Question

The Funny Business Company has the following balance sheet last year:

ASSETS			LIABILITIES and EQUITY
Cash	$52,500.00		Accounts Payable	$35,000.00
Accounts Rec.	$122,500.00		Accrued Wages	$17,500.00
Inventory	$262,500.00		Notes Payable	$122,500.00
Fixed Assets	$1,312,500.00		Bonds	$525,500.00
Total Assets	$1,750,000.00		Common Stock	$612,500.00
			Retined Earnings	$437,000.00
			Total Claims	$1,750,000.00

Funny Business sales in 2007 totaled $3.5 million. The ratio of net profit to sales was 3% with a dividend payout ratio of 60% of income. Sales are expected to increase by 20% in 2008.

1. Using the percent of sales method, determine how much outside financing is required.

2. Calculate the company's working capital position.

Answer 1

1.

Sales in 2007 = $3,500,000

Sales are expected to increase by 20% in 2008

Hence, expected sales in 2008 = 3,500,000 x 120%

= $4,200,000

The ratio of net profit to sales = 3%

Profit margin = Sales x Profit margin %

= 4,200,000 x 3%

= $126,000

Dividend payout ratio = 60%

Hence, retained earnings = 40%

= 126,000 x 40%

= $50,400

Increase in assets = 20%

= 1,750,000 x 20%

= $350,000

External funds needed = Increase in assets - Increase in liabilities - Increase in retained earnings

= 350,000 - 0 - 50,400

= $299,600

2.

Current assets = Cash + Accounts receivable + Inventory

= 52,500 + 122,500 + 262,500

= $437,500

Current liabilities = Accounts payable + Accrued wages + Note payable

= 35,000 + 17,500 + 122,500

= $175,000

Working capital = Current assets - Current liabilities

= 437,500 - 175,000

= $262,500