a. The AFN equation can be written as:
(assets/sales)*ChangeInSales - (liab/sales)*ChangeInSales - ProfitMargin*SalesInComingYear)*(1-DividendPayoutRatio). Using the following data, an AFN of $180.9 million is calculated.
b. When the percentage of sales method is used and a second "pass" is done to take into account the effect of financing (including increased interest payments due to the debt that is taken on to finance the additional funds needed), the following financial statements are derived from NWC's operations in 1999:
The first time through, the AFN is $189.72 million. However, this step goes further and takes into account the financing of the funds needed and the retained earnings that arise as a result. This yields the above financial data and AFN of $148.95.
c. The difference in the two AFN forecasts is related to the method of calculating the company's upcoming needs. Without considering how the additional funds will be financed, the company cannot accurately take into account monies associated with that financing, including interest payments. Since interest payments are also tax deductible, there are additional tax ramifications. In addition, the percentage of sales method allows different items to increase at different rates (as a percentage of sales) and also overcomes the shortcoming of the AFN equation that assumes a constant profit margin. By using the percentage of sales technique where the funds are factored into the calculations, the company has a more accurate forecast of its financial picture.
d. Key ratios are as follows (using the solution to step b as the source data):
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