = $8 million + $6 million = $14 million
New Spontaneous Liabilities = $1 million
New Total Asset Turnover = $14 million / Total Assets

Using the current total asset turnover, we can solve for total assets:

1.2 = $8 million / Total Assets
Total Assets = $6.67 million

Using the total asset turnover with the projected increase in sales, we can solve for the new total assets:

New Total Asset Turnover = $14 million / New Total Assets
1.2 = $14 million / New Total Assets
New Total Assets = $11.67 million

Assuming all assets and current liabilities will grow with sales, we can find the new spontaneous liabilities:

Spontaneous Liabilities / Sales = Current Spontaneous Liabilities / Current Sales
$1 million / $14 million = Current Spontaneous Liabilities / $8 million
Current Spontaneous Liabilities = $571,429
New Spontaneous Liabilities = $1 million + $571,429 = $1,571,429

Next, we can calculate the new net income:

Net Income / Sales = Current Net Margin
$2 million / $8 million = 0.25
New Net Income / $14 million = 0.25
New Net Income = $3.5 million

Now we can calculate the funds needed from external sources:

Addition to Retained Earnings = New Net Income x (1 - Payout Ratio) - Increase in Spontaneous Liabilities
= $3.5 million x (1 - 0.5) - $1,571,429
= $875,000
Total Funds Needed = Addition to Retained Earnings / (1 - Total Asset Turnover)
= $875,000 / (1 - $14 million / $11.67 million)
= $2,250,000