Chapter 16 Financial Planning and Forecasting 51716-3a Excess Capacity Adjustments
The AFN equation includes the term A 0 /S 0 , which is called the capital intensity
ratio. For Allied, this ratio is calculated as $2,000/$3,000 " 0.6667. When multiplied
by #S " $300 million, this ratio indicated that Allied must increase its assets by $200
million. However, the CFO thought that in 2008, Allied had more! xed assets than it
really needed; he wanted to demonstrate to the Executive Committee how excess
capacity adjustments might affect the! rm’s need for external funds. He noted that
Allied had $1,000 million of current assets and $1,000 million of! xed assets; so he
broke A 0 /S 0 into two parts, one for! xed assets and one for current assets:
Current assets: A 0 C/S 0 " $1,000/$3,000 " 0.333 " 33.3%
Fixed assets: A 0 F/S 0 " $1,000/$3,000 " 0.333 " 33.3%
Now suppose that the current assets were used at full capacity but that! xed
assets had been used at only 96% of capacity in 2008. Therefore, if! xed assets had
been used to full capacity, sales could have reached $3,125 million before any ad-
ditions to! xed assets were required versus the actual $3,000 million of sales. In
this example, the calculated $3,125 million sales is Allied’s full capacity sales:
Full capacity sales! ____Actual sales
Percentage of capacity
at which! xed^ assets^
were operated
! $3,000 million/0.96! $3,125 million
This indicates that Allied’s Target! xed assets/Sales ratio should be 32% rather
than the indicated 33.3% calculated previously:
Target! xed assets/Sales! Actual ____Full capacit! xed (^) y salesassets
! $1,000/$3,125! 0.32! 32%
Under these conditions, sales could increase to $3,125 million with no increase in
! xed assets and a sales increase to $3,300 million would require only $1,056 mil-
lion of! xed assets, or an additional $56 million of! xed assets:
Requir ed level
of! xed assets
! (Target! xed assets/Sales)(Projected sales)
! 0.32($3,300)! $1,056 million
Capital Intensity Ratio
The ratio of assets required
per dollar of sales (A 0 /S 0 ).
Capital Intensity Ratio
The ratio of assets required
per dollar of sales (A 0 /S 0 ).
Excess Capacity
Adjustments
Changes made to the
existing asset forecast
because the firm is not
operating at full capacity.
Excess Capacity
Adjustments
Changes made to the
existing asset forecast
because the firm is not
operating at full capacity.
29
30
31
32
33
0.1000, up from 0.0392. If the pro!t margin increases, more
earnings will be available to support growth and thus the
smaller the AFN. With a higher pro!t margin, more net income
is earned; so the AFN declines.
20%, down from 48.94%. If Allied lowers the dividend payout
ratio, more of its earnings will be retained and thus the smaller
the AFN. Here we lower the payout, so the AFN declines.
Change all variables simultaneously to g = 5% and the other values as indicated
above. The result is a large but negative AFN, indicating that the !rm is generating
a substantial amount of capital—more than su#cient to meet its forecasted asset
requirements.
Part V. Sustainable Growth Rate. Maximum achievable growth rate without raising external funds
(i.e., g that forces AFN = 0, holding other variables at base-case levels). Use g = 3.45%, and you
will see that AFN = 0.
M:
Payout:
$12
$77
–$189
–$102
–$303
3.45%
–$37
Tabl e 16 - 1 Additional Funds Needed (AFN) Model ($ in Millions)