Howton & Howton Worldwide (HHW) is planning its operations for the coming year,

Question

Howton & Howton Worldwide (HHW) is planning its operations for the coming year, and  the CEO wants you to forecast the firm's additional funds needed (AFN).  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 80%, 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.  

$300.0

$50.0

40%

$15.0

$500.0

$20.0

20.0%

10.0%

Last yr's sales             =  S0

$300.0

Last yr's accounts payable

$50.0

Sales growth rate        =   g

40%

Last yr's notes payable

$15.0

Last yr's total assets    =  A*

$500.0

Last yr's accruals

$20.0

Last yr's profit margin  =  PM

20.0%

Initial payout ratio

10.0%

New payout ratio 80%

Explanation / Answer

Solution.

Last year’s sales = S 0 $300

]Sales growth rate = g 40%

Forecasted sales = S 0 (1 + g) $420

S = change in sales = S 1 – S 0 = S 0 g $120

Last year’s total assets = A 0 = A* since full capacity $500

Forecasted total assets = A 1 = A 0 (1 + g) $700

Last year’s accounts payable $50

Last year’s notes payable. Not spontaneous, so does not enter AFN calculation $15

Last year’s accruals $20 L* = payables + accruals $70

Profit margin = M 20%

Initial payout ratio 10%

New payout ratio 80%

Initial retention ratio = (1 – Payout) 90%

New retention ratio = (1 – Payout) 20%

AFN= (A*/S 0 ) S – (L*/S 0 ) S – Margin x S 1 x (1 – Payout)

Old AFN= $200.0 – $28.0 – $75.6 = $96.4

New AFN= $200.0 – $28.0 – $16.80 = $104.80

Change in AFN = $8.40.

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