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Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937

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BuyFindarrow_forward

Fundamentals of Financial Manageme...

9th Edition
Eugene F. Brigham + 1 other
ISBN: 9781305635937
Textbook Problem
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SALES INCREASE Paladin Furnishings generated $4 million in sales during 2016, and its year-end total assets were $3.2 million Also, at year-end 2016, current liabilities were $500,000, consisting of $200,000 of notes payable, $200,000 of accounts payable, and $100,000 of accrued liabilities. Looking ahead to 2017, the company estimates that its assets must increase by $0.80 for every $1.00 increase in sales. Paladin’s profit margin is 3%, and its retention ratio is 50%. How large of a sales increase can the company achieve without having to raise funds externally?

Summary Introduction

To compute: The increase in sales that a company can achieve without any raise of additional funds.

Introduction:

Additional Funds Needed (AFN) Equation:

The AFN equation explains the amount of money that a company needs to fulfill the financial needs of the company. It gives the information related to the external financing, as the options available to a company to finance through external financing methods. This equation basically gives a new capital structure that includes an optimum mix of debt, preferred and common stock.

Sales Forecast:

The sales forecast is the important point raise while making the plans. The management generally takes 5 years financial records and then studies it and decides the amount of turnover for the current and upcoming years.

Explanation

Given information:

Sales in 2016 are $4million

Total assets in 2016 are $3.2 million

Total liability in 2016 is $500,000 includes $200,000 for notes payable, $200,000 for accounts payable, and $100,000 for accrued liability.

In 2017:

If sales increase by $1 then the assets will increase by $0.80

Profit margin is 3%

Retention ratio is 50%

No increase in additional funds needed is possible so AFN will be $0.

The formula to calculate AFN is

AFN=(ProjectedincreaseinassetsSpontaneousincreaseinliabilitiesIncreaseinretainedearnings)=(A0S0)×ΔS(L0S0)×ΔSMS1(1payout)

Where,

  • A0 is original assets.
  • S0 is current sales.
  • L0 is original liabilities.
  • ΔS is increase in sales.
  • MS1 is increase in profit margin

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