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 7%.

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?

A. Under this scenario the company would have a higher level of retained earnings, which would reduce the amount of additional funds needed.

B. Under this scenario the company would have a higher level of retained earnings, which would reduce the amount of assets needed.

C. Under this scenario the company would have a higher level of spontaneous liabilities, which would reduce the amount of additional funds needed.

D. Under this scenario the company would have a lower level of retained earnings, which would increase the amount of additional funds needed.

E. Under this scenario the company would have a lower level of retained earnings, which would decrease the amount of additional funds needed.

Answer 1

Answer a.

2016:

Sales = $5,000,000
Total Assets = $4,000,000
Profit Margin = 7.00%

Retention Ratio = 1 - Payout Ratio
Retention Ratio = 1 - 0.00
Retention Ratio = 1.00

Spontaneous Current Liabilities = Accounts Payable + Accruals
Spontaneous Current Liabilities = $250,000 + $250,000
Spontaneous Current Liabilities = $500,000

2017:

Sales = $6,000,000

Addition to Retained Earnings = Sales * Profit Margin * Retention Ratio
Addition to Retained Earnings = $6,000,000 * 7.00% * 1.00
Addition to Retained Earnings = $420,000

Increase in Total Assets = $4,000,000 * 0.20
Increase in Total Assets = $800,000

Increase in Spontaneous Current Liabilities = $500,000 * 0.20
Increase in Spontaneous Current Liabilities = $100,000

Additional Fund Needed = Increase in Total Assets - Increase in Spontaneous Current Liabilities - Addition to Retained Earnings
Additional Fund Needed = $800,000 - $100,000 - $420,000
Additional Fund Needed = $280,000

Answer b.

Under this scenario the company would have a higher level of retained earnings, which would reduce the amount of additional funds needed.