AFN EQUATION Carlsbad Corporation\'s sales are expected to increase from $5 mill

Question

AFN EQUATION

Carlsbad Corporation's sales are expected to increase from $5 million in 2016 to $6 million in 2017, or by 20%. Its assets totaled $3 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 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 cent.

Explanation / Answer

We have,

a) Additional Funds Needed
= Increase in Assets? Increase in Liabilities– Increase in Retained Earnings

Increase in asset = Last year assets × sales growth rate

                            =$3,000,000×20%

                            = $600,000

Spontaneous Increase in Liabilities = Last year current liabilities excluding note payable × Sales growth rate

                                     =($1,000,000-$500,000)×20%= $100,000

Increase in Retained Earnings
= current sales × profit margin × retention rate
= $6,000,000×5%×0.25

=$75,000

Substituting the values ,

Additional Funds Needed =$600,000-$100,000-$75,000      

                                          = $425,000

Hence the additional fund needed = $425,000

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