Question

Problem 12-03
AFN Equation

Broussard Skateboard's sales are expected to increase by 15% from $7.4 million in 2016 to $8.51 million in 2017. Its assets totaled $4 million at the end of 2016. Broussard is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2016, current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 4%. Assume that the company pays no dividends. Under these assumptions, what would be the additional funds needed for the coming year? Do not round intermediate calculations. Round your answer to the nearest dollar.
$ __________

Why is this AFN different from the one when the company pays dividends?
I. Under this scenario the company would have a higher level of retained earnings which would reduce the amount of additional funds needed.
II. Under this scenario the company would have a higher level of retained earnings which would increase the amount of additional funds needed.
III. Under this scenario the company would have a higher level of retained earnings but this would have no effect on the amount of additional funds needed.
IV. Under this scenario the company would have a lower level of retained earnings which would reduce the amount of additional funds needed.
V. Under this scenario the company would have a lower level of retained earnings but this would have no effect on the amount of additional funds needed.

I

Answer 1

Additional Funds Needed [AFN] for the coming year

Expected Next Year Sales = $8,510,000

After Tax profit Margin

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

= $8,510,000 x 4.00%

= $340,400

Additions to Retained Earnings

Here, the company is not paying any dividend for the year, therefore, the additions to the Retained Earnings will be $340,400

Increase in Total Assets

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

= $4,000,000 x 15%

= $600,000

Increase in Spontaneous liabilities

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

= [$450,000 + $450,000] x 15%

= $900,000 x 15%

= $135,000

Additional Funds Needed [AFN]

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

= $600,000 - $135,000 - $340,400

= $124,600

“Hence, the additional funds needed for the coming year will be $124,600”

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

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