Question

AFN EQUATION

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 3%.

1. 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.
   $
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.
   
   -Select the right option

Answer 1

ANSWER:

a) Calculation of Additional Funds needed:

AFN = Increase in assets-Increase in spontaneous liabilities -Retained earnings

Increase in assets = Increase in sales * Total Assets = 20% * 4,000,000 = $800,000

Increase in spontaneous liabilities = (accounts payable + accrued liabilities) * (Increase in sales)

= (250,000 + 250,000) * 20% = $100,000

Retained earnings =(Profit margin * Sales) - Dividend = 3% * 6,000,000 = $180,000

Additional Funds needed = 800,000 - 100,000 - 180,000 = $520,000

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

When the company pays dividends, the retained earnings are lesser and hence the amount of additional funds required will be more since internal funds will be lesser.

Option 1 is incorrect because paying dividends will decrease the retained earnings due to which external funds will be required more.

Option 2 and 3 are incorrect because paying dividends will not increase retained earnings rather decrease them.

Option 4 is incorrect because paying dividends will not change the spontaneous liabilities.