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by: Dora


Marketplace > Purdue University > Chapter4_Slides_forstudents_withanswer
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Date Created: 03/10/15
CHAPTER 4 LONGTERM FINANCIAL PLANNING AND GROWTH Chapter Outline a What Is Financial Planning a Financial Planning Models A First Look a The Percentage of Sales Approach 1 External Financing and Growth 1 Some Caveats Regarding Financial Planning Models MGMT 31000 Financial Management 42 11 Elements of Financial Planning III Investment in new assets determined by capital budgeting decisions El Degree of financial leverage determined by capital structure decisions III Cash paid to shareholders determined by dividend policy decisions a Liquidity requirements determined by net working capital decisions MGMT 31000 Financial Management 4 3 12 Role of Financial Planning a Examine interactions help management see the interactions between decisions a Explore options give management a systematic framework for exploring its opportunities a Avoid surprises help management identify possible outcomes and plan accordingly a Ensure feasibility and internal consistency help management determine if goals can be accomplished and if the various stated and unstated goals of the firm are consistent with one another MGMT 31000 Financial Management 4 4 13 Financial Planning Process a Planning Horizon divide decisions into shortrun decisions usually next 12 months and longrun decisions usually 2 5 years a Aggregation combine capital budgeting decisions into one large project a Assumptions and Scenarios Make realistic assumptions about important variables Run several scenarios where you vary the assumptions by reasonable amounts Determine at a minimum worst case normal case and best case scenanos MGMT 31000 Financial Management 4 5 2 Financial Planning Model Ingredients a Sales Forecast many cash flows depend directly on the level of sales often estimated using sales growth rate a Pro Forma Statements setting up the plan using projected financial statements allows for consistency and ease of interpretation u Asset Requirements the additional assets that will be required to meet sales projections in Financial Requirements the amount of financing needed to pay for the required assets 1 Plug Variable determined by management deciding what type of financing will be used to make the balance sheet balance a Economic Assumptions explicit assumptions about the coming economic environment MGMT 31000 Financial Management 4 6 21 Ex Historical Financial Statements Gourmet Coffee Inc Gourmet Coffee Inc Balance Sheet Income Statement Dec 31 2013 For Year Ended Dec 31 2013 Assets 1000 Debt 400 Revenues 2000 Less costs 1600 EqUIty 600 Net Income 400 Total 1000 Total 1000 MGMT 31000 Financial Management 4 7 22 Ex Pro Forma Income Statement a Initial Assumptions Gourmet Coffee Inc Pro Forma Income Statement 1 Revenues will For the Year Ended 2014 O grow at 15 25000 1 3915 2011 Forecasted Pro 2 All items are tied directly to growth rate forma sales and the current 2012 relationships are optimal Revenues 2000 115 2300 3 Consequently all other items Less 1600 115 1840 will also grow at 15 Costs Net 400 115 460 Income MGMT 31000 Financial Management 4 8 23 Ex Pro Forma Balance Sheet a Case I Dividends are the plug variable so equity increases at 15 constant DE ratio a Dividends 460 NI 90 increase in equity 370 dividends paid III Case ll Debt is the plug variable and no dividends are paid a Debt 1150 600460 90 a Repay 400 90 310 in debt Gourmet Coffee Inc Pro Forma Balance Sheet K Dec 31 2014 2011 Forecasted Pro forma growth 2012 Total Assets 1 000 1 15 1 150 Total Debt 400 115 460 Equity 600 1 15 690 Total Liab 1150 OE Gourmet Coffee Inc Pro Forma Balance Sheet Dec 31 2014 2011 Forecasted Pro forma growth 2012 Total Assets 1 000 1 15 1 150 Total Debt 400 115 90 Equity 600 115 1060 Total Liab 1150 OE 3 Percentage of Sales Approach III Some items vary directly with sales while others do not III Income Statement 5 Costs may vary directly with sales if this is the case then the profit margin is constant a Depreciation and interest expense may not vary directly with sales if this is the case then the profit margin is not constant a Dividends are a management decision and generally do not vary directly with sales this influences additions to retained earnings MGMT 31000 Financial Management 4 1O 3 Percentage of Sales Approach III Balance Sheet a Initially assume all assets including fixed vary directly with sales a Accounts payable will also normally vary directly with sales a Notes payable longterm debt and equity generally do not vary directly with sales because they depend on management decisions about capital structure a The change in the retained earnings portion of equity will come from the dividend decision MGMT 31000 Financial Management 31 Example Income Statement E E Tasha s Toy Emporium Income Statement 2013 00 Of Sales Sales 5000 Less costs 3000 60 EBT 2000 40 Less taxes 800 16 40 of EBT Net Income 1200 24 Dividends 600 Add To RE 600 Tasha s Toy Emporium Pro Forma Income Statement 2014 Sales 5500 Less costs 3300 EBT 2200 Less taxes 880 Net Income 1320 Dividends 660 Add