Question

Blue Elk Manufacturing reported sales of $720,000 at the end of last year, but this year, sales are expected to grow by 8%. Blue Elk expects to maintain its current profit margin of 23% and dividend payout ratio of 10%. The following information was taken from Blue Elk’s balance sheet:

Total assets:	$400,000
Accounts payable:	$80,000
Notes payable:	$45,000
Accrued liabilities:	$80,000

Based on the AFN equation, the firm’s AFN for the current year is _____ .

A positively signed AFN value represents:

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

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

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

Because of its excess funds, Blue Elk Manufacturing is thinking about raising its dividend payout ratio to satisfy shareholders. Blue Elk could pay out____ % of its earnings to shareholders without needing to raise any external capital. (Hint: What can Blue Elk increase its dividend payout ratio to before the AFN becomes positive?)

Answer 1

Additional Funds Needed [AFN] for the coming year

Expected Next Year Sales

Expected Next Year Sales = Last Year Sales x 107%

= $720,000 x 108%

= $777,600

After Tax profit Margin

After Tax profit Margin = Expected Next Year Sales x Profit Margin

= $777,600 x 23%

= $178,848

Dividend Pay-out

Dividend Pay-out = After Tax profit Margin x Dividend Pay-out Ratio

= $178,848 x 10%

= $17,885

Additions to Retained Earnings

Additions to Retained Earnings = After Tax profit Margin - Dividend Pay-out

= $178,848 - $17,885

= $160,960

Increase in Total Assets

Increase in Total Assets = Total Assets x Percentage of Increase in sales

= $400,000 x 8%

= $32,000

Increase in Spontaneous liabilities

Increase in Spontaneous liabilities = [Accounts Payable + Accruals] x Percentage of Increase in sales

= [$80,000 + $80,000] x 8%

= $160,000 x 8%

= $12,800

Additional Funds Needed [AFN]

Therefore, the Additional Funds Needed [AFN] = Increase in Total Assets – Increase in in Spontaneous liabilities – Additions to retained earnings

= $32,000 - $12,800 - $160,963

= -$141,763 (Negative AFN)

“Hence, the firm’s AFN for the coming year would be -$141,763”

A positively signed AFN value represents “a shortage of internally generated funds that must be raised outside the company to finance the company’s forecasted future growth”

The Revised Dividend Payout Ratio which equals the AFN to Zero

The Excess AFN for the coming year = $141,763

Expected Dividend Payment for the next year = $17,885

The Revised Dividend Payment which equals the AFN to Zero = $159,648 [$141,763 + $17,885]

Therefore, the Dividend Pay-out Ratio = [Dividend Payment / After Tax profit Margin] x 100

= [$159,648 / $178,848] x 100

= 89.3%

“Hence, Blue Elk should increase the Dividend Pay-out Ratio to 89.3%”