Fundamentals of Financial Management (Concise 6th Edition)

516 Part 6 Working Capital Management, Forecasting, and Multinational Financial Management

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A B C D E F G H I J

Part I. 2008 Data from Chapter 3, Tables 3-1 and 3-2

A 0 * = Assets at 12/31/08; all assets were needed for 2008 sales

S 0 = 2008 Sales

2008 Net Income

2008 Dividends

L 0 * = 2008 payables + accruals, which increase spontaneously with sales

Part II. Data Used in the AFN Equation: 2008 Ratios Held Constant

AFN = Additional Funds Needed to buy assets needed to support growth. AFN is in addition to

funds raised internally (i.e., AFN represents required external funds).

g = Target growth rate in sales

A 0 */S 0 = Assets required per $1 of sales = $2,000/$3,000. Shows the required new assets for the

coming year when multiplied by the increase in sales. Also called the capital intensity ratio. The

higher this ratio, the more new assets the !rm will need to support a given amount of growth.

S 1 = 2009 Sales = (1+g)(S 0 ) = (1.1)($3,000)

∆S = Growth in sales = S 1 - S 0 = $3,300 - $3,000. It can also be found as ∆S = g(S 0 ).

L 0 */S 0 = Spontaneously generated funds per dollar of new sales. When multiplied by ∆S, we

!nd the new payables and accruals that are available to support growth.

M = Pro!t margin on sales = 2008 net income/S 0 = $117.5/$3,000. Multiply by S 1 (not S 0 ) to

!nd the net income available in 2009 for dividends or growth.

RR = Retention Rate = (1 - Dividend Payout Ratio) = (1 - Dividends/Net Income) =

(1 - $57.5/$117.50). The higher the retention rate, the greater the proportion of

net income that is retained to support growth.

Part III. The AFN Equation

AFN = Required increase in – Spontaneous – Funds obtained as new

assets increase in Payables Retained Earnings.

and Accruals Based on 2009 Sales

= (A 0 */S 0 )∆S - (L 0 */S 0 )∆S - MS 1 (RR)

= 0.6667($300) - 0.0667($300) - 0.0392($3,300)(0.5106)

= $200 - $20 - $66

AFN = $114 million

Part IV. Sensitivity Analysis: AFN with Changed Input Values

$2,000

$3,000

$117.5

$57.5

$200

Base Case:

2008 Data

10.00%

0.6667

$3,300

$300

0.0667

0.0392

0.5106

15%, up from 10%. With faster growth, the !rm needs more

new assets.

5%, down from 10%. With slower growth, the !rm needs less

new assets. At g < 3.45%, new retained earnings plus

spontaneous funds exceed required new assets.

0.5000, down from 0.6667. This factor is called the capital

intensity ratio. We lowered it in this example; and with a

lower value, fewer assets are required for any given level of sales.

If Allied's management can increase the total assets turnover ratio,

the A 0 */S 0 ratio will decline, which will reduce AFN.

0.0800, up from 0.0667. Allied spontaneously generates funds

from accounts payable and accruals; and the larger the L 0 */S 0

ratio, the smaller the need for external !nancing. With a higher

value, more spontaneous funds are available; so the AFN declines.

AFN (Old = $114)

Change:

New New - Old

Higher

Growth:

Lower

Growth:

A 0 */S 0 :

L 0 */S 0 :

$201

$27

$64

$110

$87

–$87

–$50

–$4

Tabl e 16 - 1 Additional Funds Needed (AFN) Model ($ in Millions)

(Continued)