The Booth Company’s sales are forecasted to double from $1,000 in 2013 to $2,000
ID: 2653579 • Letter: T
Question
The Booth Company’s sales are forecasted to double from $1,000 in 2013 to $2,000 in
2014. Here 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
Booth’s fixed assets were used to only 50% of capacity during 2013, but its current assets were
at their proper levels in relation to sales. All assets except fixed assets must increase at the
same rate as sales, and fixed assets would also have to increase at the same rate if the current
excess capacity did not exist. Booth’s after-tax profit margin is forecasted to be 5% and its
payout ratio to be 60%. What is Booth’s additional funds needed (AFN) for the coming year?
Explanation / Answer
Additional Funds Needed (AFN) (Millions of Dollars)
Part A. Inputs and Definitions
S0:
Most recent year's sales
$1,000
g:
Forecasted growth rate in sales
100.00%
S1:
Next year's sales: S0 × (1 + g)
$2,000
gS0:
Change in sales = S1 – S0 = S
$1,000 ($1,000*100.00%)
A0*:
Most recent year's operating assets
$500
A0* / S0:
Required assets per dollar of sales
50.00% ($500 /$1,000)
L0*:
Most recent year's spontaneous liabilities i.e., payables + accruals
$100
L0* /S0:
Spontaneous liabilities per dollar of sales
10.00% ($100 /$1,000)
Profit margin (M):
Most recent profit margin = net income/sales
5.00%
Payout ratio (POR):
Most recent year's dividends / net income = % of income paid out
60.00%
Part B. Additional Funds Needed (AFN) to Support Growth
AFN =
Required Increase in Assets
-
Increase in Spon. Liab.
-
Addition to Retained Earnings.
=
(A0*/S0)S
-
(L0*/S0)S
-
S1 × M × (1 – POR)
-
-
=
(A0*/S0)(gS0)
-
(L0*/S0)(gS0)
-
(1+g)S0 × M × (1 – POR)
-
-
=
(0.710)($500)
-
(0.10)($500)
-
$5,500(0.044)(1 – 0.2273)
=
$500 (50%*$1,000)
$100.00 ($1,000*10%)
$40.00 [($2,000* 5% *(1-60%)]
AFN = $500-$100-$40 = $360
Self-Supporting Growth Rate:
Using algebra- The sustainable growth rate can also be found by solving the equation as shown on the 3rd row above g, then finding the value of g that causes AFN to equal zero.
Sustainable g = PM (1 – POR)(S0) / A0* – L0* – PM(1 – POR)S0
Sustainable g = $20* / $380**
Sustainable g = 5.26%
Calculation-
5% (1-60%)*$1,000 = $20*
$500 - $100 - 5% (1-60%)*$1,000 = $380**
Additional Funds Needed (AFN) (Millions of Dollars)
Part A. Inputs and Definitions
S0:
Most recent year's sales
$1,000
g:
Forecasted growth rate in sales
100.00%
S1:
Next year's sales: S0 × (1 + g)
$2,000
gS0:
Change in sales = S1 – S0 = S
$1,000 ($1,000*100.00%)
A0*:
Most recent year's operating assets
$500
A0* / S0:
Required assets per dollar of sales
50.00% ($500 /$1,000)
L0*:
Most recent year's spontaneous liabilities i.e., payables + accruals
$100
L0* /S0:
Spontaneous liabilities per dollar of sales
10.00% ($100 /$1,000)
Profit margin (M):
Most recent profit margin = net income/sales
5.00%
Payout ratio (POR):
Most recent year's dividends / net income = % of income paid out
60.00%
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