Question

Green Caterpillar Garden Supplies Inc. reported sales of $775,000 at the end of last year; but this year, sales are expected to grow by 7%. Green Caterpillar expects to maintain its current profit margin of 20% and dividend payout ratio of 10%. The firm’s total assets equaled $400,000 and were operated at full capacity. Green Caterpillar’s balance sheet shows the following current liabilities: accounts payable of $70,000, notes payable of $30,000, and accrued liabilities of $70,000. Based on the AFN (Additional Funds Needed) equation, what is the firm’s AFN for the coming year?

-$163,831

-$137,618

-$131,065

-$170,384

A negatively-signed AFN value represents:

A point at which the funds generated within the firm equal the demands for funds to finance the firm’s future expected sales requirements

A surplus of internally generated funds that can be invested in physical or financial assets or paid out as additional dividends

A shortage of internally generated funds that must be raised outside the company to finance the company’s forecasted future growth

Because of its excess funds, Green Caterpillar is thinking about raising its dividend payout ratio to satisfy shareholders. What percentage of its earnings can Green Caterpillar pay to shareholders without needing to raise any external capital? (Hint: What can Green Caterpillar increase its dividend payout ratio to before the AFN becomes positive?)

89.0

75.6

84.6

62.3

Answer 1

AFN = Total Assets*% increase in sales – Spontaneous Liabilities*% increase in sales – Forecasted Sales*Profit Margin Ratio*(1-Payout ratio)

= 400,000*7% - (70,000+70,000)*7% - 775000*1.07*20%*(1-10%)

= -$131,065

A negatively-signed AFN value represents:

A surplus of internally generated funds that can be invested in physical or financial assets or paid out as additional dividends

Let the % dividend be x

0 = 400,000*7% - 140,000*7% - 775000*1.07*20%*(1-x)

0 = 18200 – 165850*(1-x)

x = 89.03%

i.e. 89.0