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Chap018

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Morten Andersen

This document discusses long-term financial planning. It explains that long-term planning focuses on goals, investments, financing needs, dividend policies and debt ratios. Percentage of sales models are introduced, where sales forecasts drive most other variables. Planning models can explore alternative strategies but do not determine the best plan or whether growth creates shareholder value. External financing may be needed if growth exceeds the internal growth rate, which is the maximum sustainable without new funds.

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McGraw-Hill/Irwin Copyright 息 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Long-Term Financial Planning Financial plans establish a firms financial goals and provide a benchmark for evaluating 18-2 performance. This chapter analyzes long-term financial plans and provides a discussion of growth.
Financial Planning Firms plan for both the short term and the long 18-3 term. Planning Horizon Short-term planning: Plans for the next 12 months. Long-term planning: Plans that exceed the next 12 months.
Long-Term Planning 18-4 Long-term planning focuses on: Long-term financial goals Investments required to meet these goals Financing that must be obtained Dividend policies Appropriate debt ratios
Focus on the Big Picture Financial plans combine the planning of managers at every level, but they also reflect senior managements strategic 18-5 plans. Firms dont plan on a project-by-project basis. Small projects are aggregated and treated as one large project. Best Case Scenario Normal Growth Scenario Worst Case Scenario 3 Plans in One:
Why Build Financial Plans? 18-6 Contingency Planning Considering Options Forcing Consistency
Financial Planning Models Financial planning models help planners explore the consequences of alternative strategies. The effects of a change in sales on working capital will be seen in which section of a financial plan? 18-7
Percentage of Sales Models 18-8 Percentage of Sales Models Planning model in which sales forecasts are the driving variables and most other variables are proportional to sales. Why are they useful? Balancing Item Variable that adjusts to maintain the consistency of a financial plan.
Percentage of Sales Models: 18-9 Example A forecast using a percentage of sales model expects sales to increase by 12% annually over the next five years. If costs are proportional to sales at 80%, and last year's sales were $1,000, what is the projected net income in year 5? Projected sales in year 5: Projected COGS in year 5:
Planning Model: Example Assume this years financial statements are as follows: Calculate pro forma statements for 2012, assuming: 1.Sales and operating costs are expected to grow 10%. 2.Interest rates will remain constant. 3.The firm will continue to pay 2/3 earnings in dividends. 4.The firm will need 10% more fixed assets and net working capital next year to support the higher sales volume. 18-10
Planning Model: Example 2,200 10% higher 1,980 10% higher 220 10% higher 40 Unchanged 180 EBIT - Interest 72 40% of (EBIT Interest) 108 EBIT Interest - Taxes 72 2/3 Net Income 36 Net Income - Dividends 220 10% higher 880 10% higher 1,100 10% higher 400 Temporarily Fixed 636 Increased by retained earnings 1,036 Debt + Equity 64 Balancing Required External Financing Item (1,100 1,036) 18-11
Planning Model: Example Assuming the firm uses debt as its balancing item, the 2nd round pro forma balance sheet will look like this: Notice how the statement once again balances after use of 18-12 the plug item.
Planning Model Limits 18-13 Pitfalls in Model Design Percentage of Sales Models Assumptions Fixed assets arent added in small increments
Planning Model Limits Planning models do not tell which plan is best Models can tell how much money the firm must raise to fund its planned growth, but not whether that growth contributes to shareholder value. 18-14
External Financing and Growth 18-15
External Financing and Growth Example: A firms financial planners have projected a growth rate of 12% for the coming year. Currently, it has assets of $8,000,000 and retained earnings of $480,000. How much external financing will the firm need? 18-16 -
Internal Growth Rate 18-17
Internal Growth Rate: Example What is the maximum internal growth rate consistent with not requiring external funding for a firm reporting net income of $850,000, a dividend payout ratio of 35%, and total assets of $14 million? 18-18
Sustainable Growth Rate The steady rate at which a firm can grow without changing leverage. How is the sustainable growth rate different from the 18-19 internal growth rate?
Sustainable Growth Rate: 18-20 Example Calculate the rate at which a firm can grow without changing its leverage if its payout ratio is 35%; equity outstanding at the beginning of the year is $8,000,000; and its net income for the year is $1,500,000.

