Chapter 16, Problem 8P

LONG-TERM FINANCING NEEDED At year-end 2019, total assets for Arrington Inc. were $1.8 million and accounts payable were $450,000. Sales, which in 2019 were $3.0 million, are expected to increase by 25% in 2020. Total assets and accounts payable are proportional to sales, and that relationship will be maintained; that is, they will grow at the same rate as sales. Arrington typically uses no current liabilities other than accounts payable. Common stock amounted to $500,000 in 2019, and retained earnings were $475,000. Arrington plans to sell new common stock in the amount of $130,000. The firm’s profit margin on sates is 5%; 35% of earnings will be retained.

1. a. What were Arrington’s total liabilities in 2019?
2. b. How much new long-term debt financing will be needed in 2020? (Hint: AFN - New stock = New long-term debt.)

Summary Introduction

To Determine: The total liabilities of Company AI in 2019.

AFN is abbreviated as additional funds needed, is the measure of cash an organization must rise from outer sources to back the expansion in assets necessary to help expanded level of sales. It is additionally called as external financing needed (EFN).

Answer to Problem 8P

The total liabilities of Company AI in 2019 are $825,000.

Explanation of Solution

Determine the total liabilities of Company AI in 2019

$\begin{array}{c}TotalLiabilities=\left[\begin{array}{l}Totalliabilitiesandequity-Commonstock-\\ \mathrm{Re}tainedearnings\end{array}\right]\\ =\left[\$1,800,000-\$500,000-\$475,000\right]\\ =\$825,000\end{array}$

Therefore the total liabilities of Company AI in 2019 is $825,000.

Summary Introduction

To Determine: The new long-term debt financing needed in 2020.

Answer to Problem 8P

The new long-term debt financing needed in 2020 is $141,875.

Explanation of Solution

Determine the sales for the year 2020

$\begin{array}{c}Sale{s}_{2019}=\left[Sale{s}_{2018}\times \left(1+IncreaseinSales\right)\right]\\ =\left[\$3,000,000\times \left(1+25\%\right)\right]\\ =\$3,750,000\end{array}$

Therefore, the sales for the year 2020 is $3,750,000.

Determine the change in sales

$\begin{array}{c}ChangeinSales=\left[Sale{s}_{2019}-Sale{s}_{2018}\right]\\ =\left[\$3,750,000-\$3,000,000\right]\\ =\$750,000\end{array}$

Therefore the change in sales is $750,000.

Determine the total liabilities of Company AI in 2020

$\begin{array}{c}AFN=\left[\begin{array}{l}\left(\frac{A_0^{*}}{S_0}\right)\times \Delta S-\left(\frac{L_0^{*}}{S_0}\right)\times \Delta S-\left(M\times S_1\times RR\right)-\\ SaleofCommonStock\end{array}\right]\\ =\left[\begin{array}{l}\left(\frac{\$1,800,000}{\$3,000,000}\right)\times \$750,000-\left(\frac{\$450,000}{\$3,000,000}\right)\times \$750,000-\\ \left(5\%\times \$3,750,000\times 35\%\right)-\$130,000\end{array}\right]\\ =\left[\left(0.6\times \$750,000\right)-\left(0.15\times \$750,000\right)-\$65,625-\$130,000\right]\\ =\left[\$450,000-\$112,500-\$65,625-\$130,000\right]\\ =\$141,875\end{array}$

Here,

AFN - Denotes additional funds needed

$\left(\frac{A_0^{*}}{S_0}\right)\times \Delta S$ - Denotes projected increase in assets

$\left(\frac{L_0^{*}}{S_0}\right)\times \Delta S$- Denotes spontaneous increase in liabilities

$\left(M\times S_1\times RR\right)$ - Denotes increase in retained earnings

Therefore, the new long-term debt financing needed in 2020 is $141,875.