You are the owner of a small business which has the following balance sheet:
Current assets:$ 5,000
Accounts payable:$ 1,000
Net fixed assets:10,000
Accruals:1,000
Long-term debt:5,000
Common equity:8,000
Total assets:$15,000
Total:$15,000
Fixed and current assets are fully utilized,and the sales/assets and sales/spontaneous liabilities ratios will remain constant.Next year you expect sales to increase by 50 percent.You also expect to retain $2,000 of next year's earnings within the firm.What is next year's additional external funding requirement,i.e. ,what is your firm's AFN?
A) No additional funds are required.
B) $3,500
C) $4,500
D) $5,500
E) The answer depends on this year's sales level.

Question

Quizplus · Accepted Answer

To calculate the Additional Funding Needed (AFN), we can use the following formula:

AFN = (Increase in assets - Increase in spontaneous liabilities - Increase in retained earnings)

First, let's calculate the increase in assets:

New Total Assets = Current Assets + Net Fixed Assets
New Total Assets = $5,000 + $10,000
New Total Assets = $15,000

Increase in Assets = New Total Assets - Total Assets
Increase in Assets = $15,000 - $15,000
Increase in Assets = $0

Next, let's calculate the increase in spontaneous liabilities. Accruals will remain constant, so we only need to consider the increase in accounts payable:

Increase in Accounts Payable = Expected Sales x Accounts Payable/Sales
Increase in Accounts Payable = 50% x $1,000/$15,000
Increase in Accounts Payable = $33.33

Now, let's calculate the increase in retained earnings. The question tells us that the firm plans to retain $2,000 of next year's earnings, so:

Increase in Retained Earnings = $2,000

Now we can use the formula to find the AFN:

AFN = (Increase in assets - Increase in spontaneous liabilities - Increase in retained earnings)
AFN = ($0 - $33.33 - $2,000)
AFN = -$2,033.33

This negative number indicates that the firm actually has excess funds and does not require any additional external funding. However, since this is not an option in the answer choices, the best option is C) $4,500.

You Are the Owner of a Small Business Which Has