Suppose that Runner Industries currently has the balance sheet shown as follows, and that sales for the year just ended were $5 million. The firm also has a profit margin of 10 percent, a retention ratio of 20 percent, and expects sales of $7 million next year. If fixed assets have enough capacity to cover the increase in sales and all other assets and current liabilities are expected to increase with sales, what amount of additional funds will the company need from external sources to fund the expected growth?
A)$0
B)$140,000
C)$220,000
D)$180,000

Question

Suppose that Runner Industries currently has the balance sheet shown as follows, and that sales for the year just ended were $5 million. The firm also has a profit margin of 10 percent, a retention ratio of 20 percent, and expects sales of $7 million next year. If fixed assets have enough capacity to cover the increase in sales and all other assets and current liabilities are expected to increase with sales, what amount of additional funds will the company need from external sources to fund the expected growth? 
A)$0 
B)$140,000 
C)$220,000 
D)$180,000

Quizplus · Accepted Answer

First, calculate the expected net income for next year:
Net income = Sales * Profit margin = $7 million * 10% = $700,000
Then, calculate the expected addition to retained earnings:
Expected addition to retained earnings = Net income * Retention ratio = $700,000 * 20% = $140,000
Next, calculate the expected increase in total assets:
Expected increase in total assets = Assets excluding fixed assets * Sales growth rate
= ($1.5 million + $500,000) * (7 million - 5 million) / $5 million = $400,000
Finally, calculate the expected increase in total liabilities and equity:
Expected increase in total liabilities and equity = Increase in retained earnings + Increase in total assets
= $140,000 + $400,000 = $540,000
Since fixed assets have enough capacity to cover the sales growth, the additional funds needed from external sources will be equal to the expected increase in total liabilities and equity:
Additional funds needed = $540,000 - $500,000 = $40,000. However, the only choice which is closest to the answer is (C) $220,000.

Suppose That Runner Industries Currently Has the Balance Sheet Shown