The discussion of EFN in the chapter implicitly assumed that the company was ope

Question

The discussion of EFN in the chapter implicitly assumed that the company was operating at full capacity. Often, this is not the case. For example, assume that Rosengarten was operating at 90 percent capacity. Full-capacity sales would be $1,000 / .90 = $1,111. The balance sheet shows $1,800 in fixed assets. The capital intensity ratio for the company is:

This means that Rosengarten needs $1.62 in fixed assets for every dollar in sales when it reaches full capacity. At the projected sales level of $1,250, it needs $1,250 × 1.62 = $2,025 in fixed assets, which is $225 lower than our projection of $2,250 in fixed assets. So, EFN is only $565 – 225 = $340.

Thorpe Mfg., Inc., is currently operating at only 90 percent of fixed asset capacity. Current sales are $747,000 and sales are projected to grow to $852,000. The current fixed assets are $712,000.

How much in new fixed assets are required to support this growth in sales?

The discussion of EFN in the chapter implicitly assumed that the company was operating at full capacity. Often, this is not the case. For example, assume that Rosengarten was operating at 90 percent capacity. Full-capacity sales would be $1,000 / .90 = $1,111. The balance sheet shows $1,800 in fixed assets. The capital intensity ratio for the company is:

Explanation / Answer

Current Capacity intensity ratio = Fixed assets / Full capacity sales = $712,000 / $747,000 = 0.95

So, Thorpe needs $0.95 of fixed assets per dollar in sales. When sales increases to $852,000:

Required fixed assets = Capacity intensity ratio x New Sales = 0.95 x $852,000 = $809,400

New fixed assets = $(809,400 - 712,000) = $97,400

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