Question

Broussard Skateboard's sales are expected to increase by 20% from $7.8 million in 2016 to $9.36 million in 2017. Its assets totaled $4 million at the end of 2016. Broussard is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2016, current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 5%, and the forecasted payout ratio is 75%. What would be the additional funds needed? Do not round intermediate calculations. Round your answer to the nearest dollar. $

Assume that an otherwise identical firm had $2 million in total assets at the end of 2016. Broussard's capital intensity ratio (A0*/S0) is (higher/lower/equal) is than the otherwise identical firm; therefore, Broussard is (less/more/equal) capital intensive - it would require (smaller/larger/same) increase in total assets to support the increase in sales.

Answer 1

Solution :

Additional fund needed is the amount of fund that will be required to support the sales growth. There are some assets and some liability that are associated with it.

Formula for AFN is

A*0 = 4 million as assets are at full capacity,

L*0 = 450,000 =0.45 million ( we generally associate account payable in liability that is associated with sales because this is a source of funds

S0 = 7.8 million , S1 = 9.36 million , PM = 5% , b = 1-0.75( Dividend payout) = 0.25

Putting all the values in the formula

So additional fund needed is 593,000

Another firm has 2 million in assets that means Capital intensity ratio = 2/7.8 = 0.2561, while Broussard has 4 million in assets so their ratio would be double of 0.2561 = 0.512

So, Broussard's capital intensity ratio (A0*/S0) is higher than the otherwise identical firm

That means if sales increases then capital requirement will be higher as we can see from the formula

AFN = A*0/S0 * growth in sales

Broussard is more capital intensive - it would require a larger increase in total assets to support the increase in sales.