Question

1.  Problem 16.01 (AFN Equation)

eBook Problem Walk-Through

Carlsbad Corporation's sales are expected to increase from $5 million in 2019 to $6 million in 2020, or by 20%. Its assets totaled $4 million at the end of 2019. Carlsbad is at full capacity, so its assets must grow in proportion to projected sales. At the end of 2019, 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%, and the forecasted retention ratio is 25%. Use the AFN equation to forecast the additional funds Carlsbad will need 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 dollar.

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Answer 1

Spontaneous Current Liabilities = Accounts Payable + Accruals = $250,000 + $250,000 = $500,000

Net Income = Sales * After-tax Profit Margin = $6,000,000 * 0.05 = $300,000

Addition to Retained Earnings = Net Income * Retention ratio = $300,000 * 0.25 = $75,000

Increase in Total Assets = 20% * $4,000,000 = $800,000

Increase in Spontaneous Current Liabilities = 20% * $500,000 = $100,000

Additional Funds Needed = Increase in Total Assets - Increase in Spontaneous Current Liabilities - Addition to Retained Earnings

Additional Funds Needed = $800,000 - $100,000 - $75,000

Additional Funds Needed = $625,000