Answer to Question #6525 in Economics of Enterprise for LaMarcus Streeter
a. When we use the AFN equation, we assume that the ratios of assets and liabilities to sales (A0*/S0 and L0*/S0) vary from year to year in a stable, predictable manner.
b. When fixed assets are added in large, discrete units as a company grows, the assumption of constant ratios is more appropriate than if assets are relatively small and can be added in small increments as sales grow.
c. Firms whose fixed assets are “lumpy” frequently have excess capacity, and this should be accounted for in the financial forecasting process.
d. For a firm that uses lumpy assets, it is impossible to have small increases in sales without expanding fixed assets.
e. There are economies of scale in the use of many kinds of assets. When economies occur the ratios are likely to remain constant over time as the size of the firm increases. The
small increments but must be obtained in large, discrete units. That's why they
have excess capacity (situation in which actual production is less than what is
achievable or optimal for a firm). The demand for such assets in the market is
below what the firm could potentially supply to the market.
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