Download CHAPTER 17 Financial Planning and Forecasting

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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
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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


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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
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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

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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

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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

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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

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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
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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
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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?
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Higher profit margin?
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Higher capital intensity ratio?
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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