Howton & Howton Worldwide 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 50%, 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* $500.0 Last year's accruals $20.0
Last year's profit margin = PM 20.0% Initial payout ratio 10.0%
A)$31.9
B)$33.6
C)$35.3
D)$37.0
E)$38.9

Question

Quizplus · Accepted Answer

AFN = (A1 - L1 - S0*(1-g)*PM)*g

Where A1 = required total assets for next year
L1 = required total liabilities for next year
S0 = last year's sales
g = sales growth rate
PM = profit margin

First, we need to calculate the required total assets for next year with the current payout ratio of 10%.

A1 = S0*(1+g)*(1-PM)/Assets-to-Sales ratio
Assets-to-Sales ratio = Total Assets / Sales

Assets-to-Sales ratio = A0/S0 = $500.0/$300.0 = 1.67

A1 = $300.0*(1+40%)*(1-20%)/1.67 = $542.16 million

Now, we can calculate the required total liabilities for next year with the current payout ratio of 10%.

L1 = (S0*(1+g)*PM*PR) - (A0*(L/S))*g
PR = new payout ratio = 50%
L/S = last year's liabilities to sales ratio

L/S = (Accounts Payable + Notes Payable + Accruals) / S0 = ($50.0 + $15.0 + $20.0) / $300.0 = 28.33%

L1 = ($300.0*(1+40%)*20%*50%) - ($500.0*28.33%*40%) = $77.36 million

Therefore, AFN with the current payout ratio of 10% = ($542.16 - $77.36 - $300.0*(1+40%)*(1-20%)*10%)*40% = $13.26 million

Now, let's calculate the required total assets and total liabilities for next year with the new payout ratio of 50%.

A1 = $300.0*(1+40%)*(1-20%)/1.67 = $542.16 million (same as before)

L/S = ($50.0 + $15.0 + $20.0) / $300.0 = 28.33% (same as before)

L1 = ($300.0*(1+40%)*20%*50%) - ($500.0*28.33%*40%) = $110.72 million

AFN with the new payout ratio of 50% = ($542.16 - $110.72 - $300.0*(1+40%)*(1-20%)*50%)*40% = $46.62 million

Therefore, the change in AFN due to the increase in payout ratio from 10% to 50% is:

Change in AFN = AFN (new payout ratio) - AFN (current payout ratio) = $46.62 million - $13.26 million = $33.36 million ≈ $33.6 million

Hence, B) $33.6 is the correct answer.

Howton & Howton Worldwide the Firm Is Operating at Full