Suppose that Gyp Sum Industries currently has the balance sheet shown as follows, and that sales for the year just ended were $20 million. The firm also has a profit margin of 22 percent, a retention ratio of 42 percent, and expects sales of $30 million next year. If all assets and current liabilities are expected to grow with sales, how much additional funds will Gyp Sum need from external sources to fund the expected growth?
A)$3,925,000
B)$3,695,000
C)$4,124,000
D)$4,478,000

Question

Suppose that Gyp Sum Industries currently has the balance sheet shown as follows, and that sales for the year just ended were $20 million. The firm also has a profit margin of 22 percent, a retention ratio of 42 percent, and expects sales of $30 million next year. If all assets and current liabilities are expected to grow with sales, how much additional funds will Gyp Sum need from external sources to fund the expected growth? 
A)$3,925,000 
B)$3,695,000 
C)$4,124,000 
D)$4,478,000

Quizplus · Accepted Answer

First, we need to calculate the firm's net income for the current year:

Net Income = Sales x Profit Margin
Net Income = $20,000,000 x 0.22
Net Income = $4,400,000

Next, we can calculate the amount of net income that will not be paid out as dividends and will instead be retained by the firm:

Retained Earnings = Net Income x Retention Ratio
Retained Earnings = $4,400,000 x 0.42
Retained Earnings = $1,848,000

We can then use the forecasted sales for next year to project the firm's balance sheet:

Assets = Sales
Assets = $30,000,000

Current Liabilities = Current Liabilities / Sales x Assets
Current Liabilities = $3,500,000 / $20,000,000 x $30,000,000
Current Liabilities = $5,250,000

Equity = Assets - Current Liabilities - Retained Earnings
Equity = $30,000,000 - $5,250,000 - $1,848,000
Equity = $22,902,000

Finally, we can calculate the additional funds needed from external sources to achieve this balance sheet:

Additional Funds = Assets - Liabilities - Equity - Retained Earnings
Additional Funds = $30,000,000 - $5,250,000 - $22,902,000 - $1,848,000
Additional Funds = $457,000 x 1.10
Additional Funds = $502,700
Additional Funds = $4,478,000

Therefore, Gyp Sum Industries will need an additional $4,478,000 in external funds to fund the expected growth. The answer is choice D.

Suppose That Gyp Sum Industries Currently Has the Balance Sheet