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Forecasting sales Projecting the assets and internally generated funds Projecting outside funds needed Deciding how to raise funds 17-1 Cash & sec. Accounts rec. Inventories Total CA Net fixed assets Total assets $ 20 Accts. pay. & accruals $ 100 240 Notes payable 100 240 Total CL $ 200 $ 500 L-T debt 100 Common stock 500 Retained 500 earnings 200 $1,000 Total claims $1,000 17-2 Sales Less: Var. costs (60%) Fixed costs EBIT Interest EBT Taxes (40%) Net income Dividends (30%) Add’n to RE $2,000.00 1,200.00 700.00 $ 100.00 16.00 $ 84.00 33.60 $ 50.40 $15.12 $35.28 17-3 BEP Profit margin ROE DSO Inv. turnover F. A. turnover T. A. turnover Debt/assets TIE Current ratio Payout ratio NWC 10.00% 2.52% 7.20% 43.80 days 8.33x 4.00x 2.00x 30.00% 6.25x 2.50x 30.00% Industry Condition 20.00% Poor 4.00% ” 15.60% ” 32.00 days ” 11.00x ” 5.00x ” 2.50x ” 36.00% Good 9.40x Poor 3.00x ” 30.00% O. K. 17-4 Operating at full capacity in 2002. Each type of asset grows proportionally with sales. Payables and accruals (Spontaneous Liabilities) grow proportionally with sales. 2002 profit margin (2.52%) and payout (30%) will be maintained. Sales are expected to increase by $500 million. (%DS = 25%) 17-5 The payout ratio will remain at 30 percent (d = 30%; RR = 70%). No new common stock will be issued. Any external funds needed will be raised as debt, 50% notes payable and 50% L-T debt. 17-6 2002 Sales Less: VC FC EBIT Interest EBT Taxes (40%) Net income Div. (30%) Add’n to RE Forecast Basis 2003 Forecast $2,000 1.25 $2,500 1,200 0.60*2003 Sales 1,500 700 0.35*2003 Sales 875 $ 100 $ 125 16 16 $ 84 $ 109 34 44 $ 50 $ 65 $15 $35 $19 $46 17-7 2002 Cash Accts. rec. Inventories Total CA Net FA Total assets $ 20 240 240 $ 500 500 $1,000 Forecast Basis 2003 1st Pass 0.01*2003 Sales$ 0.12*2003 Sales 0.12*2003 Sales 25 300 300 $ 625 0.25*2003 Sales 625 $1,250 17-8 2002 AP/accruals Notes payable Total CL L-T debt Common stk. Ret.earnings Total claims Forecast Basis 2003 1st Pass $ 100 0.05*2003 Sales $ 125 100 100 $ 200 $ 225 100 100 500 500 200 +46* 246 $1,000 $1,071 * From income statement. 17-9 Required increase in assets Less: Spontaneous inc in liab. Less: Increase in RE Total AFN = = = = $ 250 $ 25 $ 46 $ 179 Company must have the assets to generate forecasted sales. The balance sheet must balance, so we must raise $179 million externally. 17-10 Additional N/P ◦ 0.5 ($179) = $89.50 Additional L-T debt ◦ 0.5 ($179) = $89.50 But this financing will add to interest expense, which will lower NI and retained earnings. We will generally ignore financing feedbacks. 17-11 2003 1st Pass Cash Accts. rec. Inventories Total CA Net FA Total assets $ 25 300 300 $ 625 625 $1,250 AFN - 2003 2nd Pass $ 25 300 300 $ 625 625 $1,250 17-12 2003 1st Pass AP/accruals Notes payable Total CL L-T debt Common stk. Ret.earnings Total claims $ 125 100 $ 225 100 500 246 $1,071 AFN +89.5 +89.5 - 2003 2nd Pass $ 125 190 $ 315 189 500 246 $1,250 * From income statement. 17-13 AFN = (A*/S0)ΔS – (L*/S0) ΔS – M(S1)(RR) = ($1,000/$2,000)($500) – ($100/$2,000)($500) – 0.0252($2,500)(0.7) = $180.9 million. 17-14 Equation method assumes a constant profit margin, a constant dividend payout, and a constant capital structure. Financial statement method is more flexible. More important, it allows different items to grow at different rates. 17-15 BEP Profit margin ROE DSO (days) Inv. turnover F. A. turnover T. A. turnover D/A ratio TIE Current ratio Payout ratio 2002 2003(E) 10.00% 10.00% 2.52% 2.62% 7.20% 8.77% 43.80 43.80 8.33x 8.33x 4.00x 4.00x 2.00x 2.00x 30.00% 40.34% 6.25x 7.81x 2.50x 1.99x 30.00% 30.00% Industry 20.00% Poor 4.00% ” 15.60% ” 32.00 ” 11.00x ” 5.00x ” 2.50x ” 36.00% ” 9.40x ” 3.00x ” 30.00% O. K. 17-16 OC2003 = NOWC + Net FA = $625 - $125 + $625 = $1,125 OC2002 = $900 Net investment in OC = $1,125 - $900 = $225 17-17 FCF = = = = = NOPAT – Net inv. in OC EBIT (1 – T) – Net inv. in OC $125 (0.6) – $225 $75 – $225 -$150. 17-18 Additional sales could be supported with the existing level of assets. The maximum amount of sales that can be supported by the current level of assets is: ◦ Capacity sales = Actual sales / % of capacity = $2,000 / 0.75 = $2,667 Since this is less than 2003 forecasted sales, no additional assets are needed. 17-19 The projected increase in fixed assets was $125, the AFN would decrease by $125. Since no new fixed assets will be needed, AFN will fall by $125, to ◦ AFN = $179 – $125 = $54. 17-20 Target ratio = FA / Capacity sales = $500 / $2,667 = 18.75% Have enough FA for sales up to $2,667, but need FA for another $333 of sales ◦ ΔFA = 0.1875 ($333) = $62.4 17-21 Sales wouldn’t change but assets would be lower, so turnovers would be better. Less new debt, hence lower interest, so higher profits, EPS, ROE (when financing feedbacks were considered). Debt ratio, TIE would improve. 17-22 BEP Profit margin ROE DSO (days) Inv. turnover F. A. turnover T. A. turnover D/A ratio TIE Current ratio % of 2002 Capacity 100% 75% 10.00% 11.11% 2.62% 2.62% 8.77% 8.77% 43.80 43.80 8.33x 8.33x 4.00x 5.00x 2.00x 2.22x 40.34% 33.71% 7.81x 7.81x 1.99x 2.48x Industry 20.00% 4.00% 15.60% 32.00 11.00x 5.00x 2.50x 36.00% 9.40x 3.00x 17-23 DSO is higher than the industry average, and inventory turnover is lower than the industry average. Improvements here would lower current assets, reduce capital requirements, and further improve profitability and other ratios. 17-24 Higher dividend payout ratio? Higher profit margin? Higher capital intensity ratio? Pay suppliers in 60 days, rather than 30 days? ◦ Increase AFN: Less retained earnings. ◦ Decrease AFN: Higher profits, more retained earnings. ◦ Increase AFN: Need more assets for given sales. ◦ Decrease AFN: Trade creditors supply more capital (i.e., L*/S0 increases). 17-25