Eli Lilly is very excited because sales for his nursery and plant company are ex

Question

Eli Lilly is very excited because sales for his nursery and plant company are expected to double from $660,000 to $1,320,000 next year. Eli notes that net assets (Assets ? Liabilities) will remain at 60 percent of sales. His firm will enjoy a return on total sales of 8 percent. He will start the year with $260,000 in the bank and is bragging about the Jaguar and luxury townhouse he will buy.

Compute his likely cash balance or deficit for the end of the year. Start with beginning cash and subtract the asset buildup (equal to 60 percent of the sales increase) and add in profit. (Negative amount should be indicated by a minus sign.)

Eli Lilly is very excited because sales for his nursery and plant company are expected to double from $660,000 to $1,320,000 next year. Eli notes that net assets (Assets ? Liabilities) will remain at 60 percent of sales. His firm will enjoy a return on total sales of 8 percent. He will start the year with $260,000 in the bank and is bragging about the Jaguar and luxury townhouse he will buy.

Explanation / Answer

Cash required for asset buildup = (year 2 revenue - year 1 revenue)*60% = (1,320,000-660,000)*0.6 = 396,000

Cash from profits = 8%*1,320,000 = 105,600

So ending cash balance = starting cash balance + cash from profits - cash required for asset buildup = 260,000 + 105,600 - 396,000 = -30,400, i.e. negative 30,400

Is his optimistic outlook correct? The answer is NO.

Hope this helped ! Let me know in case of any queries.

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