Cold Duck Manufacturing Inc. reported sales of $775,000 at the end of last year,
ID: 2793855 • Letter: C
Question
Cold Duck Manufacturing Inc. reported sales of $775,000 at the end of last year, but this year, sales are expected to grow by 7%. Cold Duck expects to maintain its current profit margin of 23% and dividend payout ratio of 20%. The following information was taken from Cold Duck's balance sheet: Total assets: Accounts payable: Notes payable: Accrued liabilities: $400,000 $75,000 $40,000 $60,000 Based on the AFN equation, the firm's AFN for the current year is A positively signed AFN value represents: A point at which the funds generated within the firm equal the demands for funds to finance the firm's future expected sales requirements A surplus of internally generated funds that can be invested in physical or financial assets or paid out as additional dividends A shortage of internally generated funds that must be raised outside the company to finance the company's forecasted future growth Because of its excess funds, Cold Duck Manufacturing Inc. is thinking about raising its dividend payout ratio to satisfy shareholders. Cold Duck could pay out external capital. (Hint: What can Cold Duck increase its dividend payout ratio to before the AFN becomes positiver) of its earnings to shareholders without needing to raise anyExplanation / Answer
Answer :- Additional Funds Needed (AFN) = Increase in assets Increase in liabilities - Increase in Retained Earnings
= ( Current Level of Assets * ( Change in Sales / Current Sales) - (Change in sales / Current Sales ) * New Level of Sales * profit margin * Retention rate)
Increase in Assets = Current Assets $ 400000 x 7 % = $ 28000
Spontaneous Increase in Liabilities = Current Liabilities x Sales Growth Rate = $ 175000 x 7% = $ 12250
Increase In Retained Earnings = Projected Sales x Profit Margin X Retention rate = Current sales x (1+ Sales Growth Rate ) x Profit margin x retention rate = $ (775000 + 7 % of 775000) x 23% x 80% = $ 152582.00
Additional Funds Needed = $ 28000 -12250 -152582.00 = (- )$ 136832
Answer to Part 1 :-
Based on the AFN equation ,the firm's AFN of current Year is $ 136832 (negative)
Answer to Part 2) A postively signed AFN Value Represents : A shortage of internally generated funds that must be raised outside the company to finance company's forecasted future growth.
Answer to Part 3) The dividend Pay out Ratio to be revised so that additional fund need not be raised from external sources.Hence in this situation AFN needs to be zero.
Hence Increase In Retained Earnings needed= $ 28000-12250 = $ 15750
Increase in Retained Earnings = Projected Sales x Profit margin x Retention Rate
$ 15750= $ 829250 x 23% x Retention Rate
Retention Rate = 15750 /190728 x 100 = 8.26 %
The revised Dividend Pay out Ratio shall be (100 % - 8.26 % ) = 91.74 %
Cold Duck could pay 91.74 % of its earnings.