AFN EQUATION Carter Corporation’s sales areexpected to increase from $ 5 million

ID: 2662590 • Letter: A

Question

AFN EQUATION Carter Corporation’s sales areexpected to increase from $ 5 million in 2008 to $ 6 million in2009, or by 20%. Its assets totaled $ 3 million at the end of 2008.Carter is at full capacity, so its assets must grow in proportionto projected sales. At the end of 2008, current liabilities are $ 1million, consisting of $ 250,000 of accounts payable, $ 500,000 ofnotes payable, and $ 250,000 of accrued liabilities. Its profitmargin is forecasted to be 5%, and the forecasted retention ratiois 30%. Use the AFN equation to forecast the additional fundsCarter will need for the coming year.

Explanation / Answer

AFN = (A*/S0)S- (L*/S0)S- MS1(RR)

= (3.6/5)*1 – (1/5)*1 – 0.3*0.30 = 0.72-0.2-0.09=0.43M= $430k

Where:

A* = Assets tied directly to sales and will increase : $3M &will grow by 20% to $3.6M

L* = Spontaneous liabilities that will be affected by sales. (NOTE:Not all liabilities will be affected by sales such as long-termdebt) : $1M

S0 =Sales during the last year $5M

S1 =Total sales projected for next year (the new level of sales). $6M

S = The increase in sales between S0 andS1 :$1M

M = Profit margin, or the profit per $1 of sales : 5% i.e (5%of $6M= $300k)

MS1 =Projected Net Income : 5% of $6M= $300k

The AFN equation is as follows: