Tulley Appliances Inc. projects next year’s sales to be $20 million. Current sal

Question

Tulley Appliances Inc. projects next year’s sales to be $20 million. Current sales are $15 million, based on current assets of $5 million and fixed assets of $5 million. The firm’s net profit margin is 5 percent after taxes. Tulley forecasts that its current assets will rise in direct proportion to the increase in sales, but that its fixed assets will increase by only $100,000. Currently, Tulley has $1.5 million in accounts payable (which vary directly with sales), $2 million in long-term debt (due in 10 years), and common equity (including $4 million in retained earnings) totaling $6.5 million. Tulley plans to pay $500,000 in common stock dividends next year.

Explanation / Answer

Discretionary financing = Projected Total Assets - Projected Total Liabilities - Projected Equity
The percent increase in sales is 1/3 (approximately 33%). Both current assets and current
liabilities increase in direct proportion to sales.

Current Assets: 5,000,000 * 4/3 = 6,666,667
Current Liabilities: 1,500,000 * 4/3 = 2,000,000

To project fixed assets, we first need to determine current year fixed assets.
In the current year, total liabilities + total equity = 10,000,000.

This is A/P of 1.5M + LTD of 2M + Equity of 6.5M = 10M
We know current assets are 5M so fixed assets must also be 5M for balance sheet to balance.
A 100,000 increase to 5M is 5,100,000.
Total Assets for Next Year are Projected at 11,766,667

We must next project retained earnings.
Multiply the 5% Net profit margin by sales
20,000,000 * 5% = 1,000,000
Projected Retained Earnings= Current Retained Earnings + Net Profit - Dividends
4,000,000 + 1,000,000 - 500,000 = 4,500,000
Long-term debt and common stock will remain the same.
Projected liabilities + equity = 11M
This is A/P of 2M + LTD of 2M + Stock of 2.5M + RE of 4.5M
So discretionary financing is:
11,766,667 - 11,000,000 = 766,667

C. The highest sales can be without needing discretionary financing is 15,818,180
It is calculated as follows. In this problem, x is the percent increase in sales.
5,000,000x + 5,100,000 = 1,500,000x +2,000,000 +2,500,000 + 4,000,000 - 5,000,000 + 750,000x
5,000,000x -1,500,000x - 750,000x = 2,000,000 +2,500,000 +4,000,000 - 500,000 - 5,100,000
2,750,000x = 2,900,000
x=1.054
15,000,000 * 1.054 = 15,818,180

Note that 1.054 is a repeating fraction so if you multiply by 1.054 exact you don't get the above answer, but
this is the right answer because you need to use the full fraction.

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