Business finance ch 17 financial planning and forecasting

CHAPTER 17 Financial Planning and Forecasting     Forecasting sales Projecting the assets and internally generated funds Projecting outside funds needed Deciding how to raise funds 17-1 Balance sheet (2002), in millions of dollars Cash & sec Accounts rec Inventories Total CA Net fixed assets Total assets $ 20 Accts pay & accruals 240 Notes payable 240 Total CL $ 500 L-T debt Common stock Retained 500 earnings $1,000 Total claims $ 100 100 $ 200 100 500 200 $1,000 17-2 Income statement (2002), in millions of dollars 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 Key ratios 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 Key assumptions      Operating at full capacity in 2002 Each type of asset grows proportionally with sales Payables and accruals grow proportionally with sales 2002 profit margin (2.52%) and payout (30%) will be maintained Sales are expected to increase by $500 million (%∆S = 25%) 17-5 Determining additional funds needed, using the AFN equation 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 17-6 How shall AFN be raised?    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 17-7 Forecasted Income Statement (2003) 2002 Sales Less: VC FC EBIT Interest EBT Taxes (40%) Net income $2,000 1,200 700 $ 100 16 $ 84 34 $ 50 Div (30%) Add’n to RE $15 $35 Forecast Basis 2003 Forecast 1.25 0.60 0.35 $2,500 1,500 875 $ 125 16 $ 109 44 $ 65 $19 $46 17-8 Forecasted Balance Sheet (2003) Assets 2002 Cash Accts rec Inventories Total CA Net FA Total assets $ 20 240 240 $ 500 500 $1,000 Forecast Basis 0.01 0.12 0.12 0.25 2003 1st Pass $ 25 300 300 $ 625 625 $1,250 17-9 Forecasted Balance Sheet (2003) Liabilities and Equity Forecast 2003 AP/accruals Notes payable Total CL L-T debt Common stk Ret.earnings Total claims 2002 Basis 1st Pass $ 100 100 $ 200 100 500 200 $1,000 0.05 $ 125 100 $ 225 100 500 246 $1,071 +46* * From income statement 17-10 What is the additional financing needed (AFN)?     Required increase in assets = $ 250 Spontaneous increase in liab =$ Increase in retained earnings =$ Total AFN = $ 179 25 46 NWC must have the assets to generate forecasted sales The balance sheet must balance, so we must raise $179 million externally 17-11 How will the AFN be financed?  Additional N/P   Additional L-T debt   0.5 ($179) = $89.50 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 17-12 Forecasted Balance Sheet (2003) Assets – 2nd pass 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 17-13 Forecasted Balance Sheet (2003) nd Liabilities and Equity – 2003 2003 Pass Pass AFN pass st AP/accruals Notes payable Total CL L-T debt Common stk Ret.earnings Total claims $ 125 100 $ 225 100 500 246 $1,071 nd +89.5 +89.5 - $ 125 190 $ 315 189 500 246 $1,250 * From income statement 17-14 Why the AFN equation and financial statement method have different results?   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 Forecasted ratios (2003) 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 What was the net investment in operating capital?  OC2003 $1,125 = NOWC + Net FA = $625 - $125 + $625  OC2002  Net investment in OC = = $900 = $1,125 - $900 = $225 17-17 How much free cash flow is expected to be generated in 2003? FCF = NOPAT– Net inv in OC = EBIT (1 – T) – Net inv in OC = $125 (0.6) – $225 = $75 – $225 = -$150 17-18 Suppose fixed assets had only been operating at 75% of capacity in 2002   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 How would the excess capacity situation affect the 2003 AFN?   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 If sales increased to $3,000 instead, what would be the fixed asset requirement?  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 How would excess capacity affect the forecasted ratios?  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 Forecasted ratios (2003) with projected 2003 sales of $2,500 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 How is NWC managing its receivables and inventories?  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 How would the following items affect the AFN?  Higher dividend payout ratio?   Higher profit margin?   Decrease AFN: Higher profits, more retained earnings Higher capital intensity ratio?   Increase AFN: Less retained earnings Increase AFN: Need more assets for given sales Pay suppliers in 60 days, rather than 30 days?  Decrease AFN: Trade creditors supply more capital (i.e., L*/S0 increases) 17-25 ... must balance, so we must raise $179 million externally 17- 11 How will the AFN be financed?  Additional N/P   Additional L-T debt   0.5 ( $179 ) = $89.50 0.5 ( $179 ) = $89.50 But this financing... income statement 17- 14 Why the AFN equation and financial statement method have different results?   Equation method assumes a constant profit margin, a constant dividend payout, and a constant... O K 17- 16 What was the net investment in operating capital?  OC2003 $1,125 = NOWC + Net FA = $625 - $125 + $625  OC2002  Net investment in OC = = $900 = $1,125 - $900 = $225 17- 17 How much