Question

After adding a new line of widgets, Worldwide Widget Manufacturing, Inc., expects all assets and current liabilities to shrink with sales. The company has sales for the year just ended of $20 million. The company also has a profit margin of 20 percent, a return ratio of 25 percent, and expected sales of $18 million next year. Worldwide Widget Manufacturing, Inc., shows the following on its balance sheet.

Assets	Liabilities and Equity
Current assets- $2,500,000	Current liabilities- $1,250,000
Fixed assets- $3,500,0000	Long-term debt- $1,500,000
Total assets- $6,000,000	Equity- $3,250,0000
	Total liabilities and equity- $6,000,000

What amount of additional funds (AFN) will Worldwide Widget Manufacturing, Inc., need from external sources to fund the expected growth? What does the AFN show?

Answer 1

Part 1)

The value of AFN can be derived with the use of formula given below:

Additional Funds Needed (AFN) = (Total Assets/Sales for the Current Year)*(Change in Sales) - Spontaneous Liabilities/Sales for the Current Year)*(Change in Sales) - Profit Margin*Estimated Sales for Next Year*Retention Ratio

Substituting values in the above formula, we get,

Additional Funds Needed (AFN) = (6,000,000/20,000,000)*(18,000,000 - 20,000,000) - (1,250,000/20,000,000)*(18,000,000 - 20,000,000) - 20%*18,000,000*25% = -$1,375,000

_____

Part 2)

AFN shows the value of funds that may be required to be raised by the company from external sources in order to finance the increase in assets necessitated by growth/increase in sales. A negative AFN (as in the given case) indicates that the company will be able to generate extra income from the proposed project/product which can be used for investment purposes. It would also indicate that the company's current level of capital is in surplus if no new project/product is proposed to be undertaken.