Question

Problem 2: AFN

Consider the following financial information for the Royals, Inc.:

Accounts Payable 40 60 Cash Accounts Receivable 160 20 Inventory 200 80 80 Net Fixed Assets 400 Accruals Notes Payable Bonds Common Stock Retained Eamings Total Liabilities & Equity 80 480 Total Assets 800 800

In the most recent year, the firm had sales of $6,000 with a profit margin of 8%. Management chose to pay out 50% of the firm’s income to its shareholders. Royals, Inc. was operating at full capacity.

The company expects to increase sales by 20% next year and hopes to improve their profit margin by 2%.

Determine the company’s AFN for next year through use of the formula: AFN = (A*/S)∆S – (L*/S)∆S – MS₁(1-d)      

Explain what this result will mean for the company.

Place a check next to each factor that will increase a firm’s AFN

Factor	Increase AFN?
Firm improves its production system and increases its profit margin
Firm increases its dividend payout ratio
Firm’s forecasted sales unexpectedly increase
Firm previously thought its fixed assets were operating at full capacity, but now learns that it has excess capacity
Firm switched its supplier for raw materials to a supplier who offers more favorable credit terms
Firm’s inventory turnover decreases, with no effect on the sales forecast

Answer 1

8% Existing Forecast Sales $6,000 $7,200 20% increase Profit margin 10% Profit $720 Dividend payout 50% Dividend $360 50 % of $720 Net addition to RE $360 (RE= Retained earnings) AFN= (A*/S)AS - (L*/S)4S-MS (1-d) AFN= ($800/$6,000) *$1,200 - ($80/$6,000) *$1,200 - $720(1-50%) AFN= $160- $16- $360 AFN= -$216 The company is not in needed of additional funds There is excess cash with the company The excess cash can be used to repay debts

Increase AFN? No Yes Yes Factor Firm improves its production system and increases its profit margin Firm increases its dividend payout ratio Firm's forecasted sales unexpectedly increase Firm previously thought its fixed assets were operating at full capacity, but now learns that it has excess capacity Firm switched its supplier for raw materials to a supplier who offers more favorable credit terms Firm's inventory turnover decreases, with no effect on the sales forecast No No Yes