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 $4 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 5%.

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 lower level of retained earnings, which would decrease 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 additional funds needed.
   3. Under this scenario the company would have a higher level of retained earnings, which would reduce the amount of assets needed.
   4. Under this scenario the company would have a higher level of spontaneous liabilities, which would reduce the amount of additional funds needed.
   5. Under this scenario the company would have a lower level of retained earnings, which would increase the amount of additional funds needed.
   
   

Answer 1

Answer a.

2019:

Sales = $5,000,000
Total Assets = $4,000,000
Profit Margin = 5.00%

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

2020:

Sales = $6,000,000

Addition to Retained Earnings = Sales * Profit Margin * Retention Ratio
Addition to Retained Earnings = $6,000,000 * 5.00% * 1.00
Addition to Retained Earnings = $300,000

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 - $300,000
Additional Fund Needed = $400,000

Answer b.

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