(P17-1) AFN equation Carter Corporation\'s sales are expected to increase from $
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Question
(P17-1) AFN equation Carter Corporation's sales are expected to increase from $5 million in 2005 to $6 million in 2006, or by 20 percent. Its assets totaled $3 million at the end of 2005. Carter is at full capacity, so its assets must grow in proportion to projected sales. At the end of 2005, current liabilities are $1 million, consisting of $250,000 of accounts payable, $500,000 of notes payable, and $250,000 of accrued liabilities. The after-tax profit margin is forecasted to be 5 percent, and the forecasted retention ratio is 30 percent. Use the AFN equation to forecast Carter's additional funds needed for the coming year.Explanation / Answer
AFN = (A* / S0) Changein Sales - (L* / S0) Change inSales - MS1(RR) AFN = Additional Funds needed S1 = Projected Sales for Next Year S0 = Last years Sales M = Profit Margin (or) Profit per $1 ofSales RR = Retention Ratio A*/S0 = $4,000,000 /$5000,000 = 0.80 Thus, for every $1 increase in Sales, Assets must increase byabout 80% L* / S0 = [$250,000 + $500,000+ $250,000] / $5000,000 = $1,000,000 / $5,000,000 L* / S0 = 0.2 Thus, every $1 increase in Sales generates about20% of Spontaneous financing Profit Margin (M) = 5% (or) 0.05 Retention Ratio (RR) = 30% (or) 0.3 Change in Sales = S1 – S0 Change in Sales = $6,000,000 - $5,000,000 Change in Sales = $1,000,000 AFN = (A* / S0) Changein Sales - (L* / S0) Change inSales - MS1(RR) = (0.80) $1,000,000 – (0.20) $1,000,000 –0.05 * $1,000,000 (0.3) = $800,000 - $200,000 - $15,000 = $585,000 Additional Funds Needed (AFN) =$585,000 Capital Intensity: A*/S0 = $4,000,000/ $5000,000 = 0.80, this ratiowill effect on capital requirements. In the Previous Problemwe got 0.60 (or) 60%, here we noticed if the Last years Sales areincreased the Capital Intensity ratio also will increase. Thehigher the assets to Sales ratio indicates will require moreassets for a given increase in sales. Hope it may help you
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