The Hudson River Line Company has a balance sheet as of the end of the year as follows:
Last year, the firm had sales of $148,750. This year the company expects sales to increase 25%, to generate earnings after tax of $16,000, and to pay a dividend of $5,000. Hudson operated its fixed assets at 85% capacity last year. What additional financing will be needed to support the sales increase?
A) $2,125
B) $4,625
C) $1,500
D) $375 surplus -- no financing needed.

Question

The Hudson River Line Company has a balance sheet as of the end of the year as follows: 
Last year, the firm had sales of $148,750. This year the company expects sales to increase 25%, to generate earnings after tax of $16,000, and to pay a dividend of $5,000. Hudson operated its fixed assets at 85% capacity last year. What additional financing will be needed to support the sales increase?
A) $2,125 
B) $4,625 
C) $1,500 
D) $375 surplus -- no financing needed.

Quizplus · Accepted Answer

Solution:
Full capacity sales = $148,750/0.85 = $175,000
New Sales = $148,750(1.25) = $185,938
$50,000 net fixed assets will support $175,000 in sales. Hence net fixed assets must increase by 50/175, or 0.2857 times sales in excess of capacity, or 0.2857($185,938 - $175,000) = $3,125
AFN = $65,000(0.25) + $3,125 - $15,000(0.25) - ($16,000 - $5,000)
= $16,250 + $3,125 - $3,750 - $11,000 = $4,625

The Hudson River Line Company Has a Balance Sheet as of the End