Question

Urban’s, which is currently not operating at full capacity, has sales of $47,000, current assets of $5,100, current liabilities of $6,200, net fixed assets of $51,500, and a 5 percent profit margin. The firm has no long-term debt and does not plan on acquiring any. No new equity will be issued. The firm does not pay any dividends. Sales are expected to increase by 3 percent next year. The following items vary directly with sales – current assets and short-term liabilities. The profit margin percentage remains constant. How much is the external financing needed (EFN) to balance the projected Balance Sheet for next year?

(HINT: First prepare the original Income Statement and Balance Sheet. Then project the Income Statement at the sales increase of 3%. Then project the Balance Sheet. Show the original and projected financial statements on the worksheet provided.) Expert Answer

Answer 1

External Financing Needed [EFN]

• Expected Next Year Sales = $48,410 [$47,000 x 103%]
• After Tax profit Margin = $2,420.50 [$48,410 x 5%]
• The company is not paying any dividend, Therefore, Additions to Retained Earnings will be $2,420.50
• Total Assets = $56,600 [$5,100 + 51,500]
• Increase in Total Assets = $1,698 [$56,600 x 3%]
• Increase in Current Liabilities = $186 [$6,200 x 3%]

External Financing Needed [EFN]

External Financing Needed [EFN] = Increase in Total Assets – Increase in Current Liabilities – Additions to retained earnings

= $1,698 - $186 - $2,420.50

= -$908.50 (Negative)

The sum of the Increase in Current Liabilities & the Addition to Retained Earnings is more than the Increase in total assets, therefore, the company is not required to raise additional equity.