financing costs of additional strongfundsstrong needed a modified.pdfVIP

Financing Costs of Additional Funds Needed: A Modified Equation Approach By: Daniel T. Winkler Winkler, D. T. Financing Costs of Additional Funds Needed: A Modified Equation Approach, Financial Education and Practice, Summer 1994, pp. 149-154. Made available courtesy of Financial Management Association International : /fm.htm ***Note: Figures may be missing from this format of the document The additional funds needed (AFN) equation is a popular forecasting model for estimating additional funds requirements (Brigham [3]). Academicians regard the AFN equation as an excellent pedagogical tool; practitioners find it highly beneficial for many forecasting needs. To apply the model, an analyst needs to know the amount of assets required per dollar of sales, the amount of spontaneous liabilities available per dollar of sales, the change in sales, and additions to retained earnings. Additions to retained earnings are calculated by multiplying the net profit margin by forecasted sales and the retention ratio. The equation is shown as follows: The first term on the right-hand side (RHS) of equation (1) is the increase in assets required to support the change in sales. The second term subtracts the increase in spontaneous liabilities associated with the sales increase. The third term deducts additions to retained earnings. As useful as practitioners and academicians find the AFN equation, it is subject to considerable estimation error when financing costs change substantially. The financing costs associated with additional funds needed create feedback, requiring a firm to borrow more than the original additional funds needed in order to meet the interest and dividend obligations of the amount borrowed. Original additional funds needed is calculated from a pro forma statement as a firms total asset projections minus initially projected liabilities and equity. The recalculation of interest expense and dividends to accommodate the financing of origi