Question

The Bohemian Manufacturing Company has the following end-of-year balance sheet: Assets: Current Assets: Cash and Equivalents $150,000, Accounts Receivable $400,000, Inventories $350,000. Net Fixed Assets: Net Plant and Equipment $2,100,000. Liabilities: Current Liabilities: Accounts Payable $250,000, Accrued Liabilities $150,000. Long-Term Liabilities: Notes Payable $100,000. Common Equity: Common Stock $800,000, Retained Earnings $700,000. The firm generated $400,000 net income on sales of $13,500,000 in the previous year. Sales are expected to increase by 18% this year. The firm's long-run dividend payout ratio is 45%. Using the additional funds needed (AFN) equation, determine the increase in total assets necessary to support the expected sales.

Answer 1

To support an expected 18% increase in sales, the Bohemian Manufacturing Company needs to increase total assets by $1,316,460, after accounting for the retained earnings of $220,000 from the net income.

Step-by-step explanation:

To calculate the increase in total assets necessary to support the expected increase in sales using the additional funds needed (AFN) equation, we first need to determine several key figures:

• The firm's sales are expected to increase by 18%, so the projected sales for this year are $13,500,000 * 1.18 = $15,930,000.
• The firm's net income is $400,000, and they will retain 55% (100% - 45% dividend payout ratio) of this, which is $400,000 * 0.55 = $220,000.
• The total assets at the end of last year were $150,000 + $400,000 + $350,000 + $2,100,000 = $3,000,000.

Next, we assume that the firm's assets vary directly with sales, and calculate the assets needed per dollar of sales: $3,000,000 / $13,500,000 = $0.222 per dollar of sales. The projected increase in total assets needed to support the new level of sales is thus $15,930,000 * $0.222 - $3,000,000. However, since the firm will retain $220,000 of earnings, the AFN will be this result minus the retained earnings. We calculate:

• Additional Assets Required = $15,930,000 * $0.222 - $3,000,000 = $1,536,460
• AFN = Additional Assets Required - Retained Earnings = $1,536,460 - $220,000 = $1,316,460

The increase in total assets necessary to support the expected sales is, therefore, $1,316,460.