The most recent balance sheet for the Armadillo Dog Biscuit Co. is shown in the following table. The company is about to embark on an advertising campaign that is expected to raise sales from the current level of $5 million to $7 million by the end of next year. The firm is currently operating at full capacity and will have to increase its investment in both current and fixed assets to support the projected level of new sales. In fact, the firm estimates that both categories of assets will rise in direct proportion to the projected increase in sales.

The firm’s net profits were 6 percent of current year’s sales but are expected to rise to 7 percent of next year’s sales. To help support its anticipated growth in asset needs next year, the firm has suspended plans to pay cash dividends to its stockholders. In past years, a $1.50 per share dividend was paid annually.
Armadillo’s payables and accrued expenses are expected to vary directly with sales. In addition, notes payable will be used to supply the funds that are needed to finance next year’s operations that are not forthcoming from other sources.
a. Fill in the table and project the firm’s needs for discretionary financing. Use notes payable as the balancing entry for future discretionary financing needs.
b. Compare Armadillo’s current ratio and debt ratio (total liabilities/total assets) before the growth in sales and after. What was the effect of the expanded sales on these two dimensions of Armadillo’s financial condition?
c. What difference, if any, would have resulted if Armadillo’s sales had risen to $6 million in one year and $7 million only after two years? Discuss only; no calculations arerequired.

Armadillo Dog Biscuit Co., Inc. (S millions) Present Level $2.0 3.0 Percent of Sales Projected Level Current assets Net fixed assets Total Accounts payable Accrued expenses Notes payable S0.5 0.5 Current liabilities Long-term debt Common stock Retained earnings Common equity $1.0 $2.0 0.5 $2.0 Total