To RE 660 Assume Sales grew at 10 Dividend Payout Rate 50 MGMT 31000 Financial Management 412 32 Example Balance Sheet D Tasha s Toy Emporium Balance Sheet Current o of Pro Current o of Pro Sales Forma Sales Forma Assets Liabilities amp Owners Equity Current Assets Current Liabilities Cash 500 10 550 AP 900 18 990 AR 2000 40 2200 NP 2500 na 2500 Inventory 3000 60 3300 Total 3400 na 3490 Total 5500 110 6050 LT Debt 2000 na 2000 Fixed Assets Owners Equity Net PPampE 4000 80 4400 CS amp APIC 2000 na 2000 Total Assets 9500 190 10450 RE 2100 na 2760 Total 4100 na 4760 Total L amp OE 9500 10250 MGMT 31000 Fina Ciai Management 4 13 33 Ex External Financing Needed a The firm needs to come up with an additional 200 in debt or equity to make the balance sheet balance a TA TLampOE 10450 10250 200 III Choose plug variable 200 EFN The options are Borrow more shortterm Notes Payable Borrow more longterm LT Debt Sell more common stock CS amp APIC Decrease dividend payout which increases the Additions To Retained Earnings MGMT 31000 Financial Management 4 14 34 Extension Operating at Less than Full Capacity El Suppose that the company is currently operating at 80 capacity Full Capacity sales 5000 8 6250 Estimated sales 5500 so we would still only be operating at 88 a Therefore no additional fixed assets would be required a Proforma Total Assets 6050 4000 10050 a Total Liabilities and Owners Equity 10250 El Choose plug variable for 200 EXCESS financing Repay some shortterm debt decrease Notes Payable Repay some longterm debt decrease LT Debt Buy back stock decrease CS amp APIC Pay more in dividends reduce Additions To Retained Earnings Increase cash account MGMT 31000 Financial Management 4 15 4 External Financing and Growth El At low growth levels internal financing retained earnings may exceed the required investment in assets III As the growth rate increases the internal financing will not be enough and the firm will have to go to the capital markets for money El Examining the relationship between growth and external financing required is a useful tool in longrange planning MGMT 31000 Financial Management 4 16 41 The Internal Growth Rate a Definition The internal growth rate tells us how much the firm can grow assets using retained earnings as the only source of financing III Example Using the information from Tasha s Toy Emporium ROA 1200 9500 01263 B 05 Internal Growth Rate 2 RCA X b l ROAxb 01263x05 200674 1 01263gtlt05 674 MGMT 31000 Financial Management 4 17 42 The Sustainable Growth Rate a Definition The sustainable growth rate tells us how much the firm can grow by using internally generated funds and issuing debt to maintain a constant debt ratio III Example Using Tasha s Toy Emporium ROE 1200 4100 02927 b 05 Sustainable Growth Rate ROEXb LROExb 02927x05 01714 1 02927 x 05 1714 MGMT 31000 Financial Management 4 18 43 Determinants of Growth El Profit margin E Operating efficiency El Total asset turnover E Asset use efficiency El Financial leverage E Choice of optimal debt ratio III Dividend policy E Choice of how much to pay to shareholders versus reinvesting in the firm MGMT 31000 Financial Management 419 Important Questions a It is important to remember that we are working with accounting numbers therefore we must ask ourselves some important questions as we go through the planning process a How does our plan affect the timing and risk of our cash flows a Does the plan point out inconsistencies in our goals a If we follow this plan will we maximize owners wealth MGMT 31000 Financial Management 4 20 Quick Quiz III What is the purpose of longrange planning III What are the major decision areas involved in deve0ping a plan III What is the percentage of sales approach III How do you adjust the model when operating at less than full capacity III What is the internal growth rate III What is the sustainable growth rate III What are the major determinants of growth MGMT 31000 Financial Management 4 21 Comprehensive Problem EIIIIEIEIEIEI XYZ has the following financial information for 2012 Sales 2M Net lnc 04M Div 01 M GA 04M PA 36M CL 02M LTD 1 M 08 2M RE 08M What is the sustainable growth rate If 2013 sales are projected to be 24M what is the amount of external financing needed assuming XYZ is operating at full capacity and profit margin and payout ratio remain constant MGMT 31000 Financial Management 4 22 Answers 1 ROE net income shareholders equity 4M 2M 8M 1429 Payout ratio dividendsnet income 1 M4M 25 Plowback ratio b 1 payout ratio 1 25 75 Sustainable rowth rate ROE X b 1 ROE X b 1429 X 75 1 1429 X 75 12 Profit margin net incomesales 4M2M 2 Prcgected net income profit margin X projected sales Projected addition to retained earnin s pro39ected net ch neg payout ratio 48M 1 2 48M MGMT 31000 Financial Management Answers 2 El change in sales 24M 2M2M 2 2012 total assets 4M 36M 4M Projected total assets 4M X 12 48M Projected CL 2M X 12 24M Pro39ected RE 2012 RE projected addition to R 8M 36M 1 16M Projected liabilities and owners equity projected CL LTD CS pr0jected RE 24M 1 M 2M 1 16M 44M External Financing Needed rojected assets projected liabs and OE 4 M 44M 4M MGMT 31000 Financial Management


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