More on the AFN (Additional Funds Needed) equation Green Caterpillar Garden Supplies Inc. reported sales of $890,000 at the end of last year; but this year, sales are expected to grow by 8%. Green Caterpillarexpects to maintain its current profit margin of 24% and dividend payout ratio of 25%. The firm’s total assets equaled $400,000 and were operated at full capacity. Green Caterpillar’s balance sheet shows the following current liabilities: accounts payable of $80,000, notes payable of $40,000, and accrued liabilities of $70,000. Based on the AFN (Additional Funds Needed) equation, what is the firm’s AFN for the coming year? -$145, 365 -$183, 619 -$153, 016 -$175, 968 A negatively signed AFN value represents: A shortage of internally generated funds that must be raised outside the company to finance the company’s forecasted future growth A surplus of internally generated funds that can be invested in physical or financial assets or paid out as additional dividends A point at which the funds generated within the firm equal the demands for funds to finance the firm’s future expected sales requirements Because of its excess funds, Green Caterpillar is thinking about raising its dividend payout ratio to satisfy shareholders. What percentage of its earnings can Green Caterpillar pay to shareholders without needing to raise any external capital? 63. 9% 91.3% 73.0% 86.7%
The Correct Answer and Explanation is :
Let’s break this down:
AFN Equation
The Additional Funds Needed (AFN) equation calculates the additional financing required for a company to support projected growth in sales. The equation is: AFN=Required Increase in Assets−Spontaneous Increase in Liabilities−Retained Earnings\text{AFN} = \text{Required Increase in Assets} – \text{Spontaneous Increase in Liabilities} – \text{Retained Earnings}
Where:
- Required Increase in Assets = (Sales Growth) * (Total Assets)
- Spontaneous Increase in Liabilities = (Sales Growth) * (Accounts Payable + Accrued Liabilities)
- Retained Earnings = (Net Income) * (1 – Dividend Payout Ratio)
Step-by-Step Calculation:
- Sales Growth:
Expected sales growth = 8%.
New sales = 890,000×(1+0.08)=961,200890,000 \times (1 + 0.08) = 961,200 - Profit Margin & Net Income:
Profit margin = 24%, so net income = 961,200×0.24=230,688961,200 \times 0.24 = 230,688. - Retained Earnings:
Retained earnings = 230,688×(1−0.25)=173,016230,688 \times (1 – 0.25) = 173,016. - Required Increase in Assets:
Since total assets were at full capacity:
961,200×400,000890,000=432,000961,200 \times \frac{400,000}{890,000} = 432,000.
Increase in assets = 432,000−400,000=32,000432,000 – 400,000 = 32,000. - Spontaneous Increase in Liabilities:
Accounts payable = $80,000, Accrued liabilities = $70,000.
Increase = (80,000+70,000)×0.08=12,000(80,000 + 70,000) \times 0.08 = 12,000. - AFN:
AFN = 32,000−12,000−173,016=−153,01632,000 – 12,000 – 173,016 = -153,016.
Interpretation of AFN:
- Negative AFN indicates the company has more internal funds than it needs, which means it can use these excess funds for other purposes, like paying out dividends or investing.
- The correct answer for AFN is -153,016.
Dividend Payout without External Capital:
Green Caterpillar can raise its dividend payout ratio without needing to raise external capital as long as the retained earnings are sufficient to cover the increase in assets.
The correct percentage for this scenario is 73.0%.
Thus, Green Caterpillar can pay 73.0% of its earnings in dividends without external financing.