Suppose that Runner Industries currently has the balance sheet shown as follows,

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

Assets Current Assets $1,500,000 Fixed Assets $3,000,000 Liabilities and Equity Current Liabilities Long-term Debt Equity Total Liabilities and Equity $600,000 $1,400,000 $2,500,000 S4,500,000 Total Assets $4,500,000

Explanation / Answer

Current Year Sales = $5,000,000
Next Year Sales = $7,000,000

Change in Sales = ($7,000,000 - $5,000,000) / $5,000,000
Change in Sales = 40%

Increase in Current Assets = $1,500,000 * 40%
Increase in Current Assets = $600,000

Increase in Current Liabilities = $600,000 * 40%
Increase in Current Liabilities = $240,000

Next Year Sales = $7,000,000

Net Income = Next Year Sales * Profit Margin
Net Income = 10% * $7,000,000
Net Income = $700,000

Addition to Retained Earnings = Net Income * Retention Ratio
Addition to Retained Earnings = $700,000 * 20%
Addition to Retained Earnings = $140,000

Additional Funds Needed = Increase in Current Assets - Increase in Current Liabilities - Addition to Retained Earnings
Additional Funds Needed = $600,000 - $240,000 - $140,000
Additional Funds Needed = $220,000

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