Question

Quantitative Problem 1: Beasley Industries' sales are expected to increase from $5 million in 2015 to $6 million in 2016, or by 20%. Its assets totaled $3 million at the end of 2015. Beasley is at full capacity, so its assets must grow in proportion to projected sales. At the end of 2015, current liabilities are $720,000, consisting of $170,000 of accounts payable, $350,000 of notes payable, and $200,000 of accrued liabilities. Its profit margin is forecasted to be 4%, and its dividend payout ratio is 70%. Using the AFN equation, forecast the additional funds Beasley will need for the coming year. Do not round intermediate calculations. Round your answer to the nearest dollar.
$  

The AFN equation assumes that ratios remain constant. However, firms are not always operating at full capacity so adjustments need to be made to the existing asset forecast. Excess capacity adjustments are changes made to the existing asset forecast because the firm is not operating at full capacity. For example, a firm may not be at full capacity with respect to its fixed assets. First, the firm's management must find out the firm's full capacity sales as follows:

Next, management would calculate the firm's target fixed assets ratio as follows:

Finally, management would use the target fixed assets ratio with the projected sales to calculate the firm's required level of fixed assets as follows:

Required level of fixed assets = (Target fixed assets/Sales) × Projected sales

Quantitative Problem 2: Mitchell Manufacturing Company has $1,700,000,000 in sales and $360,000,000 in fixed assets. Currently, the company's fixed assets are operating at 75% of capacity.

1. What level of sales could Mitchell have obtained if it had been operating at full capacity? Do not round intermediate calculations. Round your answer to the nearest dollar.
   $  
2. What is Mitchell's Target fixed assets/Sales ratio? Do not round intermediate calculations. Round your answer to two decimal places.
   %
3. If Mitchell's sales increase by 50%, how large of an increase in fixed assets will the company need to meet its Target fixed assets/Sales ratio? Do not round intermediate calculations. Round your answer to the nearest dollar.
   $  

Answer 1

Question 1. As Beasley Industries is already operating at full capacity, we do not have to calculate the full capacity of assets

Required Level of Fixed Assets = (Target fixed assets/Sales) × Projected sales = ($3 Million/$5 Million) * $6 Million = $3.6 Million

Question 2. Here as Mitchell Manufacturing Company is not operating at full capacity we will need to calculate the sales at full capacity:

a. Full Capacity Sales: Actual Sales/ Capacity at which fixed assets are operated

$1,700,000,000/75% = $2,266,666,666

b. Target fixed assets/Sales, ratio = Actual Fixed Assets/Full Capacity Sales

  $360,000,000/$2,266,666,666 = 0.16

c. Sales increased by 50%

New Sales = $1,700,000,000*1.5 = $2,550,000,000

Target Fixed Assets/Sales = 0.16 (found in part b)

From above equation we can find Target Fixed Assets as we have sales and 0.16 ratio

Target Fixed Assets/$2,550,000,000 = 0.16

Target Fixed Assets = $2,550,000,000*0.16

Target Fixed Assets = 408,000,000