You have been asked to forecast the additional funds needed (AFN) for Smith Corp

Question

You have been asked to forecast the additional funds needed (AFN) for Smith Corp. which is planning its operation for the coming year. The firm is operating at full capacity. 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 50%, 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 Smith increased the payout from 10% to the new and higher level? All dollars are in millions. Show your solution using the forecasted financial statement method and the AFN equation. Assume that assets and spontaneous liabilities are expected to increases by the same percentage as sales.

Last year's sales = S0

$300.0

Last year's accounts payable

$50.0

Sales growth rate = g

40%

Last year's notes payable

$15.0

Last year's total assets = A0*

$500.0

Last year's accruals

$20.0

Last year's profit margin = PM

20.0%

Initial payout ratio

10.0%

Last year's sales = S0

$300.0

Last year's accounts payable

$50.0

Sales growth rate = g

40%

Last year's notes payable

$15.0

Last year's total assets = A0*

$500.0

Last year's accruals

$20.0

Last year's profit margin = PM

20.0%

Initial payout ratio

10.0%

Explanation / Answer

Solution-

Last year's sales (S0)

$300

Sales growth rate (g)

40%

Forecasted sales (S0 × (1 + g)

$420

S = change in sales (S1 S0 = S0 × g)

$120

Last year's total assets = A0* = A0* since full capacity

$500

Forecasted total assets = A1* = A0* × (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

L0* = payables + accruals

$70

Profit margin = PM

20%

Initial payout ratio

10%

New payout ratio

50%

Initial retention ratio = (1 Payout)

90%

New retention ratio = (1 Payout)

50%

Calculation-

AFN = (A0*/S0) S – (L0*/S0) S – Profit margin × S1 × (1 Payout)

Old AFN = $200.0 – $28.0 – $75.6

Old AFN = $96.4

New AFN = $200.0 – $28.0 – $42.0

New AFN = $130.0

Change in AFN = $33.6

Last year's sales (S0)

$300

Sales growth rate (g)

40%

Forecasted sales (S0 × (1 + g)

$420

S = change in sales (S1 S0 = S0 × g)

$120

Last year's total assets = A0* = A0* since full capacity

$500

Forecasted total assets = A1* = A0* × (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

L0* = payables + accruals

$70

Profit margin = PM

20%

Initial payout ratio

10%

New payout ratio

50%

Initial retention ratio = (1 Payout)

90%

New retention ratio = (1 Payout)

50%

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