Question

1. In your internship with Lewis, Lee, & Taylor Inc. you have been asked to forecast the firm's additional funds needed (AFN) for next year. The firm is operating at full capacity. Data for use in your forecast are shown below. Based on the AFN equation, what is the AFN for the coming year?

Last year's sales = S0	$200,000	Last year's accounts payable	$50,000
Sales growth rate = g	40%	Last year's notes payable	$15,000
Last year's total assets = A0*	$122,500	Last year's accruals	$122,500
Last year's profit margin = PM	20.0%	Target payout ratio	25.0%

Select the correct answer.

a. - $21,040

b. - $20,940

c. - $21,000

d. - $20,980

e. - $20,960

2. You have been asked to forecast the additional funds needed (AFN) for Houston, Hargrove, & Worthington (HHW), which is planning its operation for the coming year. The firm is operating at full capacity. Data for use in the forecast are shown below. However, the CEO is concerned about the impact of a change in the payout ratio from the 10% that was used in the past to 70%, which the firm's investment bankers have recommended. Based on the AFN equation, by how much would the AFN for the coming year change if HHW increased the payout from 10% to the new and higher level? All dollars are in millions.

Last year's sales = S0	$300.0	Last year's accounts payable	$50.0
Sales growth rate = g	40%	Last year's notes payable	$15.0
Last year's total assets = A0*	$500	Last year's accruals	$20.0
Last year's profit margin = PM	20.0%	Initial payout ratio	10.0%

Select the correct answer.

a. $50.4

b. $44.7

c. $46.6

d. $54.2

e. $48.5

Answer 1

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

1). AFN = [$122,500 x 0.40] - [($50,000 + $122,500) x 0.40] - [($200,000 x 1.40) x 0.20 x (1 - 0.25)]

= $49,000 - $69,000 - $42,000 = -$62,000

Options given are incorrect.

2). AFN(Old Payout Ratio) = [$500 x 0.40] - [($50 + $20) x 0.40] - [($300 x 1.40) x 0.20 x (1 - 0.10)]

= $200 - $28 - 75.6 = $96.40

AFN(New Payout Ratio) = [$500 x 0.40] - [($50 + $20) x 0.40] - [($300 x 1.40) x 0.20 x (1 - 0.70)]

= $200 - $28 - $25.2 = $146.80

Change in AFN = AFN(New Payout Ratio) - AFN(Old Payout Ratio) = $146.80 - $96.40 = $50.40

Hence, Option A is correct.