Question

3. More on the AFN (Additional Funds Needed) equation

Fuzzy Button Clothing Company reported sales of $743,000 at the end of last year, but this year, sales are expected to grow by 10%. Fuzzy Button expects to maintain its current profit margin of 23% and dividend payout ratio of 15%. The following information was taken from Fuzzy Button’s balance sheet:

Total assets:	$500,000
Accounts payable:	$80,000
Notes payable:	$45,000
Accrued liabilities:	$75,000

a) Based on the AFN equation, the firm’s AFN for the current year is ------????

b) A positively signed AFN value represents:

1) a point at which the funds generated within the firm equal the demands for funds to finance the firm’s future expected sales requirements.

2) a surplus of internally generated funds that can be invested in physical or financial assets or paid out as additional dividends.

3) a shortage of internally generated funds that must be raised outside the company to finance the company’s forecasted future growth.

c) Because of its excess funds, Fuzzy Button Clothing Company is thinking about raising its dividend payout ratio to satisfy shareholders. Fuzzy Button could pay out ______? of its earnings to shareholders without needing to raise any external capital. (Hint: What can Fuzzy Button increase its dividend payout ratio to before the AFN becomes positive?)

Answer 1

a) Based on the AFN equation, the firm’s AFN for the current year is -$125282.15

b) A positively signed AFN value represents:

3) a shortage of internally generated funds that must be raised outside the company to finance the company’s forecasted future growth.

c) Because of its excess funds, Fuzzy Button Clothing Company is thinking about raising its dividend payout ratio to satisfy shareholders. Fuzzy Button could pay out 81.6% (1 - ((50000-15500) / 187979))of its earnings to shareholders without needing to raise any external capital. (Hint: What can Fuzzy Button increase its dividend payout ratio to before the AFN becomes positive?)

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