Question

Beasley Industries' sales are expected to increase from $4 million in 2017 to $5 million in 2018, or by 25%. Its assets totaled $3 million at the end of 2017. Beasley is at full capacity, so its assets must grow in proportion to projected sales. At the end of 2017, current liabilities are $720,000, consisting of $150,000 of accounts payable, $350,000 of notes payable, and $220,000 of accrued liabilities. Its profit margin is forecasted to be 4%, and its dividend payout ratio is 70%. Using the AFN equation, forecast the additional funds Beasley will need for the coming year. Do not round intermediate calculations. Round your answer to the nearest dollar.
$  

The AFN equation assumes that ratios remain constant. However, firms are not always operating at full capacity so adjustments need to be made to the existing asset forecast. Excess capacity adjustments are changes made to the existing asset forecast because the firm is not operating at full capacity. For example, a firm may not be at full capacity with respect to its fixed assets. First, the firm's management must find out the firm's full capacity sales as follows:

Next, management would calculate the firm's target fixed assets ratio as follows:

Finally, management would use the target fixed assets ratio with the projected sales to calculate the firm's required level of fixed assets as follows:

Required level of fixed assets = (Target fixed assets/Sales)(Projected sales)

Quantitative Problem 2: Mitchell Manufacturing Company has $1,300,000,000 in sales and $200,000,000 in fixed assets. Currently, the company's fixed assets are operating at 75% of capacity.

1. What level of sales could Mitchell have obtained if it had been operating at full capacity? Do not round intermediate calculations. Round your answer to the nearest dollar.
   $  
2. What is Mitchell's Target fixed assets/Sales ratio? Do not round intermediate calculations. Round your answer to two decimal places.
   %
3. If Mitchell's sales increase by 50%, how large of an increase in fixed assets will the company need to meet its Target fixed assets/Sales ratio? Do not round intermediate calculations. Round your answer to the nearest dollar.

Answer 1

Solution to Question – 1

Additional Funds Needed [AFN] for the coming year

Expected Next Year Sales

Expected Next Year Sales = $5,000,000

After Tax profit Margin

After Tax profit Margin = Expected Next Year Sales x Profit Margin

= $5,000,000 x 4%

= $200,000

Dividend Pay-out

Dividend Pay-out = After Tax profit Margin x Dividend Pay-out Ratio

= $200,000 x 70%

= $140,000

Additions to Retained Earnings

Additions to Retained Earnings = After Tax profit Margin - Dividend Pay-out

= $200,000 - $140,000

= $60,000

Increase in Total Assets

Increase in Total Assets = Total Assets x Percentage of Increase in sales

= $3,000,000 x 25%

= $750,000

Increase in Spontaneous liabilities

Increase in Spontaneous liabilities = [Accounts Payable + Accruals] x Percentage of Increase in sales

= [$150,000 + $220,000] x 25%

= $370,000 x 25%

= $92,500

Additional Funds Needed [AFN]

Therefore, the Additional Funds Needed [AFN] = Increase in Total Assets – Increase in in Spontaneous liabilities – Additions to retained earnings

= $750,000 - $92,500 - $60,000

= $597,500

“Hence, the additional funds Beasley will need for the coming year will be $597,500”

Solution to Question – 2

Requirement-(a), Full Capacity Sales

Full Capacity Sales = Current Sales / Percentage capacity of operation

= $1,300,000,000 / 0.75

= $1,733,333,333

Requirement (b), Target fixed assets/sales ratio

Fixed Assets / Sales Ratio = [Fixed Assets / Sales] x 100

= [$200,000,000 / $1,733,333,333] x 100

= 11.54%

Requirement (c), Increase in fixed assets will the company need to meet its target fixed assets/sales ratio

New Sales = $1,950,000,000 [$1,300,000,000 x 150%]

Sales at full capacity = $1,733,333,333

Increase in fixed assets will the company need to meet its target fixed assets/sales ratio = [New sales – Sales at full capacity] x Fixed Asset to sales ratio

= [$1,950,000,000 - $1,733,333,333] x 11.54%

= $216,666,667 x 11.54%

= $25,003,333