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Calculating current ratio

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Snowball & Company has the following balance sheet:

Current assets $ 7,000 A/P & Accruals $ 1,500
Fixed assets 3,000 S-T (3-month) Loans 2,000
Common Stock 1,500
Ret. Earnings 5,000
Total assets $10,000 Total claims $10,000

Snowball's after-tax profit margin is 11 percent, and the company pays out 60 percent of its earnings as dividends. Its sales last year were $10,000; its assets were used to full capacity; no economies of scale exist in the use of assets; and the profit margin and payout ratio are expected to remain constant. The company uses the AFN equation to estimate funds requirements, and it plans to raise any required external capital as short-term bank loans. If sales grow by 50 percent, what will Snowball's current ratio be after it has raised the necessary expansion funds? (Note: Ignore any financing feedback effects.)

a. 2.36
b. 2.00
c. 1.78
d. 1.50
e. 1.34

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Solution Preview

We first find the AFN
AFN = increase in assets - increase in spontaneous liabilities - retained earnings
increase in assets = 10,000X50%=5,000 ( assets increase in proportion of sales)
increase in ...

Solution Summary

The solution explains the calculation of current ratio after the external funds are raised.