38.

Maximum growth rate Answer: b Diff: T

Let S = S0(g), S1 = S0(1 + g), RR = (1 - d) = (1 - 0.5) = 0.5, and AFN = 0.

Find g = ?

A* L*
AFN = (S0)(g) - (S0)(g) - MS0(1 + g)(RR) = 0.
S0 S0
$10,000
0 = 1.2($100,000g) - ($100,000g) - (0.10)($100,000)(1 + g)(0.5)
$100,000
0 = $120,000g - $10,000g - $5,000g - $5,000
$5,000 = $105,000g
g = 4.76%  4.8%.

39. AFN formula method Answer: b Diff: T

Facts given: M = 5%; RR = (1 - 0.4) = 0.6; S0 = $6,000 million; A* =

$1,500 million (Firm at full capacity); S1 = 1.30  $6,000 million = $7,800
million; S = 0.3  $6,000 million = $1,800 million; L* = $200 million +
$200 million = $400 million. (From balance sheet.)

Step 1: Use the AFN formula to determine the additional funds needed:
A* L*
AFN = (S) - (S) – MS1(RR)
S0 S0
$1,500 $400
= ($1,800) – ($1,800) - [(0.05)($7,800)(0.6)]
$6,000 $6,000
= $450 - $120 - $234
= $96 million.

The company needs $96 million in additional funds, which it will

raise with short-term bank loans.

Step 2: Determine the new projected level of current assets:

CA = $600/$6,000  $7,800 = $780 million.

Step 3: Determine the new projected level of current liabilities:

CL = A/P + Accrued liabilities + ST Loans
= ($200/$6,000  $7,800) + ($200/$6,000  $7,800) + $96
= $520 + $96
= $616 million.

Step 4: Determine the firm’s new current ratio:

CR = CA/CL = $780/$616
= 1.27.

Chapter 17 - Page 32