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AFN Formulas for Baxter Video Products

1. Baxter Video Products' sales are expected to increase from $5 million in 2007 to $6 million in 2008 or by 20%. Its assets totaled $3 million at the end of 2007. Baxter is at full capacity, so its assets must grow at the same rate as projected sales. At the end of 2007, current liabilities were $1 million, consisting of $250,000 of accounts payable, $500,000 of notes payable, and $250,000 of accruals. The after-tax profit margin is forecasted to be 5%, and the forecasted payout ratio is 70%. Use the AFN formula to forecast Baxter's additional funds needed for the coming year.

2. Refer to Problem 1. What would be the additional funds needed if the company's year-end 2007 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 1? Is the company's 'capital intensity' the same or different?

3. Refer to Problem 1. Return to the assumption that the company had $3 million in assets at the end of 2007, 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 1?

Solution Preview

1. Additional funds are needed for investment in fixed assets and current assets. A part of the requirement is met from increase in spontaneous liabilities and retained earnings. The remaining amount is additional funds needed from external sources. The AFN formula can be expressed as

AFN = Increase in assets - increase in spontaneous liabilities - increase in retained earnings
In terms of equation, AFN formula is written as
AFN = (A*/S0)deltaS - (L*/S0)delta - MS1(1 - d)
Where
A*/S0 is the present assets as a percentage of sales. Multiplying by delta which is the increase in sales gives the increase ...

Solution Summary

This solution calculates and discusses the additional funds needed for investment in fixed assets and current assets. Capital intensity is calculated whereby, if capital intensity increases, this implies the firm needs more assets for each dollar of sales. The solution is given in 420 words.

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