12.

Broussard Skateboard’s sales are expected to increase by 15% from $8 million in 2013 to $9.2 million in
2014. Its assets totaled $5 million at the end of 2013. Broussard is already at full capacity, so its assets
must grow at the same rate as projected sales. At the end of 2013, 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%, and the forecasted payout ratio is 40%. Use the AFN
equation to forecast Broussard’s additional funds needed for the coming year.

Solution:

The AFN (Additional Funds Needed) equation is given by: AFN = (Expected Sales Growth
x (1 - Payout Ratio)) - (Expected Growth in Assets)

Plugging in the given values: AFN = (15% x $8 million x (1 - 40%)) - (15% x $5 million)
AFN = $960,000 - $750,000 AFN = $210,000

So, Broussard Skateboard needs $210,000 in additional funds for the coming year.
12.2

Broussard Skateboard’s sales are expected to increase by 15% from $8 million in 2013 to $9.2
million in 2014. Its assets totaled $5 million at the end of 2013. Broussard is already at full
capacity, so its assets must grow at the same rate as projected sales. At the end of 2013, 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%, and the
forecasted payout ratio is 40%. Use the AFN equation to forecast Broussard’s additional funds
needed for the coming year. What would be the additional funds needed if the company’s
yearend 2013 assets had been $7 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?

The AFN equation is calculated as follows:

AFN = (Sales growth x (1 - After-tax profit margin)) / (Payout ratio + (1 - Payout ratio) /
Capital intensity)

First, let's calculate the AFN using the given information in Problem 12-1:

AFN = (15% x 94 million) / (40% + (1 - 40%) / Capital intensity) = $1.4 million

Where capital intensity = Assets / Sales = 5 million / 8 million = 0.625

Now, if the company's yearend 2013 assets had been $7 million, then the capital
intensity would be:

Capital intensity = 7 million / 8 million = 0.875

The new AFN would be:

AFN = (15% x 94 million) / (40% + (1 - 40%) / 0.875) = $1.2 million

So, the AFN is different because the capital intensity has changed, which affects the
calculation. The capital intensity ratio is different.
12.3

12-1 Broussard Skateboard’s sales are expected to increase by 15% from $8 million in 2013 to $9.2
million in 2014. Its assets totaled $5 million at the end of 2013. Broussard is already at full capacity, so
its assets must grow at the same rate as projected sales. At the end of 2013, 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%, and the forecasted payout ratio is 40%.

Refer to Problem 12-1. Return to the assumption that the company had $5 million in assets at the end of
2013, 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?

Solution:

To calculate the Additional Funds Needed (AFN) for the coming year, we need to find the amount of
new assets required to support the projected sales increase and then subtract any increase in current
liabilities.

The projected sales increase of 15% is $1.2 million ($8 million x 15%). Assuming the after-tax profit
margin is 6%, the profit would be $72,000 ($1.2 million x 6%).

The company's assets must grow at the same rate as projected sales, so new assets of $1.2 million
are required to support the sales increase. This means that the company's total assets at the end of
2014 would be $6.2 million ($5 million + $1.2 million).

If the company pays no dividends, the entire profit of $72,000 can be used to reduce liabilities or
increase assets, thus decreasing the AFN.

Finally, to find the AFN, we need to subtract any increase in current liabilities from the required new
assets. If the current liabilities remain unchanged at $1.4 million, the AFN would be $0.8 million ($1.2
million - $1.4 million).

This AFN is different from the one found in Problem 12-1 because the assumption that the company
pays no dividends has changed, resulting in a different use of profits and thus a different AFN.
12.4

Maggie’s Muffins, Inc., generated $5,000,000 in sales during 2013, and its year-end total assets were
$2,500,000. Also, at year-end 2013, current liabilities were $1,000,000, consisting of $300,000 of notes
payable, $500,000 of accounts payable, and $200,000 of accruals. Looking ahead to 2014, 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 7%, and its payout ratio will be 80%. How large a sales
increase can the company achieve without having to raise funds externally—that is, what is its self-
supporting growth rate?

