Question

Carter Corporation’s sales are expected to increase from$5 million in 2005 to $6 million in 2006, or by 20 percent. Itsassets totaled $3 million at the end of2005. Carter is at fullcapacity, so its assets must grow in proportion to projected sales.At the end of 2005, current liabilities are $1 milion, consistingof$250,000 of accounts payable, $500,000 of notes payable, and$250,000 of accrued liabilities. The after-tax profit margin isforecasted to be 5 percent, and theforecasted retention ratio is30 percent. Use the AFN equation to forecast Carter’sadditional funds needed for the coming year.

Answer 1

AFN=(A^* / S₀) Changein Sales -(L^* / S₀) ChangeinSales-MS₁(RR)

AFN = Additional Funds needed

S₁=Projected Sales for Next Year

S₀= Last years Sales

M =Profit Margin (or) Profit per $1 ofSales

RR =Retention Ratio

A^*/S₀=$3,000,000 /$$5,000,000

=0.6

Thus, for every $1 increase in Sales, Assets must increase byabout 60%

L^* / S₀ =[$250,000 + $500,000+ $250,000] / $5,000,000

= $1,000,000 / $5,000,000

L^* / S₀=0.2

Thus, every $1 increase in Sales generates about 20% of Spontaneousfinancing

Profit Margin (M) = 5% (or) 0.05

Retention Ratio (RR) = 30% (or) 0.3

Change in Sales = S₁ – S₀

Change in Sales = $6,000,000 - $5,000,000

Change in Sales = $1,000,000

AFN=(A^* / S₀) Changein Sales-(L^* / S₀) ChangeinSales-MS₁(RR)

=(0.6) $1,000,000 – (0.2) $1,000,000 –0.05 * $1,000,000 (0.3)

=$600,000 - $200,000 - $15,000

=$385,000

Additional Funds Needed (AFN) =$385,000