Question

(AFN) for Houston, Hargrove, & Worthington (HHW), which is planning its operation for the coming year. The firm is operating at full capacity. Data for use in the forecast are shown below. However, the CEO is concerned about the impact of a change in the payout ratio from the 10% that was used in the past to 65%, which the firm's investment bankers have recommended. Based on the AFN equation, by how much would the AFN for the coming year change if HHW increased the payout from 10% to the new and higher level? All dollars are in millions. Last year's sales = S0 $300.0 Last year's accounts payable $50.0 Sales growth rate = g 40% Last year's notes payable $15.0 Last year's total assets = A0* $500 Last year's accruals $20.0 Last year's profit margin = PM 20.0% Initial payout ratio 10.0%

Answer 1

AFN = (A0/S0)*ΔS - (L0/S0)*ΔS - Profit Margin*S1*(1-Payout)
Where,
A0 = Last Year's Total Assets = $500
S0 = Last Year's Sales = $300
S1 = Forecasted Sales = Last Year's Sales (1 + Growth Rate)
		= $300 (1 + 40%)
		= $300 (1 + 0.40)
		= $420
ΔS = Change in Sales = Forecastesd Sales (S1) - Last Year's Sales (S0)
		=$420 - $300
		=$120
L0 = Payables + Accruals = Accounts Payable + Accruals = $50 + $20 = $70
Please note that, notes payable should not be included in payables, as it is not spontaneous
and in AFN Calculation only spontaneous increase in liabilities should be included.
Profit margin = 20% = 0.20
Old Payout Ratio = 10% = 0.10
New Payout Ratio = 65% = 0.65
Therefore,
Old AFN	= ($500/$300)*$120 - ($70/$300)*$120 - 0.20*$420*(1-0.10)
	=$200 - $28 - $75.6
	=$96.40
New AFN	= ($500/$300)*$120 - ($70/$300)*$120 - 0.20*$420*(1-0.65)
	=$200 - $28 - $29.40
	=142.60
Change in AFN = New AFN - Old AFN
	= $142.60 - $96.40
	= $46.20