Broussard Skateboard\'s sales are expected to increase by 25% from $7.6 million

Question

Broussard Skateboard's sales are expected to increase by 25% from $7.6 million in 2015 to $9.50 million in 2016. Its assets totaled $5 million at the end of 2015. Baxter is already at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2015, current liabilities were $1.4 million, consisting of $450,000 of accounts payable, $500,000 of notes payable, and $450,000 of accruals. The after-tax profit margin is forecasted to be 6%. Assume that the company pays no dividends. Under these assumptions, what would be the additional funds needed for the coming year? Do not round intermediate calculations. Round your answer to the nearest dollar.
$  

Why is this AFN different from the one when the company pays dividends?
-Select-IIIIIIIVVItem 2
I. Under this scenario the company would have a lower level of retained earnings which would reduce the amount of additional funds needed.  
II. Under this scenario the company would have a lower level of retained earnings but this would have no effect on the amount of additional funds needed.  
III. Under this scenario the company would have a higher level of retained earnings which would reduce the amount of additional funds needed.  
IV. Under this scenario the company would have a higher level of retained earnings which would increase the amount of additional funds needed.  
V. Under this scenario the company would have a higher level of retained earnings but this would have no effect on the amount of additional funds needed.

Explanation / Answer

AFN (Additional Fund Needed) is the amount of external financing needed which is required to finance the increase in assets to support the increased level of sales.

While calculating AFN it is assumed that financial ratio do not change. So when sales are increased the assets must be increased. Part of this increase in asset is offset by increase in spontaneous liabilities and part is offset by increase in retained earnings.

AFN=

(Required Increase in Assets)- (Increase in Spontaneous Liabilities) – (Increase in Retained Earnings)

Required Increase in Asset= 5.00 million x 25 %

Required Increase in assets= 1.25 million

Increase in spontaneous liabilities= 1.40 million x 25 %

Increase in spontaneous liabilities= 0.35 million

Increase in retained earnings = Projected sales x Profit Margin x Retention Rate

Increase in retained earnings= (9.5 Million) x 0.06 x 100 %

Increase in retained earnings= 0.57 millions

Hence AFN= 1.25-0.35-0.57

AFN= $ 0.33 Millions

AFN = $ 330,000

Part-2

Effect of Dividend Pay-out on AFN

By observing the formula it is appearing that two figures are constant and those are increase in assets and increase in liabilities.

But when company pays dividend its level of retained earnings decrease so by the same amount AFN will increase.

Under the current scenario company pays no dividend hence its retention is 100%. Hence AFN will decrease as the level of retained earnings is higher.

Hence in current scenario where no dividend paid option number III is the correct answer.

If the dividend paid then retained earnings will decreased sand by the same amount AFN will increase.

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