4. More on the AFN (Additional Funds Needed) equation Aa Aa Green Caterpillar Ga

Question

4. More on the AFN (Additional Funds Needed) equation Aa Aa Green Caterpillar Garden Supplies Inc. reported sales of $720,000 at the end of last year; but this year, sales are expected to grow by 8%. Green Caterpillarexpects to maintain its current profit margin of 20% and dividend payout ratio of 10%. The firm's total assets equaled $425,000 and were operated at full capacity. Green Caterpillar's balanc sheet shows the following current liabilities: accounts payable of $75,000, notes payable of $40,000, and accrued liabilities of $80,000. Based on the AFN (Additional Funds Needed) equation, what is the firm's AFN for the coming year? O -$118,368 O -$142,042 O -$106,531 O -$124,286 A negatively-signed AFN value represents: O A point at which the funds generated within the firm equal the demands for funds to finance the firm's future O A shortage of internally generated funds that must be raised outside the company to finance the company's O A surplus of internally generated funds that can be invested in physical or financial assets or paid out as expected sales requirements forecasted future growth additional dividends Because of its excess funds, Green Caterpillar is thinking about raising its dividend payout ratio to satisfy shareholders. What percentage of its earnings can Green Caterpillar pay to shareholders without needing to raise any external capital? (Hint: What can Green Caterpillar increase its dividend payout ratio to before the AFN becomes positive?) O 77.5% 73.2% 81.8% o 86.1%

Explanation / Answer

We have,

a) Additional Funds Needed
= Increase in Assets? Increase in Liabilities– Increase in Retained Earnings

Increase in asset = Last year assets × sales growth rate

                            =$425,000×8%

                            = $34,000

Spontaneous Increase in Liabilities = Last year current liabilities× Sales growth rate

                                     =$155,000×8%= $12400

Increase in Retained Earnings
= current sales × profit margin × retention rate
= last year sales × (1 + sales growth rate) × profit margin × retention rate

=$720,00×(1+0.08)×0.20×0.90

=$139,968

Substituting the values ,

Additional Funds Needed =$34000-$12,400-$139,968            

                                          = -$118,368

Hence the additional fund needed = -$118,368

b) Negatively signed APN, indicates a surplus of internally generated fund that can be invested in physical or financial assets or paid out as additional dividends.

c) Let "Y" be the retention ratio at which APN becomes positive.

Additional Funds Needed
= Increase in Assets? Increase in Liabilities– Increase in Retained Earnings

substituting values

0= 34,000-12,400-720,000*1.08*0.20*Y

155,520Y=21600

Y=21600/155,520

Y=13.88%

Hence the dividend payout ratio = 100%-13.88%= 86.1%

Hence the maximum dividend payout ratio =86.1%

Please feel free to ask if you have any query in the comment section.

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