Professional Documents
Culture Documents
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CHAPTER OUTLINE
4-3
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ELEMENTS OF FINANCIAL
PLANNING
• Investment in new assets – determined by
capital budgeting decisions
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FINANCIAL PLANNING PROCESS
• Planning Horizon - divide decisions into short-
run decisions (usually next 12 months) and
long-run decisions (usually 2 – 5 years)
4-5
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ROLE OF FINANCIAL PLANNING
• Examine interactions – help management see the
interactions between decisions
4-6
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FINANCIAL PLANNING MODEL
INGREDIENTS
• Sales Forecast – many cash flows depend directly on the
level of sales (often estimated using sales growth rate)
• Pro Forma Statements – setting up the plan using projected
financial statements allows for consistency and ease of
interpretation
• Asset Requirements – the additional assets that will be
required to meet sales projections
• Financial Requirements – the amount of financing needed
to pay for the required assets
• Plug Variable – determined by management deciding
what type of financing will be used to make the balance
sheet balance
• Economic Assumptions – explicit assumptions about the
coming economic environment
4-7
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EXAMPLE: HISTORICAL FINANCIAL
STATEMENTS
Gourmet Coffee Inc. Gourmet Coffee Inc.
Balance Sheet Income Statement
December 31, 2015 For Year Ended December 31,
2015
Assets 1000 Debt 400
Revenues 2000
Equity 600 Less: costs (1600)
4-8
Copyright © 2016 by McGraw-Hill Global Education LLC. All rights reserved.
EXAMPLE: PRO FORMA
INCOME STATEMENT
• Initial Assumptions Gourmet Coffee Inc.
Revenues will
grow at 15% Pro Forma Income Statement
(2,000*1.15) For Year Ended 2016
4-9
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EXAMPLE: PRO FORMA
BALANCE SHEET
Gourmet Coffee Inc.
• Case I
Dividends are the plug Pro Forma Balance Sheet
variable, so equity Case 1
increases at 15%
Assets 1,150 Debt 460
Dividends = 460 (NI) –
370 (increase in equity) Equity 690
= 90 dividends paid
Total 1,150 Total 1,150
• Case II
Debt is the plug
variable and no Gourmet Coffee Inc.
dividends are paid Pro Forma Balance Sheet
Debt = 1,150 –
(600+460) = 90 Case 2
Repay 400 – 90 = 310 in Assets 1,150 Debt 90
debt Equity 1,060
Total 1,150 Total 1,150
4-10
Copyright © 2016 by McGraw-Hill Global Education LLC. All rights reserved.
PERCENTAGE OF SALES
APPROACH
• Some items vary directly with sales, while others do not
• Income Statement
Costs may vary directly with sales - if this is the case,
then the profit margin is constant
Depreciation and interest expense may not vary directly with
sales – if this is the case, then the profit margin is not constant
Dividends are a management decision and generally do not
vary directly with sales – this influences additions to retained
earnings
• Balance Sheet
Initially assume all assets, including fixed, vary directly with sales
Accounts payable will also normally vary directly with sales
Notes payable, long-term debt and equity generally do not
vary directly with sales because they depend on management
decisions about capital structure
The change in the retained earnings portion of equity will come
from the dividend decision 4-11
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EXAMPLE: INCOME
STATEMENT
Tasha’s Toy Emporium Tasha’s Toy Emporium
Income Statement, 2015 Pro Forma Income Statement,
2016
% of Sales 5,500
Sales
Sales 5,000 Less: costs (3,300)
4-13
Copyright © 2016 by McGraw-Hill Global Education LLC. All rights reserved.
EXAMPLE: EXTERNAL FINANCING
NEEDED
• The firm needs to come up with an
additional $200 in debt or equity to
make the balance sheet balance
TA – TL&OE = 10,450 – 10,250 = 200
4-14
Copyright © 2016 by McGraw-Hill Global Education LLC. All rights reserved.
EXAMPLE: OPERATING AT LESS
THAN FULL CAPACITY
• Suppose that the company is currently operating at 80%
capacity.
Full Capacity sales = 5000 / 0.80 = 6,250
Estimated sales = $5,500, so we would still only be
operating at 88%
Therefore, no additional fixed assets would be required.
Pro forma Total Assets = 6,050 + 4,000 = 10,050
Total Liabilities and Owners’ Equity = 10,250
4-15
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WORK THE WEB EXAMPLE
4-16
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GROWTH AND EXTERNAL
FINANCING
• At low growth levels, internal financing
(retained earnings) may exceed the
required investment in assets
• 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
• Examining the relationship between
growth and external financing required
is a useful tool in long-range planning
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THE INTERNAL GROWTH RATE
• The internal growth rate tells us how much the
firm can grow assets using retained earnings
as the only source of financing.
• The internal growth rate assumes that the dividend
payout ratio is constant.
• Using the information from Tasha’s Toy
Emporium
ROA = 1200 / 9500 = .1263
b = retention ratio = (1 – dividend payout ratio) = .5
ROA b
Internal Growth Rate
1 - ROA b
.1263 .5
.0674
1 .1263 .5
6.74% 4-18
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THE SUSTAINABLE GROWTH RATE
4-20
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IMPORTANT QUESTIONS
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QUICK QUIZ
• What is the purpose of long-range planning?
• What are the major decision areas involved in
developing a plan?
• What is the percentage of sales approach?
• How do you adjust the model when operating
at less than full capacity?
• What is the internal growth rate?
• What is the sustainable growth rate?
• What are the major determinants of growth?
4-22
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ETHICS ISSUES
4-23
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COMPREHENSIVE PROBLEM
4-24
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CHAPTER 4
END OF CHAPTER
4-25
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