Question

You have been asked to forecast the additional funds needed (AFN) for Houston, Hargrove, & Worthington (HHW), which is planning its operation for the coming year. The firm is operating at full capacity. Data for use in the forecast are shown below. However, the CEO is concerned about the impact of a change in the payout ratio from the 10% that was used in the past to 85%, which the firm's investment bankers have recommended. Based on the AFN equation, by how much would the AFN for the coming year change if HHW increased the payout from 10% to the new and higher level? All dollars are in millions.

Last year's sales = S0	$300.0	Last year's accounts payable	$50.0
Sales growth rate = g	40%	Last year's notes payable	$15.0
Last year's total assets = A0*	$500	Last year's accruals	$20.0
Last year's profit margin = PM	20.0%	Initial payout ratio	10.0%

Select the correct answer.

a. $57.0

b. $63.0

c. $59.0

d. $67.0

e. $61.0

Answer 1

Ans Last year’s sales = 300

Sales growth rate = 40%

Forecasted sales = 300*1.4 = 420

change in sales = 420-300 = 120

Last year’s total assets = 500

Forecasted total assets = 500*1.4 = 700

Last year’s accounts payable = 50

Last year’s notes payable = 15

Last year’s accruals = 20

Payable + accruals = 50 +20 = 70

Profit margin = 20

Target payout ratio = 10%

Retention ratio = (1 – Payout) = 90%

AFN = (Last year assets/Last year sales*Change in sales) – ((Payable+accruals)/Last year sales*Change in sales) – (Profit Margin*Retention Ratio*Forecasted sales)

= (500/300*120) - (70/300*120) - (0.2*0.9*420)

= 96.4

If payout = 85%

AFN = (500/300*120) - (70/300*120) - (0.2*0.15*420)

= 200-28-12.60 =159.40

So, Net increase in AFN = 159.40-96.40

= 63

Hence option B.