Question

Additional Funds Needed

The Booth Company's sales are forecasted to double from $1,000 in 2016 to $2,000 in 2017. Here is the December 31, 2016, balance sheet:

Cash		$  100		Accounts payable		$   50
Accounts receivable		200		Notes payable		150
Inventories		200		Accruals		50
Net fixed assets		500		Long-term debt		400
				Common stock		100
				Retained earnings		250
Total assets		$1000		Total liabilities and equity		$1000

Booth's fixed assets were used to only 50% of capacity during 2016, but its current assets were at their proper levels in relation to sales. All assets except fixed assets must increase at the same rate as sales, and fixed assets would also have to increase at the same rate if the current excess capacity did not exist. Booth's after-tax profit margin is forecasted to be 7% and its payout ratio to be 30%. What is Booth's additional funds needed (AFN) for the coming year? Round your answer to the nearest dollar.

Answer 1

NOTE: The underlying idea behind solving such questions is that any increment in sales (and therefore revenue) has to be supported by a corresponding proportional increment in the firm's assets. This increment in the firm's asset, in turn, has to be supported by a corresponding increment in firm liability and retained earnings. Any gap between the increase in assets and the corresponding increase in liabilities and retained earnings to support the same(increase in assets) is met by AFN or Additional Funds Needed or External Financing.

In this context, the company's sale rises by $ 1000 from 2016 levels to reach $ 2000 by 2017. This implies an increment of 100% year-on-year. A sales increase of 100% should be met by a corresponding increment in assets of the company. The same (asset increment of 100%) has to be met by a corresponding increment in the firm's liabilities and retained earnings. Any gap in the support level is compensated by external financing.

In 2016:

Current Assets = Cash + Accounts Receivable + Inventories = 100 + 200 + 200 = $ 500

The current assets should rise by 100% to reach $ 1000 in 2016

Net Fixed Assets = $ 500

Net Fixed Assets should also rise by 100% to reach $1000 by 2017. The Net Fixed Assets are however used only to 50% of their capacity and therefore have a spare capacity of $250 from 2016. Therefore, actual rise in net fixed assets would be (500 - 250) = $ 250, so that next fixed asset level reaches $750 by 2017 (instead of the originally expected $1000)

Therefore, total assets in 2017 = Current Assets in 2017 + Net Fixed Assets in 2017 = 1000 + 750 = $ 1750

Total Liabilities in 2016 = Accounts Payable + Notes Payable + Accruals + Long Term Debt = 50 + 150 + 50 + 400 = $ 650

Total Liabilities in 2017 = Liabilities in 2016 x 2 = 650 x 2 = $ 1300

Incremental Retained Earnings in 2017 = Sales in 2017 x After-Tax Profit Margin x (1- Payout Ratio) = 2000 x 0.07 x (1-0.3) = $ 98

Additional Funding Needed = Increase in Total Assets - Increase in Total Liabilities - Incremental Retained Earnings = 1750 - 1300 - 98 = $ 352