Question

Carlsbad Corporation's sales are expected to increase from $5 million in 2016 to $6 million in 2017, or by 20%. Its assets totaled $4 million at the end of 2016. Carlsbad is at full capacity, so its assets must grow in proportion to projected sales. At the end of 2016, 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 5%. Assume that the company pays no dividends. Under these assumptions, what would be the additional funds needed 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 cent.

$______

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.

Answer 1

Equation for AFN:-

AFN = (Total assets of 2016)*(% increase in Sales) - (Spontaneous Liabilities of 2016)*(% increase in Sales) - (Forecasted Sales of 2017)(Net Profit Margin)(1- Dividend Payout Ratio)

Spontaneous Liabilities of previous year = Accounts Payable + Accrued liabilities

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

% increase in sales = 20%

Total assets of previous year = $ 4 million

Forecasted Sales = $ 6 million

Net Profit Margin = 5%

Dividend Payout Ratio = 0%

AFN = ($ 4 million)(20%) - ($ 500,000)(20%) - ($6 million)(5%)(1-0)

= $ 800,000 - $ 100,000 - $ 300,000

= $ 400,000

So, Forecasted Carlsbad's additional funds needed for the coming year is $ 400,000

- Ans- Option IV.

When the Company pays dividend, the retained earnings decreases. Thus, Decreased in retained earnings will increase the additional funds needed. Thus Option IV is correct.

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