Howton & Howton Worldwide (HHW)is planning its operations for the coming year,and the CEO wants you to forecast the firm's additional funds needed (AFN).Data for use in the forecast are shown below.However,the CEO is concerned about the impact of a change in the payout ratio from the 10% that was used in the past to 50%,which the firm's investment bankers have recommended.Based on the AFN equation,by how much would the AFN for the coming year change if HHW increased the payout from 10% to the new and higher level? All dollars are in millions.

Question

Howton & Howton Worldwide (HHW)is planning its operations for the coming year,and the CEO wants you to forecast the firm's additional funds needed (AFN).Data for use in the forecast are shown below.However,the CEO is concerned about the impact of a change in the payout ratio from the 10% that was used in the past to 50%,which the firm's investment bankers have recommended.Based on the AFN equation,by how much would the AFN for the coming year change if HHW increased the payout from 10% to the new and higher level? All dollars are in millions.  ​

Quizplus · Accepted Answer

The AFN equation is: AFN = (A*/S0)ΔS - (L*/S0)ΔS - PM(1 - d)ΔS - MS1(1 - b)

Where:
A* = total assets required to support projected sales
S0 = spontaneous liabilities as % of sales
ΔS = projected increase in sales
L* = spontaneous liabilities
PM = profit margin on sales
d = dividend payout ratio
MS1 = additional funds required of sales increase at constant payout
b = retention ratio

To calculate the change in AFN, we need to compare the AFN with the old and new payout ratio:
AFN_old = ($640/$4,000) x $400 - ($360/$4,000) x $400 - $40(1-0.1) x $400/$4,000 - $40(0.06) x $400/$4,000 = $28 million
AFN_new = ($640/$4,000) x $400 - ($360/$4,000) x $400 - $40(1-0.5) x $400/$4,000 - $40(0.06) x $400/$4,000 = $61.6 million
Change in AFN = AFN_new - AFN_old = $61.6 million - $28 million = $33.6 million.

Therefore, increasing the payout ratio from 10% to 50% would increase the additional funds needed by $33.6 million.

Howton & Howton Worldwide (HHW)is Planning Its Operations for the Coming