Question

Which of the following statements is correct if a firm’s pro forma financial statements project net income of $12,000 and external financing required of $5,000? Total assets cannot grow by more than $10,000. Dividends cannot exceed $10,000. Retained earnings cannot grow by more than $12,000. Long-term debt cannot grow by more than $5,000.

Answer 1

Retained earnings cannot grow by more than $12,000.

Step-by-step explanation:

The most correct statement is that if a firm’s pro forma financial statements project net income of $12,000 and external financing required of $5,000, Retained earnings cannot grow by more than $12,000.

The rationale is that growth in retained earnings can only happen through net income, since opening retained earnings + net income = closing retained earnings.

What could also have been true is that: Long-term debt cannot grow by more than $5,000 but the scenario did not mention if the external financing would be short term or long term.