Question

Martin Aerospace is currently operating at full capacity based on its current level of assets. Sales are expected to increase by 4.5 percent next year, which is the firm's internal rate of growth. Net working capital and operating costs are expected to increase directly with sales. The interest expense will remain constant at its current level. The tax rate and the dividend payout ratio will be held constant. Current and projected net income is positive. Which one of the following statements is correct regarding the pro forma statement for next year?

a. Total assets will increase at the same rate as sales.
b. Long-term debt will increase in direct relation to sales.
c. Owners' equity will remain constant.
d. The pro forma profit margin is equal to the current profit margin.
e. Retained earnings will increase at the same rate as sales.

Answer 1

A. Total assets will increase at the same rate as sales.

Step-by-step explanation:

Option E is wrong because dividends will not increase at the same rate; therefore, retained earnings will not increase at the same rate as sales.

Option D is incorrect because sales are increasing, which leads to a different profit margin.

As sales increases to a specific percent, owners' equity will not remain constant. So, option C is wrong.

Option B is wrong because long-term debt will not change.

Option A is correct because if sales are credit sales; therefore, total assets will increase at the same rate as sales.