Question

The profit margin is 10% and the retention ratio is 30%. Last year’s sales were $50 million and total assets were $40 million. None of the liabilities vary directly with sales, but assets and costs do. If the sales growth rate is 20%, how much external financing is needed? Please show your work!

Answer 1

Last year sale = $50 million

Sale growth = 20%

Expected Sales = $50 million × (1 + 20%)

= $60 million.

Profit Margin = 10%

Net Income = $50 × 10%

= $5 million.

Net Income of company is $5 million.

Retention ratio = 30%

Addition to retrained earnings = $5 million × 30%

= $1.50 million

Addition to retained earnings is $1.50 million.

External finance needed = (Growth rate × Total Assets) - Addition to retained earnings

= (20% × $40 million) - $1.50 million

= $8 million - $1.50 million

= $6.50 million

External Finance needed is $6.50 million.