Chap003-longterm financial planing

Click to edit Master text styles,Second level,Third level,Fourth level,Fifth level,McGraw-Hill/Irwin,Copyright 2004 by The McGraw-Hill Companies,Inc.All rights reserved.,Click here for title,3-,*,Corporate Finance,Ross,Westerfield,Jaffe,Seventh Edition,Seventh Edition,3,Chapter Three,Long-Term Financial Planning and Growth,Chapter Outline,3.1 What is Financial Planning?,3.2 A Financial Planning Model:The Ingredients,3.3 The Percentage Sales Method,3.4 What Determines Growth?,3.5 Some Caveats of Financial Planning Models,3.6 Summary and Conclusions,3.1 What is Corporate Financial Planning?,It formulates the method by which financial goals are to be achieved.,There are two dimensions:,A Time Frame,Short run is probably anything less than a year.,Long run is anything over that;usually taken to be a two-year to five-year period.,A Level of Aggregation,Each division and operational unit should have a plan.,As the capital-budgeting analyses of each of the firms divisions are added up,the firm aggregates these small projects as a big project.,3.1 What is Corporate Financial Planning?,Scenario Analysis,Each division might be asked to prepare three different plans for the near term future:,A Worst Case,A Normal Case,A Best Case,What Will the Planning Process Accomplish?,Interactions,The plan must make explicit the linkages between investment proposals and the firms financing choices.,Options,The plan provides an opportunity for the firm to weigh its various options.,Feasibility,Avoiding Surprises,Nobody plans to fail,but many fail to plan.,3.2 A Financial Planning Model:The Ingredients,Sales forecast,Pro forma statements,Asset requirements,Financial requirements,Plug,Economic assumptions,Sales Forecast,All financial plans require a sales forecast.,Perfect foreknowledge is impossible since sales depend on the uncertain future state of the economy.,Businesses that specialize in macroeconomic and industry projects can be help in estimating sales.,Pro Forma Statements,The financial plan will have a forecast balance sheet,a forecast income statement,and a forecast sources-and-uses-of-cash statement.,These are called,pro forma,statements or,pro formas,.,Asset Requirements,The financial plan will describe projected capital spending.,In addition it will the discuss the proposed uses of net working capital.,Financial Requirements,The plan will include a section on financing arrangements.,Dividend policy and capital structure policy should be addressed.,If new funds are to be raised,the plan should consider what kinds of securities must be sold and what methods of issuance are most appropriate.,Plug,Compatibility across various growth targets will usually require adjustment in a third variable.,Suppose a financial planner assumes that sales,costs,and net income will rise at,g,1,.Further,suppose that the planner desires assets and liabilities to grow at a different rate,g,2,.These two rates may be incompatible unless a third variable is adjusted.For example,compatibility may only be reached is outstanding stock grows at a third rate,g,3,.,Economic Assumptions,The plan must explicitly state the economic environment in which the firm expects to reside over the life of the plan.,Interest rate forecasts are part of the plan.,The Steps in Estimation of Pro Forma Balance Sheet:,Express balance-sheet items that vary with sales as a percentage of sales.,Multiply the percentages determine in step 1 by projected sales to obtain the amount for the future period.,When no percentage applies,simply insert the previous balance-sheet figure into the future period.,The Steps in Estimation of Pro Forma Balance Sheet:(continued),Compute Projected retained earnings as,Present retained earnings,+Projected net income,Cash dividends,Projected retained earnings,Add the asset accounts to determine projected assets.Next,add the liabilities and equity accounts to determine the total financing;any difference is the,shortfall,.This equals the external funds needed.,Use the plug to fill EFN.,A Brief Example,The Rosengarten Corporation is think of acquiring a new machine.The machine will increase sales from$20 million to$22 million10%growth.,The firm believes that its assets and liabilities grow directly with its level of sales.Its profit margin on sales is 10%,and its dividend-payout ratio is 50%.,Will the firm be able to finance growth in sales with retained earnings and forecast increases in debt?,A Brief Example,Current Balance Sheet,Pro forma Balance Sheet,(millions),Explanation,Current assets,$6,$6.6,30%of sales,Fixed assets,$24,$26.4,120%of sales,Total assets,$30,$33,150%of sales,Short-term debt,$10,$11,50%of sales,Long-term debt,$6,$6.6,30%of sales,Common stock,$4,$4,Constant,Retained Earnings,$10,$11.1,Net Income,Total financing,$30,$32.7,$300,000,Funds needed,(millions),=10+22*10%*50%,The Percentage Sales Method:EFN,The external funds needed for a 10%growth in sales:,p,=Net profit margin=0.10,d,=Dividend payout ratio=0.5,D,Sales=Projected change i