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You have been asked to forecast the additional funds needed (AFN) for Houston, Hargrove, & Worthington (HHW), which is planning its operation for the coming year
You have been asked to forecast the additional funds needed (AFN) for Houston, Hargrove, & Worthington (HHW), which is planning its operation for the coming year. The firm is operating at full capacity. 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 75%, 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.
| Last year's sales = S0 | $300.0 | Last year's accounts payable | $50.0 |
| Sales growth rate = g | 40% | Last year's notes payable | $15.0 |
| Last year's total assets = A0* | $500 | Last year's accruals | $20.0 |
| Last year's profit margin = PM | 20.0% | Initial payout ratio | 10.0% |
Select the correct answer.
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Expert Solution
1. AFN if initial payout ratio is 10%
AFN = Increase in assets - Increase in Spontaneous Liabilities - Addition to retained earnings
AFN = Assets * Growth rate - (accounts Payable + Accruals) * Growth Rate - New Sales * Profit Margin * (1 - Payout Ratio)
AFN = 500 * 40% - (50 + 20) * 40% - 300 * 1.40 * 20% * 90%
AFN = 200 - 28 - 75.6
AFN = 96.40
2. AFN if initial payout ratio is 75%
AFN = Increase in assets - Increase in Spontaneous Liabilities - Addition to retained earnings
AFN = Assets * Growth rate - (accounts Payable + Accruals) * Growth Rate - New Sales * Profit Margin * (1 - Payout Ratio)
AFN = 500 * 40% - (50 + 20) * 40% - 300 * 1.40 * 20% * 25%
AFN = 200 - 28 - 21
AFN = 151
3. Change in AFN = 151 - 96.40 = $54.6 Option D
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