Baxter Video Product\'s sales are expected to increase by 20% from $5 million in

Question

Baxter Video Product's sales are expected to increase by 20% from $5 million in 2010 to $6 million in 2011.Its assets totaled $3 million at the end of 2010.Baxter is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2010, current liabilities were $1 million, consisting of $250,000 of accounts payable and $250,000 accruals. The after-tax profit margin is forecasted to be 5%, and the forecasted payout ratio is 70% Use the AFN equation to forecast Baxter's additional funds needed for the coming year.

Explanation / Answer

The AFN equation is AFN = (A / S0) S - (L / S0) S - MS1 (RR) Where A = Assets linked directly to sales and will increase = $3,000,000            S0 = Sales during the last year = $5,000,000            L = Liabilities that will be effected by sales (Except long-term liabilities) = $1,000,000            S1 = Total sales projected for next year = $6,000,000            S = Increase in sales between S0 and S1 = $1,000,000            M = Profit margin = 5%            MS1 = Projected net income = $300,000            RR = Retension ratio which is (1 - payout ratio) = (1-0.70) = 0.30 or 30% Substituting the values in the above equation, we get AFN = ($3,000,000 / $5,000,000) * $1,000,000 - ($1,000,000 / $$5,000,000) * $1,000,000 -                $300,000 (0.30)         = $600,000 - $200,000 - $90,000         = $310,000 Therefore, the additional funds needed are $310,000

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