Question

Eli Lilly is very excited because sales for his nursery and plant company are expected to double from $710,000 to $1,420,000 next year. Eli notes that net assets (Assets − Liabilities) will remain at 60 percent of sales. His firm will enjoy an 8 percent return on total sales. He will start the year with $310,000 in the bank and is bragging about the Jaguar and luxury townhouse he will buy.

1. Does his optimistic outlook for his cash position appear to be correct?2. Compute his likely cash balance or deficit for the end of the year. Start with beginning cash and subtract the asset buildup (equal to 50 percent of the sales increase) and add in profit.

Answer 1

1. Since the profits are not enough to cover asset buildup, Eli will probably need to borrow money to cover them. Even though the company will be more profitable, its cash position will not be very healthy.
2. ending cash balance = -$2,400

Explanation:

current sales $710,000

net assets = equity = $710,000 x 60% = $426,000

return = $710,000 x 8% = $56,800

next year's sales $1,420,000

net assets = equity = $852,000

return = $1,420,000 x 8% = $113,600

asset buildup = $852,000 - $426,000 = $426,000

ending cash balance = beginning cash balance + profit - asset buildup = $310,000 + $113,600 - $426,000 = -$2,400