What would the additional funds needed be if the company’s year-end 2001 assets had been $4 million? Assume that all other numbers are the same. Why is this AFN different from the one you found in Problem 4-1? Is the company’s “capital intensity” the same or different?
Problem 4-1
Use the AFN formula to forecast Carter’s additional funds needed for the coming year.
The Correct Answer and Explanation is :
To answer this, we need to understand the basic formula for Additional Funds Needed (AFN), which is given by:
[
AFN = (A_{T}/S_{T}) \times \Delta S – (L_{T}/S_{T}) \times \Delta S – M \times (1 – P) \times \Delta S
]
Where:
- (A_T) = Total assets at year-end
- (S_T) = Total sales
- (\Delta S) = Change in sales (from one period to the next)
- (L_T) = Total liabilities at year-end
- (M) = Profit margin
- (P) = Payout ratio
Step-by-step Calculation:
- Current Variables: Assume the sales, liabilities, and profits remain the same as in Problem 4-1. Let’s break it down step by step. If the company’s assets at the end of 2001 were $4 million instead of the original amount from Problem 4-1, it would affect the amount of funds needed because assets are part of the formula.
- Impact on Capital Intensity: Capital intensity refers to how much capital (assets) is needed to generate one dollar of sales. It is calculated as: [
\text{Capital Intensity} = \frac{\text{Assets}}{\text{Sales}}
] If the company’s assets increase to $4 million while sales remain constant, capital intensity will rise. This means that the company will need more assets to support the same level of sales, which could require more external financing (AFN).
Explanation of Difference in AFN:
- The AFN calculated with $4 million in assets would be higher than the original AFN because the company needs more assets to support the same amount of sales. Therefore, to cover the additional capital required, the company will need more external funds.
- The capital intensity is different in this case because an increase in assets means a higher capital intensity ratio. This indicates that the company is becoming more asset-heavy, requiring more funds to finance those additional assets. If assets increase without a proportional increase in sales, it leads to a higher AFN.
In summary, when assets increase to $4 million, the AFN increases due to the need for more external funds to support the additional assets, and capital intensity becomes higher, indicating a more capital-intensive business model.