Cloud 9\'s salCLOUD 9 sales were $500,000 during 2005, and its year-end assets w
ID: 2707811 • Letter: C
Question
Cloud 9's salCLOUD 9 sales were $500,000 during 2005, and its year-end assets were $400,000. For 2006, sales are expected to grow by 5%,and since the firm is operating at full capacity, its assets must grow in proportion to sales. Its 2005 current liabilities consisted of $60,000 of accounts payable, $20,000 of notes payable, and $50,000 of accruals. Its after-tax profit margin is forecasted to be 15%, and the firm plans to pay out 20% of its earnings. Based on the AFN equation, what is the firm's additional funds needed (AFN) for 2006?
a.
-$21,000
b.
-$28,500
c.
-$36,500
d.
-$41,000
e.
-$48,500
a.
-$21,000
b.
-$28,500
c.
-$36,500
d.
-$41,000
e.
-$48,500
Explanation / Answer
AFN = increase in assets - increase in spontaneous current liabilities - retained earnings in 2006
= 5%*400,000 - (60,000+50,000)*5% - 15%*500,000*(1+5%)*(1-20%) = -48,500
So the answer is choice E
Key things to note are: spontaneous current liabilities do not include notes payable. Retained earnings in 2006 = net income in 2006 * (1-payout ratio). Net income in 2006 = after tax profit margin * 2005 sales * (1+growth %)
Hope this helped ! Let me know in case of any queries.
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