Question

A firm has total asset turnover of 1.25. All assets and accounts payable vary directly with sales. Debt and equity do not vary with sales. Current sales are $1,000 and are expected to grow 10% over the year. Accounts payable are 1% of assets. The firm’s net profit margin is 6% and it expects to pay dividends in the amount of $10.

Calculate the firm’s External Financing Need

Answer 1

Asset turnover ratio = Sales / total assets
1.25 = 1000 / total assets
Total assets = 1000 / 1.25 = $800

Change in assets = $800 * 10% = $80

Change in spontaneous liabilities = ($1000 * 1%) * 10% = $10 * 10%
= $1

New sales = $1000 * 1.10 = $1,100

Net profit = $1,100 * 6% = $66

Addition to retained earnings = Net profit - dividend = $66 * $10 = $56

External financing needed = Change in assets - change in spontaneous liabilities - addition to retained earnings

= $80 - $1 - $56

= $23

External financing needed = $23