Excess capacity Krogh Lumber’s 2005 financial statements are shown here.

a. Assume that the company was operating at full capacity in 2005 with regard to all items except fixed assets; fixed assets in 2005 were being utilized to only 75 percent of capacity. By what percentage could 2006 sales increase over 2005 sales without the need for an increase in fixed assets?

b. Now suppose 2006 sales increase by 25 percent over 2005 sales. How much additional external capital will be required? Assume that Krogh cannot sell any fixed assets. Assume that any required financing is borrowed as notes payable. Use a pro forma income statement to determine the addition to retained earnings.

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Krogh Lumber: Balance Sheet as of December 31, 2005 (Thousands of Dollars) $ 1,800 $ 7,200 Accounts payable Notes payable Accrued liabilities Cash Receivables 10,800 3,472 2,520 Inventories 12,600 Total current assets $25,200 Total current liabilities $13,192 Mortgage bonds 5,000 Common stock 2,000 Net fixed assets Retained earnings 21,600 26,608 Total liabilities and equity Total assets $46,800 $46,800 Krogh Lumber: Income Statement for December 31, 2005 (Thousands of Dollars) Sales $36,000 Operating costs 30,783 $ 5,217 Earnings before interest and taxes Interest 1,017 $ 4,200 1,680 Earnings before taxes Taxes (40%) $ 2,520 Net income $ 1,512 $ 1,008 Dividends (60%) Addition to retained earnings