# AFN Equation and Assumptions

1. The following equation is sometimes used to forecast financial requirements:

AFN = (A₀ */S₀) (ΔS) - (L₀ */S₀) (ΔS) - MS₁ (1-POR)

What key assumption do we make when using this equation? Under what conditions might this assumption not hold true?

2. What is meant by the term "self-supporting growth rate?" How is this rate related to the AFN equation, and how can that equation be used to calculate the self-supporting growth rate?

3. Baxter Video Products' sales are expected to increase by 20% from 5% million in 2010 to $6 million in 2011. It 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 accruals. The after-tax 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 coming year.

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 previously calculated?

4. At year-end 2010, Bertin Inc.'s total assets were $1.2 million and its accounts payable were $375,000. Sales, which in 2010 were $2.5 million, are expected to increase by 25% in 2011. Total assets and accounts payable are proportional to sales, and that relationship will be maintained. Bertin typically uses no current liabilities other than accounts payable. Common stock amounted to $425,000 in 2010, and retained earnings were $295,000. Bertin has arranged to sell $75,000 of new common stock in 2011 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 2011, (Because the debt is added at the end of the year, there will no additional interests expense due to the new debt.) Its profit margin on sales is 6%, and 40% of earnings will be paid out as dividends.

a. What were Bertin's total long-term debt and total liabilities in 2010?

b. How much new long-term debt financing will be needed in 2011?

(Hint: AFN - New stock = New long-term debt.)

5. Upton Computers makes bulk purchases of small computers, stocks them in conveniently located warehouses, ships them to its chain of retail stores, and has a staff to advise customers and help them to its chain of retail stores, and has a staff to advise customers and help them set up their new computers. Upton's balance sheet as of December 31, 2010, is shown here (millions of dollars):

Cash $ 3.5 Accounts Payable $ 9.0

Receivables 26.0 Notes payable 18.0

Inventories 58.0 Accruals 8.5

Total Current Assets $ 87.5 Total current liabilities $ 35.5

Mortgage Loan 6.0

Net Fixed Asset $ 35.0 Common Stock 15.0

Retained Earnings 66.0

Total Liabilities and Equity $ 122.50

Sales for 2010 were $350 million and net income for the year was $10.5 million, so the firm's profit margin was 3.0%. Upton paid dividends of $4.2 million to common stockholders, so its payout ratio was 40%. Its tax rate is 40%, and it operated at full capacity. Assume that all assets/sales ratios, spontaneous liabilities/sales ratios, the profit margin, and the payout ratio remain constant in 2011. If sales are projected to increase by $70 million, or 20%, during 2011, use the AFN equation to determine Upton's projected external capital requirements.

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#### Solution Summary

This solution contains extensive responses with over 1000 words to questions and step-by step calculations.

Financial Planning and Forecasting Financial Statements for Baxter Video Products

(12-1)

Baxter Video Product's 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 and $250,000 accruals. The after-tax 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 coming year.

(12-2)

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?

(12-3)

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?

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