Carter Corporation’s sales are expected to increase from$5 million in 2005 to $6

Question

Carter Corporation’s sales are expected to increase from$5 million in 2005 to $6 million in 2006, or by 20 percent. Itsassets totaled $3 million at the end of 2005. Carter is at fullcapacity, so its assets must grow in proportion to projected sales.At the end of 2005, current liabilities are $1 milion, consistingof $250,000 of accounts payable, $500,000 of notes payable, and$250,000 of accrued liabilities. The after-tax profit margin isforecasted to be 5 percent, and the forecasted retention ratio is30 percent. Use the AFN equation to forecast Carter’sadditional 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 = $3,000,000 /$$5,000,000

           = 0.6

Thus, for every $1 increase in Sales, Assets must increase byabout 60%

L* / S0 = [$250,000 + $500,000+ $250,000] / $5,000,000

           =   $1,000,000 / $5,000,000

L* / S0 = 0.2

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)

         = (0.6) $1,000,000 – (0.2) $1,000,000 –0.05 * $1,000,000 (0.3)

         = $600,000 - $200,000 - $15,000

         = $385,000

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