To determine the self-supporting growth rate, we need to calculate the amount of

increase in assets that can be financed from the increase in profits and the increase in
spontaneous liabilities.

First, calculate the increase in spontaneous liabilities that will accompany a $1 increase
in sales: $1,000,000 (current liabilities) / $5,000,000 (sales) = 0.2.

Next, calculate the increase in profits that will accompany a $1 increase in sales:
$5,000,000 (sales) * 7% (profit margin) = $350,000.

Finally, calculate the increase in assets that can be financed from the increase in profits
and spontaneous liabilities: $350,000 (increase in profits) + 0.2 (increase in spontaneous
liabilities) = $0.55.

So, the self-supporting growth rate is 55 cents on the dollar, or 55%. This means the
company can increase its sales by up to 55% without having to raise funds externally.
12.5

At year-end 2013, Wallace Landscaping’s total assets were $2.17 million and its accounts payable were
$560,000. Sales, which in 2013 were $3.5 million, are expected to increase by 35% in 2014. Total assets
and accounts payable are proportional to sales, and that relationship will be maintained. Wallace
typically uses no current liabilities other than accounts payable. Common stock amounted to $625,000
in 2013, and retained earnings were $395,000. Wallace has arranged to sell $195,000 of new common
stock in 2014 to meet some of its financing needs. The remainder of its financing needs will be met by
issuing new long-term debt at the end of 2014. (Because the debt is added at the end of the year, there
will be no additional interest expense due to the new debt.) Its net profit margin on sales is 5%, and 45%
of earnings will be paid out as dividends.

a. What were Wallace’s total long-term debt and total liabilities in 2013?

b. How much new long-term debt financing will be needed in 2014? (Hint: AFN − New stock = New long-
term debt.)

Solution:

a. Wallace's total liabilities in 2013 are calculated as follows: Accounts payable

($560,000) + New common stock ($195,000) = $755,000. Since Wallace has no current
liabilities other than accounts payable, total liabilities are equal to total long-term debt
in 2013. Hence, Wallace's total long-term debt in 2013 is $755,000.

b. The financing need for 2014 can be calculated as follows: Expected increase in sales
(35% of $3.5 million) = $1.225 million. Earnings in 2014 (5% of $4.725 million, which is
the sum of $3.5 million and $1.225 million) = $236,375. Dividends in 2014 (45% of
earnings) = $106,769. AFN (Additional Funds Needed) = Increase in sales + Increase in
dividends = $1.225 million + $106,769 = $1.331 million. New long-term debt = AFN −
New stock = $1.331 million − $195,000 = $1.136 million.
 12.6

To calculate the Additional Funds Needed (AFN) for the coming year, we need to first
calculate the increase in the company's sales and then the required increase in its assets
to support the sales growth.

1. Increase in Sales: The sales are forecasted to double from $1,000 in 2013 to $2,000 in
2014.
2. Increase in Assets: All assets except fixed assets must increase at the same rate as sales.
Therefore, the increase in current assets = $2,000 - $1,000 = $1,000. The increase in
fixed assets would also have to increase at the same rate if the current excess capacity
did not exist. But since the company is currently using only 50% of its fixed asset
capacity, it only needs to increase its fixed assets by 50% of the increase in sales, i.e.,
$1,000 x 50% = $500.
3. After-tax profit: Booth’s after-tax profit margin is forecasted to be 5%, so the after-tax
profit = $2,000 x 5% = $100.
4. Dividend payout: The payout ratio is 60%, so the dividend payout = $100 x 60% = $60.
5. Retained earnings: The retained earnings = after-tax profit - dividend payout = $100 -
$60 = $40.
6. AFN: The AFN is equal to the increase in assets - increase in financing from retained
earnings. The increase in financing from retained earnings = increase in retained
earnings + increase in long-term debt. The increase in long-term debt is equal to the
increase in fixed assets, i.e., $500. So, the AFN = $1,000 + $500 - ($40 + $500) = $960.

Therefore, the Booth Company needs an additional $960 in funding for the coming year
to support its sales growth and maintain its current asset structure.
12.7