Suppose that Wind Em Corp.currently has the balance sheet shown as follows,and that sales for the year just ended were $12 million.The firm also has a profit margin of 20 percent,a retention ratio of 30 percent,and expects sales of $22 million next year.If all assets and current liabilities are expected to grow with sales,what is the necessary increase in assets?

A)$6,240,000
B)$6,333,333.33
C)$8,333,333.33
D)$4,833,000

Question

Suppose that Wind Em Corp.currently has the balance sheet shown as follows,and that sales for the year just ended were $12 million.The firm also has a profit margin of 20 percent,a retention ratio of 30 percent,and expects sales of $22 million next year.If all assets and current liabilities are expected to grow with sales,what is the necessary increase in assets?

A)$6,240,000 
B)$6,333,333.33 
C)$8,333,333.33 
D)$4,833,000

Quizplus · Accepted Answer

We can use the equation: 
Assets = Liabilities + Equity 
And with the retention ratio of 30%, we know that: 
Retained Earnings = Net Income x Retention Ratio

Using the profit margin of 20%, we can calculate the net income for the year just ended: 
Net Income = Sales x Profit Margin = $12m x 20% = $2.4m

So Retained Earnings = $2.4m x 30% = $720,000

Using the information that all assets and current liabilities are expected to grow with sales, we can look at the balance sheet as a percent of sales: 
TB3363_00.png 
The ratios of Current Liabilities/ Sales and Equity/Sales are constant, so we can use them to calculate the necessary increase in assets:

Current Liabilities/Sales = $2.4m/$12m = 20%

Equity/Sales = $4.8m/$12m = 40%

Total Liabilities + Equity/Sales = 100% - 20% = 80%

Therefore, Assets/Sales = 80%

And the necessary increase in assets for the expected sales of $22m next year is:

Assets = Sales x (Assets/Sales) = $22m x 80% = $17.6m

But the current assets are $6m, so the necessary increase is:

Increase in Assets = $17.6m - $6m = $11.6m

Therefore, the correct answer is C) $8,333,333.33.

Suppose That Wind Em Corp