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?
A) $4.00
B) $2.00
C) −$0.80 (Surplus)
D) −$14.00 (Surplus)
E) $0

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?
A) $4.00 
B) $2.00 
C) −$0.80 (Surplus) 
D) −$14.00 (Surplus) 
E) $0

Quizplus · Accepted Answer

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

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

where:
A* = assets at capacity
S0 = sales for the current year
ΔS = increase in sales for each year
L* = spontaneous liabilities at capacity
M = profit margin
d = dividend payout ratio

Using the information given, we can calculate the following:

A* = Fixed assets / Capacity = $240,000 / 0.8 = $300,000
S0 = $200
ΔS = $10 per year for 4 years
L* = spontaneous liabilities / Capacity = ($192,000 + $40,000) / 0.8 = $290,000
M = 5%
d = 60%

Plugging in the numbers, we get:

AFN = ($300,000 / $200)($10 + $10 + $10 + $10) - ($290,000 / $200)($10 + $10 + $10 + $10) - (0.05)($200)(0.4)
AFN = $600 - $580 - $4
AFN = -$14

This means that the firm has a surplus of $14, indicating that it does not need any external financing for the next 4 years. Therefore, the correct answer is D, -$14.00 (Surplus).

A Firm Has the Following Balance Sheet: Fixed Assets