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Baxter Video Products' sales are expected to increase by

20% from $5 million in 2010 to $6 million in 2011. Its


assets totaled $3 million at the end of 2010. Baxter is
already at full capacity, so its assets must grow at the
same rate as projected sales. At the end of 2010, current
liabilities were $1 million, consisting of $250,000 of
accounts payable, $500,000 of notes payable, and
$250,000 of accruals. The aftertax profit margin is
forecasted to be 5%, and the forecasted payout ratio is
70%. Use the AFN equation to forecast Baxter’s additional
funds needed for the current year?
AFN = (A0*/S0)* S – (L0*/S0)* S – MS1(1 – Payout)
=(3,000,000/5,000,000)*(1,000,000)-(500,000/5,000,000)*(1000,000)
-(0.05)(1-0.3)

= (0.6)($1,000,000) – (0.1)($1,000,000) – ($300,000)(0.3)


= $600,000 – $100,000 – $90,000
= $410,000.
Refer to Problem 12-1. What would be the
additional funds needed if the company’s
year-end 2010 assets had been $4 million?
Assume that all other numbers, including
sales, are the same as in Problem 12-1 and
that the company is operating at full capacity.
Why is this AFN different from the one you
found in Problem 12-1? Is the company’s
“capital intensity” ratio the same or different?
 $4,000,000 
AFN =   $1,000,000  (0.1)($1,0 00,000)  ($300,000) (0.3)
 $5,000,000 
= (0.8)($1,000,000) – $100,000 – $90,000
= $800,000 – $190,000
= $610,000.

The capital intensity ratio is measured as A 0*/S0. This firm’s capital intensity ratio is higher
than that of the firm in Problem 17-1; therefore, this firm is more capital intensive—it would
require a large increase in total assets to support the increase in sales.
Refer to Problem 12-1. Return to the assumption that the company had $3 million in
assets at the end of 2010, but now assume that the company pays no dividends. Under these
assumptions, what would be the additional funds needed for the coming year? Why is this AFN different
from the one you found in Problem 12-1?
AFN = (0.6)($1,000,000) – (0.1)($1,000,000) – 0.05($6,000,000)(1)
= $600,000 – $100,000 – $300,000
= $200,000.
 
Under this scenario the company would have a higher level of retained earnings, which would reduce the amount of additional funds needed.
Bannister Legal Services generated $2,000,000 in sales during 2010, and its year-end total assets were $1,500,000. Also, at year-end 2010, current liabilities were
$500,000, consisting of $200,000 of notes payable, $200,000 of accounts payable, and $100,000 of accruals. Looking ahead to 2011, the company estimates that its
assets must increase at the same rate as sales, its spontaneous liabilities will increase at the same rate as sales, its profit margin will be 5%, and its payout ratio will be
60%. How large a sales increase can the company achieve without having to raise funds externally; that is, what is its self-supporting growth rate?
Self-supporting g = M(1 − POR)S0
A0* − L0* − M(1 − POR)S0
=0.05*(1-0.6)*2,000,000/((1500,000-500,000)-(0.05*(1-0.6)* 2,000,000

=40,000/960000
=0.0416
sales growth in 2011=sales in 2010*Self supporting g
=2,000,000*0.0416
∆S = $83,333
The Barnsdale Corporation has the following ratios:
A0*/S0 = 1.6; L0*/S0 = 0.4; profit
margin = 0.10; and dividend payout ratio = 0.45, or 45%.
Sales last year were $100
million. Assuming that these ratios will remain constant,
use the AFN equation to
determine the firm’s self-supporting growth rate—in
other words, the maximum
growth rate Barnsdale can achieve without having to
employ nonspontaneous external funds.
To solve this problem, we first define ∆S as the change in sales and
g as the growth rate in sales. Then we use the three following
equations:
ΔS=S0g
S1=S0(1=g)
AFN = (A0*/S0)* Δ S – (L0*/S0)* Δ S – MS1(1 – Payout)

Set AFN = 0; substitute in known values for A*/S0, L*/S0, M, d,


and S0; and
then solve for g:

0=(1.6*100g)-0.4(100g)-0.10[100(1+g)(0.55)
=4.8%
Maximum growth rate without external financing
Full capacity sales =Current sales/ Percentage of capacity at which
FA were operated

$36,000/0.75= 48,000

Percentage increase=(new sales-old sales)/old sales

=(48000-36000)/36000
=0.33= 33%

Therefore, sales could expand by 33% before Van Auken Lumber


would need to add fixed assets.

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