Question

2. More on the AFN (Additional Funds Needed) equation

Blue Elk Manufacturing reported sales of $743,000 at the end of last year, but this year, sales are expected to grow by 8%. Blue Elk expects to maintain its current profit margin of 24% and dividend payout ratio of 20%. The following information was taken from Blue Elk’s balance sheet:

Total assets:	$400,000
Accounts payable:	$65,000
Notes payable:	$40,000
Accrued liabilities:	$80,000

Based on the AFN equation, the firm’s AFN for the current year is _______ .

A positively signed AFN value represents:

A point at which the funds generated within the firm equal the demands for funds to finance the firm’s future expected sales requirements.

A surplus of internally generated funds that can be invested in physical or financial assets or paid out as additional dividends.

A shortage of internally generated funds that must be raised outside the company to finance the company’s forecasted future growth.

Because of its excess funds, Blue Elk Manufacturing is thinking about raising its dividend payout ratio to satisfy shareholders. Blue Elk could pay out _______ of its earnings to shareholders without needing to raise any external capital.(Hint: What can Blue Elk increase its dividend payout ratio to before the AFN becomes positive?)

Answer 1

1]	AFN is given by the equation:
	AFN = (A/S) x (Δ Sales) - (L/S) x (Δ Sales) - (PM x FS x (1-d))
	where,
	A / S = Assets that change directly with sales.
	Δ sales = Change in sales
	L / S = Liabilities that change directly with sales
	PM = Profit Margin on Sales = net income / sales.
	FS = Forecasted Sales
	d = dividend payout ratio
	(1 - d) = retention ratio
	Substituting required values in the above equation we have,
	Additional funds needed = (400000/743000)*743000*8%-(145000/743000)*743000*8%-743000*108%*24%*(1-20%) =	$           (133,668)
	Based on the AFN equation, the firm’s AFN for the current year =.	$           (133,668)
2]	A positively signed AFN value represents:
	*A shortage of internally generated funds that must be raised outside the company to finance the company’s forecasted future growth.
3]	Equate AFN to 0, with payout ratio as the unknown figure.
	0 = (400000/743000)*743000*8%-(145000/743000)*743000*8%-743000*108%*24%*(1-p), where p = payout ratio
	Solving for p:
	743000*108%*24%*(1-p) = (400000/743000)*743000*8%-(145000/743000)*743000*8% =
	192585.6*(1-p) = 20400
	1-p = 20400/192585.6 =	10.59%
	p = 1-10.59% =	89.41%
	Blue Elk could pay out 89.41% of its earnings to shareholders without needing to raise any external capital.