Question

Carlsbad Corporation's sales are expected to increase from $5 million in 2019 to $6 million in 2020, or by 20%. Its assets totaled $2 million at the end of 2019. Carlsbad is at full capacity, so its assets must grow in proportion to projected sales. At the end of 2019, current liabilities are $1 million, consisting of $250,000 of accounts payable, $500,000 of notes payable, and $250,000 of accrued liabilities. Its profit margin is forecasted to be 3%.

1. Assume that the company pays no dividends. Use the AFN equation to forecast the additional funds Carlsbad will need for the coming year. Write out your answer completely. For example, 5 million should be entered as 5,000,000. Round your answer to the nearest dollar.
   $  
2. 
   
3. Why is this AFN different from the one when the company pays dividends?
   
   1. Under this scenario the company would have a higher level of retained earnings, which would reduce the amount of additional funds needed.
   2. Under this scenario the company would have a higher level of retained earnings, which would reduce the amount of assets needed.
   3. Under this scenario the company would have a higher level of spontaneous liabilities, which would reduce the amount of additional funds needed.
   4. Under this scenario the company would have a lower level of retained earnings, which would increase the amount of additional funds needed.
   5. Under this scenario the company would have a lower level of retained earnings, which would decrease the amount of additional funds needed.
   
   -Select-IIIIIIIVVItem 2

Answer 1

a). Formula for Additional funds Needed(AFN):-

AFN = (Assets/Sales)*Change in sales - (Spontaneous Liab/Sales)*Change in sales - [Forecasted Sales*Net profit Margin*(1-Dividend payout ratio)]

where, Change in Sales = $6M - $5M = $ 1 million

Forecasted Sales = $6 million

Spontaneous Liab = Accounts Payable + Accured Liabilities (notes Payable are not part of Spontaneous Liab)

= $ 250,000 + $ 250,000 = $500,000

Dividend payout ratio = 0%

AFN = [(2M/5M)*1M] - [(500,000/5,000,000)*1000,000] - [$6,000,000*3%*(1-0)]

AFN = 400,000 - 100,000 - 180,000

AFN= $120,000

b). Option 4

When company pays dividend, retained earnings are at lower level. Lower Level of retianed earnings would require additional funds to acquire assets. Thus, additional funds increases when company pays Dividends

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