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Chap018

  • 1. McGraw-Hill/Irwin Copyright 息 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
  • 2. Long-Term Financial Planning Financial plans establish a firms financial goals and provide a benchmark for evaluating 18-2 performance. This chapter analyzes long-term financial plans and provides a discussion of growth.
  • 3. Financial Planning Firms plan for both the short term and the long 18-3 term. Planning Horizon Short-term planning: Plans for the next 12 months. Long-term planning: Plans that exceed the next 12 months.
  • 4. Long-Term Planning 18-4 Long-term planning focuses on: Long-term financial goals Investments required to meet these goals Financing that must be obtained Dividend policies Appropriate debt ratios
  • 5. Focus on the Big Picture Financial plans combine the planning of managers at every level, but they also reflect senior managements strategic 18-5 plans. Firms dont plan on a project-by-project basis. Small projects are aggregated and treated as one large project. Best Case Scenario Normal Growth Scenario Worst Case Scenario 3 Plans in One:
  • 6. Why Build Financial Plans? 18-6 Contingency Planning Considering Options Forcing Consistency
  • 7. Financial Planning Models Financial planning models help planners explore the consequences of alternative strategies. The effects of a change in sales on working capital will be seen in which section of a financial plan? 18-7
  • 8. Percentage of Sales Models 18-8 Percentage of Sales Models Planning model in which sales forecasts are the driving variables and most other variables are proportional to sales. Why are they useful? Balancing Item Variable that adjusts to maintain the consistency of a financial plan.
  • 9. Percentage of Sales Models: 18-9 Example A forecast using a percentage of sales model expects sales to increase by 12% annually over the next five years. If costs are proportional to sales at 80%, and last year's sales were $1,000, what is the projected net income in year 5? Projected sales in year 5: Projected COGS in year 5:
  • 10. Planning Model: Example Assume this years financial statements are as follows: Calculate pro forma statements for 2012, assuming: 1.Sales and operating costs are expected to grow 10%. 2.Interest rates will remain constant. 3.The firm will continue to pay 2/3 earnings in dividends. 4.The firm will need 10% more fixed assets and net working capital next year to support the higher sales volume. 18-10
  • 11. Planning Model: Example 2,200 10% higher 1,980 10% higher 220 10% higher 40 Unchanged 180 EBIT - Interest 72 40% of (EBIT Interest) 108 EBIT Interest - Taxes 72 2/3 Net Income 36 Net Income - Dividends 220 10% higher 880 10% higher 1,100 10% higher 400 Temporarily Fixed 636 Increased by retained earnings 1,036 Debt + Equity 64 Balancing Required External Financing Item (1,100 1,036) 18-11
  • 12. Planning Model: Example Assuming the firm uses debt as its balancing item, the 2nd round pro forma balance sheet will look like this: Notice how the statement once again balances after use of 18-12 the plug item.
  • 13. Planning Model Limits 18-13 Pitfalls in Model Design Percentage of Sales Models Assumptions Fixed assets arent added in small increments
  • 14. Planning Model Limits Planning models do not tell which plan is best Models can tell how much money the firm must raise to fund its planned growth, but not whether that growth contributes to shareholder value. 18-14
  • 15. External Financing and Growth 18-15
  • 16. External Financing and Growth Example: A firms financial planners have projected a growth rate of 12% for the coming year. Currently, it has assets of $8,000,000 and retained earnings of $480,000. How much external financing will the firm need? 18-16 -
  • 18. Internal Growth Rate: Example What is the maximum internal growth rate consistent with not requiring external funding for a firm reporting net income of $850,000, a dividend payout ratio of 35%, and total assets of $14 million? 18-18
  • 19. Sustainable Growth Rate The steady rate at which a firm can grow without changing leverage. How is the sustainable growth rate different from the 18-19 internal growth rate?
  • 20. Sustainable Growth Rate: 18-20 Example Calculate the rate at which a firm can grow without changing its leverage if its payout ratio is 35%; equity outstanding at the beginning of the year is $8,000,000; and its net income for the year is $1,500,000.

Editor's Notes

  • #2: Chapter 18 Learning Objectives Describe the contents and uses of a financial plan. Construct a simple financial planning model. Estimate the effect of growth on the need for external financing.
  • #3: Chapter 18 Outline Financial Planning Long-term vs. Short-term Planning Why Plan? 3 Reasons for Financial Planning Financial Planning Models Percentage of Sales Models Planning Model Limits Common Pitfalls External Financing and Growth Internal Growth Rate Sustainable Growth Rate
  • #4: Short-term planning: Plans for the next 12 months. Long-term planning: Plans for greater than 12 months and beyond. Planning Horizon Time horizon for a financial plan. A typical planning horizon for long-term plans is 5 years.
  • #7: Contingency Planning: Financial plans allow managers to formulate quick responses to inevitable surprises. Considering Options: Financial plans often include plans to enter new markets for mere strategic reasons, not due to an immediate positive NPV Forcing Consistency: Financial plans force managers at all levels to adhere to the same standards of measure and success metrics. Note: While financial models ensure consistency between growth assumptions and financing plans, they do not identify the best financing plan.
  • #8: Pro Formas Projected or forecast financial statements.
  • #9: Percentage of Sales Model Planning model in which sales forecasts are the driving variables and most other variables are proportional to sales. Balancing Item Variable that adjusts to maintain the consistency of a financial plan. Also called a plug item. Example: Suppose a firm commits to a dividend of $100 and raises any extra money it needs by an issue of debt. In this case, debt is the balancing item.
  • #12: Note: The assets and liabilities do not equal in the first round pro forma statement, therefore we must use a plug item.
  • #14: Many models neglect to account for: Depreciation Short-term debt Changes in Leverage Percentage of Sales Models have unrealistic assumptions: In reality assets may not be proportional to sales % of sales models dont adequately account for increases in fixed assets
  • #16: As the firms projected growth rate increases, more funds are needed to pay for the necessary investments. Therefore, the line is upward-sloping. For high rates of growth the firm must issue new securities to pay for new investments. Where the sloping line crosses the horizontal axis, external financing is zero; the firm is growing as fast as possible without resorting to new security issues. This is called the internal growth rate.
  • #20: Sustainable Growth Rate Steady rate at which a firm can grow without changing leverage.