In Year 1，a company’s cash is 15 percent of sales, accounts receivable is 10 percent of sales, inventory is 20 percent of sales, accounts payable is 30 percent of sales, and long-term debt is 5 percent of sales. The company is preparing its forecasts and anticipates that sales will increase from $50,000 in Year 1 to $55,000 in Year 2. The company uses the percentage-of-sales method. What amount would be the required net working capital in Year 2?
a.($2,750)
b.$5,500
c.$7,500
d.$8,250
Answer:D
Choice “d” is correct. The net working capital amount in Year 2 is derived as follows:
Net working capital = Current assets - Current liabilities
Cash $8,250 (15%) + Accounts receivable $5,500 (10%) + Inventory $11,000 (20%) - Accounts payable $16,500 (30%) = $8,250
Note: The candidate should recognize the individual current asset and current liability weights, as a percentage of sales. It could then be observed that the net working capital amount can be derived by multiplying the cash percentage (15%) to the Year 2 net sales of $55,000, as the other current assets and current liability weights cancel each other out.
Choice “a" is incorrect. This choice uses the Year 2 long-term debt amount (only) as the net working capital amount without applying the formula above.
Choice “b” is incorrect. This choice subtracts long-term as a liability in the net working capital calculation. Because long-term debt is not a current liability, it should be excluded.
Choice “c” is incorrect. This represents the Year 1 net working capital.