I need help bad.
You have been running your small business, Craft’s Boat Shop, for several years now and have been very successful. You have come to the point where you expect sales to increase next year and want to be sure that you have enough assets available to support your sales. You also need to have the financing available to acquire those assets, if needed.
Accordingly, you have gathered the following data:
Craft’s Boat Shop
Sales Last Year
$1,000,000
Assets at the End of Last Year
750,000
Accounts Payable
60,000
Notes Payable
60,000
Accruals
30,000
Profit Margin on Sales
5%
Dividend Payout
50%
Note: All figures are as of the end of last year
Required:
If you need $0.80 in assets for every $1.00 in sales, by how much can sales increase without obtaining additional outside financing? HINT: Use the AFN formula.
I did this much:
750,000/1,000,000 (500,000)-90,000/1,000,000 (500,000)-(1,500,000) 50,000/1,000,000 (1.00)
= 0.750 (500,000)-0.090 (500,000)-1,500,000 (0.05)(1.00)
= 375,000-45,000-75,000
= 255,000
Please tell me where I went wrong? Thank you.
To calculate the increase in sales without obtaining additional outside financing, you need to use the Additional Funds Needed (AFN) formula. The AFN formula is:
AFN = (Increase in Assets - Increase in Spontaneous Liabilities) - (Retention Ratio x Increase in Sales)
Now let's calculate the increase in assets and the increase in spontaneous liabilities:
Increase in Assets = (Sales Last Year) x (Assets/Sales Ratio)
Assets/Sales Ratio = $0.80 (from the given information)
Increase in Assets = $1,000,000 x $0.80 = $800,000
Next, calculate the increase in spontaneous liabilities:
Increase in Accounts Payable = (Sales Last Year) x (Accounts Payable/Sales Ratio)
Accounts Payable/Sales Ratio = $60,000/$1,000,000 (from the given information)
Increase in Accounts Payable = $1,000,000 x ($60,000/$1,000,000) = $60,000
Increase in Notes Payable = $60,000 (given)
Increase in Accruals = $30,000 (given)
Increase in Spontaneous Liabilities = Increase in Accounts Payable + Increase in Notes Payable + Increase in Accruals
= $60,000 + $60,000 + $30,000 = $150,000
Now we have all the values needed to calculate the AFN:
AFN = ($800,000 - $150,000) - (0.5 x Increase in Sales)
= $650,000 - 0.5 x Increase in Sales
The question asks, "By how much can sales increase without obtaining additional outside financing?" This means that AFN should be equal to or greater than zero.
Setting AFN equal to zero:
0 = $650,000 - 0.5 x Increase in Sales
Now, solve for the Increase in Sales:
0.5 x Increase in Sales = $650,000
Increase in Sales = $650,000 / 0.5
Increase in Sales = $1,300,000
Therefore, sales can increase by $1,300,000 without obtaining additional outside financing.
In your calculation, it seems you missed calculating the increase in spontaneous liabilities and didn't consider the retention ratio. By following the steps outlined above, you should arrive at the correct answer.