ICU has current assets of $800,000 and net fixed assets of $1,400,000. The firm expects its sales to climb 25 percent next year from its current level of $3,500,000. ICU's only current liability is accounts payable of $1,200,000. If both current assets and current liabilities will increase proportionately with sales, what additional financing will be needed by ICU next year? Assume ICU has a net profit margin of 6 percent. An increase in net fixed assets of $500,000 will be required. The firm pays out 50 percent of its earnings as dividends.
We assume that the reason we need additional financing is that ICU will require additional assets in order to meet the demands of its increasing sales. That requirement can be met in one of three ways: By increasing the company's short-term debt load (i.e., increasing its current liabilities), funding the requirement from its earnings next year, or obtaining additional non-current liability financing. The formula is thus:
Additional financing ...
This solution illustrates how to compute the additional financing needed given that one factor will increase by a set amount.