Brown and Sons recently reported sales of $100 million, and net income equal to

Question

Brown and Sons recently reported sales of $100 million, and net income equal to $5 million. The company has $70 million in total assets. Over the next year, the company is forecasting a 20 percent increase in sales. Since the company is at full capacity, its assets must increase in proportion to sales. The company also estimates that if sales increase 20 percent, spontaneous liabilities will increase by $2 million. If the company's sales increase, its profit margin will remain at its current level. The company's dividend payout ratio is 40 percent. Based on the AFN formula, how much additional capital must the company raise in order to support the 20 percent increase in sales?

Explanation / Answer

AFN = (A/S0)S–(L/S0)S–MS1(RR)

A- Assets tied directly to sales

L-spontaneous liabilities that are affected by sales

S0=the previous year's sales

S1=total projected sales for next year

S=the change in sales between S0 and S1

MS1=projected net income

RR=the retention ratio from net income

= ($70/$100)×$20–$2–$120×5%(1-40%)

= $8.4 million

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