Question

Wagner Industrial Motors, which is currently operating at full capacity, has sales of $2,400, current assets of $740, current liabilities of $430, net fixed assets of $1,590, and a 5 percent profit margin. The firm has no long-term debt and does not plan on acquiring any. The firm does not pay any dividends. Sales are expected to increase by 10 percent next year. If all assets, short-term liabilities, and costs vary directly with sales, how much external equity financing is needed for next year?

Answer 1

Formula to calculate External equity financing is needed for next year

External equity financing is needed for next year = A0 * ΔS/S0 − L0 * ΔS/S0 - S1 * PM * b

Where,

A0 = current level of assets = Current asset + net fixed asset = $740 + $1,590 =$2,330

S0 = current sales = $2,400

ΔS/S0 = percentage increase in sales = 10%

L0 = current level of liabilities = $430

S1 = Increased sales = S0*(1+10%) = $2,400 *1.10 = $2,640

PM = profit margin = 5%

In the case the company pays no dividends, the retained earnings is 100%

b = retention rate = 100% = 1

Therefore

AFN = $2,330 * 10% - $430 *10% - $2,640 *5% *1

= $233 - $43 - $132 = $58.0

The external equity financing of $58.0 is needed for next year