Question

Carlsbad Corporation's sales are expected to increase from $5 million in 2016 to $6 million in 2017, or by 20%. Its assets totaled $4 million at the end of 2016. Carlsbad is at full capacity, so its assets must grow in proportion to projected sales. At the end of 2016, current liabilities are $1 million, consisting of $250,000 of accounts payable, $500,000 of notes payable, and $250,000 of accrued liabilities. Its profit margin is forecasted to be 5%.

1. Assume that the company pays no dividends.
   Under these assumptions, what would be the additional funds needed for the coming year? Write out your answer completely. For example, 5 million should be entered as 5,000,000. Round your answer to the nearest cent.
   $
2. 
   
3. Why is this AFN different from the one when the company pays dividends?
   
   1. Under this scenario the company would have a lower level of retained earnings, which would decrease the amount of additional funds needed.
   2. Under this scenario the company would have a higher level of retained earnings, which would reduce the amount of additional funds needed.
   3. Under this scenario the company would have a higher level of retained earnings, which would reduce the amount of assets needed.
   4. Under this scenario the company would have a higher level of spontaneous liabilities, which would reduce the amount of additional funds needed.
   5. Under this scenario the company would have a lower level of retained earnings, which would increase the amount of additional funds needed.

Answer 1

Additional Funds Needed [AFN] for the coming year

Expected Next Year Sales = $6,000,000

After Tax profit Margin

After Tax profit Margin = Expected Next Year Sales x Profit Margin

= $6,000,000 x 5.00%

= $300,000

Additions to Retained Earnings

Here, the company is not paying any dividend for the year, therefore, the additions to the Retained Earnings will be $300,400

Increase in Total Assets

Increase in Total Assets = Total Assets x Percentage of Increase in sales

= $4,000,000 x 20%

= $800,000

Increase in Spontaneous liabilities

Increase in Spontaneous liabilities = [Accounts Payable + Accruals] x Percentage of Increase in sales

= [$250,000 + $250,000] x 20%

= $500,000 x 20%

= $100,000

Additional Funds Needed [AFN]

Therefore, the Additional Funds Needed [AFN] = Increase in Total Assets – Increase in in Spontaneous liabilities – Additions to retained earnings

= $800,000 - $100,000 - $300,000

= $400,000

“Hence, the additional funds needed for the coming year will be $400,000”

Reason for difference in the AFN from the one when the company pays dividends

(II)-Under this scenario the company would have a higher level of retained earnings which would reduce the amount of additional funds needed.