Question

In: Finance

The Booth Company’s sales are forecasted to double from $1,000 in 2013 to $2,000 in 2014....

The Booth Company’s sales are forecasted to double from $1,000 in 2013 to $2,000 in 2014. Below is the December 31, 2013 balance sheet:

Cash

$100

Accounts payable

$50

Accounts receivable

200

Notes payable

150

Inventories

200

Accruals

50

Net fixed assets

500

Long-term debt

400

Common stock

100

Retained earnings

250

Total assets

$1,000

Total liabilities and Equity

$1,000


Assume Booth is at operating at full capacity and its spontaneous liabilities grow with sales. Further, Booth’s after-tax profit margin is forecasted to be 5% and its payout ratio to be 60%. With this information, answer the following questions.

  1. What is Booth’s additional funds needed (AFN) for the coming year?
  2. Now assume that the company pays no dividends. Assume that all other numbers, including sales, remain the same. Under this assumption, what would be the additional funds needed for the coming year? Why is this AFN different from the one in part a?
  3. Define the self-supporting growth rate and compute it for this example. In doing so, return to the assumption that the payout ratio is 60%.
  4. Again, return to the assumption that the payout ratio is 60%. Now consider that while the current assets are being used efficiently, the fixed assets are only being used at 65.3% capacity. What will Booth’s AFN needs be under this scenario? Why is it different than the one in part a?

Solutions

Expert Solution

1 ) What is Booth’s additional funds needed (AFN) for the coming year?

solution:

Before solving we must understand what is AFN and how it is computed.

so AFN is the additional fund needed is required to be calculated as excess of required increase in the asset over the increase in the liabilities and increase in the retained earnings.

AFN is computed using a formula:-

Current Level of Assets* %increase in sale i .e change in sale/current sale- current level of liabilities* %increase in sale i .e change in sale/current sale-new sale level*profit margin *retention rate.

Now here from the question we can get

current asset =(cash +account receivable+inventories)=$(100+200+200)=$500

Current Liabilities=(Accounts Payable+Notes Payables+Accruals)=$(50+150+50)=$250

% increase in sale= (Expected Revenue of 2014 -Revenue of 2013)/Revenue of year 2013= 100%

Profit Margin(Forecasted) = 5%or 0.05

Retention Ratio= 1-payout ratio=1-0.6=0.4

Now putting the values in the above formula:

AFN=$500*(100%)-250(100%)-2000*0.05*0.4= $170 .

So Additional Fund Needed is $170.

Q2)Now assume that the company pays no dividends. Assume that all other numbers, including sales, remain the same. Under this assumption, what would be the additional funds needed for the coming year? Why is this AFN different from the one in part a?

Solution :

Now dear student understand what is asked in this question . In this 2 nd part of the given question all data remain the same except the dividend payout ratio. The question has asked us to assume that the company will have no payout ratio in the upcoming year .i.e there will be no dividend declaration and whole profit will be retained.So this will only impact the retained ratio

so Now the Retain Ratio= 1-payout ratio=1-0=1 or 100%

Now putting the values in the above formula:

AFN=$500*(100%)-250(100%)-2000*0.05*1= $50

So Additional Fund Needed is $50.

b)Why AFN is different from part a?

Reason: In part a of the question the company has decided to payout its shareholder 60% i.e 0.6 as result the retained earning was 40% whereas in the second assumption company decided to retain 100% as there was no payout . Hence in second assumption we needed additional fund of $ 50 only as compared to $170 in the first assumption. This also reduces our dependence on further external borrowing ($170-$50)upto $120.

Q3)Define the self-supporting growth rate and compute it for this example. In doing so, return to the assumption that the payout ratio is 60%.

Definition :

Self -Supporting Growth Rate :It is rate at which company can expand without habving to raise or utilise external capital.

It is calculated using formula:

(M*(1-POR)*S0)/(A0-LO-(M*(1-POR)*S0

Where

M=Profit margin=5%

(1-POR)=(1-0.6)=0.4

S0=Revenue 2013=$1000

A0=Asset=$500

L0=Liabilities=$250

Supporting growth rate (SGR)=(5%*(0.4)*$1000)/$500-$250-(5%*0.4)*1000= 8.69%

Q4)Again, return to the assumption that the payout ratio is 60%. Now consider that while the current assets are being used efficiently, the fixed assets are only being used at 65.3% capacity. What will Booth’s AFN needs be under this scenario? Why is it different than the one in part a?

Here if the fixed asset is only used upto 65.3% of the capacity it means it is under utilized and hence the Current asset will increase = $1000- $500*65.3%= $673.5

Now AFN= AFN=$673.5*(100%)-250(100%)-2000*0.05*0.4= $374.

With the increase in asset the AFN also increases as we can see earlier the current asset was $500 and now the current asset increased to $673.5 which resulted in high AFN as with the increae in Asset AFN also increases .so,our answer is different from part a.


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