Tulley Appliances Inc. projects next year’s sales to be $20 million. Current sal

Question

Tulley Appliances Inc. projects next year’s sales to be $20 million.
Current sales are $15 million, based on current assets of $5 million and fixed assets of $5 million. The firm’s net profit margin is 5 percent after taxes. Tulley forecasts that its current assets will rise in direct proportion to the increase in sales, but that its fixed assets will increase by only $100,000. Currently, Tulley has $1.5 million in accounts payable (which vary directly with sales), $2 million in long-term debt (due in 10 years), and common equity (including $4 million in retained earnings) totaling $6.5 million.
Tulley plans to pay $500,000 in common stock dividends next year.

a. What are Tulley's total financing needs (i.e., total assets) for the coming year?

b. Given the firm's projections and dividend payments plans, what are its discretionary financing needs?

c. Based on your projections, and assuming that the $100,000 expansion in fixed assets will occur, what is the largest increase in sales the firm can support without having to resort to the use of discretionary sources of financing?

Explanation / Answer

a)         Projected Financing Needs = Projected Total Assets

= Projected Current Assets + Projected Fixed Assets

={$5m/$15m x $20 m} +{ $5m + $.1m} = $11.77m

(b)       DFN = Projected Current Assets + Projected Fixed Assets

                          - Present LTD - Present Owner's Equity

                          - [Projected Net Income - Dividends]

                          - Spontaneous Financing

                          ={ $5m/$15m x $20m} + $5.1m - $2m - $6.5m

                          - [.05 x $20m - $.5m] -{$1.5m/$15m x $20m}

            DFN = $6.67m + $5.1m - $8.5m - $.5m - $2m = $.77m

c.

We first solve for the maximum level of sales for which DFN = 0:

            DFN = ($5m/$15m - .05 -$1.5m/$15m ) Sales – (5.1m-2m-6.5m +.5m)

DFN = .1833 SALES - $2.9m = 0

            Thus, SALES = $15.82m            

            The largest increase in sales that can occur without a need to raise "discretionary funds" is

            $15.82m - $15m= $820,000.

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