Question

1. The AFN equation

Cold Duck Manufacturing Inc. has the following end-of-year balance sheet:

Cold Duck Manufacturing Inc.

Balance Sheet

For the Year Ended on December 31

Assets		Liabilities
Current Assets:		Current Liabilities:
Cash and equivalents	$150,000	Accounts payable	$250,000
Accounts receivable	400,000	Accrued liabilities	150,000
Inventories	350,000	Notes payable	100,000
Total Current Assets	$900,000	Total Current Liabilities	$500,000
Net Fixed Assets:		Long-Term Bonds	1,000,000
Net plant and equipment(cost minus depreciation)	$2,100,000	Total Debt	$1,500,000
		Common Equity
		Common stock	800,000
		Retained earnings	700,000
		Total Common Equity	$1,500,000
Total Assets	$3,000,000	Total Liabilities and Equity	$3,000,000

The firm is currently in the process of forecasting sales, asset requirements, and required funding for the coming year. In the year that just ended, Cold Duck Manufacturing Inc. generated $500,000 net income on sales of $13,500,000. The firm expects sales to increase by 15% this coming year and also expects to maintain its long-run dividend payout ratio of 45%.

A) Suppose Cold Duck Manufacturing Inc.’s assets are fully utilized. Use the additional funds needed (AFN) equation to determine the increase in total assets that is necessary to support Cold Duck Manufacturing Inc.’s expected sales.

$450,000

$540,000

$427,500

$517,500

B) When a firm grows, some liabilities grow spontaneously along with sales. Spontaneous liabilities are a source of capital that the firm will generate internally, so they reduce the need for external capital. How much of the total increase in assets will be supplied by spontaneous liabilities for Cold Duck Manufacturing Inc. this year?

$60,000

$57,000

$69,000

$72,000

In addition, Cold Duck Manufacturing Inc. is expected to generate net income this year. The firm will pay out some of its earnings as dividends but will retain the rest for future asset investment. Again, the more a firm generates internally from its operations, the less it will have to raise externally from the capital markets. Assume that the firm’s profit margin and dividend payout ratio are expected to remain constant.

C) Given the preceding information, Cold Duck Manufacturing Inc. is expected to generate ????? from operations that will be added to retained earnings.

D) According to the AFN equation and projections for Cold Duck Manufacturing Inc., the firm’s AFN is ????

.

Answer 1

A) Suppose Cold Duck Manufacturing Inc.’s assets are fully utilized. Use the additional funds needed (AFN) equation to determine the increase in total assets that is necessary to support Cold Duck Manufacturing Inc.’s expected sales.

$450,000

Increase in Total Assets = Total Assets * Growth rate in Sales = $3000000 * 15% = $450000

B) When a firm grows, some liabilities grow spontaneously along with sales. Spontaneous liabilities are a source of capital that the firm will generate internally, so they reduce the need for external capital. How much of the total increase in assets will be supplied by spontaneous liabilities for Cold Duck Manufacturing Inc. this year?

$60,000

Increase in Spontaneous Liabilities = Spontaneous Liabilities * Growth rate in Sales = $400000 * 15% = $60000

Notes payable is not a spontaneous liability as it doesn't changes with change in sales.

C) Given the preceding information, Cold Duck Manufacturing Inc. is expected to generate ????? from operations that will be added to retained earnings.

Addition to Retained Earnings = Net Income * (1 + Growth Rate) * (1 - Dividend Payout)

Addition to Retained Earnings = 500000 * (1 + 15%) * (1 - 45%)

Addition to Retained Earnings = $316250

D) According to the AFN equation and projections for Cold Duck Manufacturing Inc., the firm’s AFN is ????

AFN = Increase in assets - increase in liabilities - addition to retained earnings

AFN = 450000 - 60000 - 316250

AFN = $73750

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