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 $6 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%, and the forecasted retention ratio is 35%. Use the AFN equation to forecast Carlsbad's 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. $ Now assume the company's assets totaled $4 million at the end of 2016. Is the company's "capital intensity" the same or different comparing to initial situation?

Answer 1

a). Additional Funds Needed = [A0 x (ΔS / S0)] - [L0 x (ΔS / S0)] - [S1 x PM x b]

Where,
A_o = current level of assets
L_o = current level of liabilities
ΔS/S_o = percentage increase in sales i.e. change in sales divided by current sales
S₁ = new level of sales
PM = profit margin
b = retention rate = 1 - payout rate

AFN = [$6,000,000 x 0.20] - [($450,000 + $450,000) x 0.20] - [$6,000,000 x 0.05 x (1 - 0.35)]

= $1,200,000 - $180,000 - $195,000 = $825,000

b). AFN = [$4,000,000 x 0.20] - [($450,000 + $450,000) x 0.20] - [$6,000,000 x 0.05 x (1 - 0.35)]

= $800,000 - $180,000 - $195,000 = $425,000

AFN amount is different because of less assets to begin with, allowing the company to put less assets into production, which decreased the AFN. The capital intensity Ratio will be lesser now as there are less assets.