A firm has the following balance sheet: Fixed assets are being used at 80 percent of capacity; sales for the year just ended were $200; sales will increase $10 per year for the next 4 years; the profit margin is 5 percent; and the dividend payout ratio is 60 percent.Assume that fixed assets cannot be sold.What are the total external financing requirements for the entire 4 years,i.e.,the total AFN for the 4-year period?

Question

A firm has the following balance sheet:  Fixed assets are being used at 80 percent of capacity; sales for the year just ended were $200; sales will increase $10 per year for the next 4 years; the profit margin is 5 percent; and the dividend payout ratio is 60 percent.Assume that fixed assets cannot be sold.What are the total external financing requirements for the entire 4 years,i.e.,the total AFN for the 4-year period?

Quizplus · Accepted Answer

To calculate the total AFN for the 4-year period, we need to use the following formula:

AFN = (A*/S0)ΔS - (L*/S0)ΔS - MS1(1 - d)/S0

where A* is the assets needed at full capacity, S0 is the current sales, ΔS is the increase in sales, L* is the spontaneous liabilities needed at full capacity, M is the profit margin, and d is the dividend payout ratio.

We can calculate the variables as follows:

- A* = FA / (1 - cap. ratio) = 1,000 / (1 - 0.80) = 5,000 
- S0 = $200 
- ΔS = $10 x 4 = $40 
- L* = spontaneous liabilities / sales x ΔS = (AP + accruals) / S0 x ΔS = $300 / $200 x $40 = $60 
- M = 5% 
- d = 60%

Substituting the values, we get:

AFN = (5,000 / 200) x 40 - (60 / 200) x 40 - 0.05 x 200 x (1 - 0.60)

AFN = $600 - $120 - $6 = $474

Since the firm has a surplus of $100, the total external financing requirements for the entire 4-year period would be a surplus of $474 - $100 = $374 or -$374. Therefore, the best choice is D, -$14.00 (Surplus).

A Firm Has the Following Balance Sheet: Fixed Assets