Question

Safelight is planning its operations for the coming year, and the CFO wants you to forecast the firm's additional funds needed (AFN). Data for use in the forecast are shown below. Based on the AFN equation, by how much would the AFN for the coming year change (indicate an increase or a decrease in AFN) if Safelight increased the dividend payout ratio from 20% to 25% and net profit margin decreased from 20% to 15%? All dollars are in millions.

Last year's sales = S0	$300		Last year's accounts payable	$50.0
Sales growth rate = g	10%		Last year's notes payable (to bank)	$15.0
Last year's spontaneous assets = A*	$500		Last year's accruals	$20.0
Last year's profit margin = PM	20.0%		Initial dividend payout ratio	20.0%
Expected profit margin = PM new	15%		New dividend payout ratio	25.0%

Answer 1

1) Find out the AFN for the given scenarios.

Additional Funds Needed (AFN) = (A0/S0)x∆S −(L0/S0)x∆S−PMx(S1)x(1−PR)

Where,

A0 - Current level of Assets

S0 - Current year level of Sales

∆S - Change in sales between current year and next year

L0 - Current level of Liabilities

PM - Profit Margin

S1 - Next year Sales

PR - Payout Ratio.

Based on the above equation, AFN is calculated for the two scenarios is provided below.

Particulars	$ in million
Current level of asset - A0	500
Current level of sales - S0	300
Percentage increase in sales - ∆S	10%
Current level of liabitlities - L0	85
New level of sales - S1	330
Profit Margin - PM	20%
Retention rate - PR	20%

AFN = -$11.3 million.

AFN based on the change in Profit Margin and Retention Rate.  

Particulars	$ in million
Current level of asset - A0	500
Current level of sales - S0	300
Percentage increase in sales - ∆S	10%
Current level of liabitlities - L0	85
New level of sales - S1	330
Profit Margin - PM	15%
Retention rate - PR	25%

AFN = $4.3m.

Change in AFN = -$11.3 m -$4.3 m = -$15.6 m.

Conclusion: At the current level of profit margin and dividend payout, the company will generate extra cash to the extent of $11.3m. However, if the profit margin dips by 5% and dividend payout increases by 5%, Addiional Funds needed will be $4.3 m.