ch05 ppt brighamfm1ce
Post on 02-Dec-2014
63 Views
Preview:
TRANSCRIPT
PowerPoint Presentationprepared by
Traven ReedCanadore College
chapter 5Financial Planning and Forecasting Financial
Statements
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-3
Corporate Valuation and Financial Planning
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-4
Topics in Chapter
• Financial planning• Additional Funds Needed (AFN)
formula• Pro forma financial statements
– Sales forecasts– Percent of sales method
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-5
Overview of Financial Planning
• Three important purposes:– Strategic plans: set appropriate
targets to meet the corporate objectives
– Operating plans: evaluate the impact of changes on the value of the firm
– Financial plans: forecast the amount of external financing that will be required
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-6
Financial Planning Process
• Forecast sales• Project the assets needed to
support sales• Project internally generated funds• Project outside funds needed• Decide how to raise funds• See effects of plan on ratios and
stock price
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved.
Sales Forecast
• An accurate sales forecast is critical to profitability.
• Forecasting the future sales growth starts with a review of sales during the past years using a regression approach
• Adjust the estimate with the reality if necessary
5-7
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-8
2009 Balance Sheet(Millions of $)
Cash $ 10 Accts. pay. Accruals $ 140
Accounts rec. 375 Notes payable 110Inventories 615 Total CL $ 310 Total CA $1,000 L-T bonds 754
Pref. stk130Net fixed
assetsCom. stkRet. earnings 766
Total assets $2,000 Total claims $2,000
1,000
$ 60ST-invest 0
$ 10
40
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-9
2009 Income Statement(Millions of $)
Sales $3,000.00Costs except Depr (60%) 2,616.20 Depreciation 100.00 EBIT $ 283.80Interest 88.00 EBT $ 195.80Taxes (40%) 78.30NI before pref. div
$ 113.50
Dividends (50.7%) $57.50Add’n to RE $56.00
4.00 117.50
preferred dividendsNet income for com.
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-10
AFN (Additional Funds Needed):Key Assumptions
• Operating at full capacity in 2009.• Each type of asset grows proportionally
with sales.• Payables and accruals grow
proportionally with sales.• 2009 profit margin ($113.5/$3,000 =
3.78%) and payout (50.7%) will be maintained.
• Sales are expected to increase by $500 million.
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-11
Definitions of Variables in AFN
• A*/S0: assets required to support sales; called capital intensity ratio.
• ∆S: change in sales.• L*/S0: spontaneous liabilities-to-
sales ratio• M: profit margin (Net income/sales)• RR: retention ratio; percent of net
income not paid as dividend.
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-12
Assets
Sales0
2,000
3,000
2,200
3,300A*/S0 = $2,000/$3,000 = 0.67 = $2,200/$3,300
Assets =(A*/S0)Sales= 0.67($300)= $200.
Assets = 0.67 sales
Assets vs. Sales
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-13
If sales increase by $300 million, what is the AFN?
AFN = (A*/S0)∆S - (L*/S0)∆S - M(S1)(RR)
AFN = Projected increase in assets – Spontaneous increase in liabilities – Increase in retained earnings
AFN = ($2,000/$3,000)($300)
- ($200/$3,000)($300)
- 0.0378($3,300)(1 – 0.507)
AFN = $118.42 million
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-14
How would increases in these items affect the AFN?
• Higher sales:– Increases asset requirements,
increases AFN.• Higher dividend payout ratio:
– Reduces funds available internally, increases AFN.
• Higher capital intensity ratio, A*/S0:– Increases asset requirements, increases
AFN.
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-15
• Higher profit margin:– Increases funds available internally,
decreases AFN.
• Pay suppliers sooner:– Decreases spontaneous liabilities, increases
AFN.
How would increases in these items affect the AFN? (cont’d)
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-16
Forecasted Financial Statement (FFS) Method
• Forecast the complete set of pro forma statements making the analysis reliable
• Information also provides financial ratios to evaluate different business plans
• Use the percentage of sales method• Begin with sales forecast, and estimate
the assets required to support the growth• Allow different asset/liability classes to
grow at different rates
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-17
• Forecast items as a percent of the forecasted sales (i.e. varying directly with sales)– Costs– Cash– Accounts receivable– Inventories– Net fixed assets– Accounts payable and accruals
Projecting Pro Forma Statements with the Percent of Sales Method
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved.
Projecting Pro Forma Statements with the Percent of Sales Method
• Choose other items that have no direct linear relationship with sales– Debt– Dividend policy (which determines
retained earnings)– Common stock
5-18
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-19
Sources of Financing Needed to Support Asset Requirements
• Given the previous assumptions and choices, we can estimate:– Required assets to support sales– Specified sources of financing
• Additional funds needed (AFN) is:– Required assets minus specified
sources of financing
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-20
Implications of AFN
• If AFN is positive, then you must secure additional financing.
• If AFN is negative, then you have more financing than is needed.– Pay off debt.– Buy back stock.– Buy short-term investments.
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-21
How to Forecast Interest Expense
• Interest expense is actually based on the daily balance of debt during the year.
• There are three ways to approximate interest expense based on: – Debt at end of year– Debt at beginning of year– Average of beginning and ending debt
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-22
Basing Interest Expense on Debt at End of Year
• Will over-estimate interest expense if debt is added throughout the year instead of all on January 1.
• Causes circularity called financial feedback: more debt causes more interest, which reduces net income, which reduces retained earnings, which causes more debt, etc.
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-23
Basing Interest Expense on Debt at Beginning of Year
• Will under-estimate interest expense if debt is added throughout the year instead of all on December 31.
• But doesn’t cause problem of circularity.
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-24
Basing Interest Expense on Average of Beginning and Ending Debt
• Will accurately estimate the interest payments if debt is added smoothly throughout the year.
• But has problem of circularity.
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-25
A Solution that Balances Accuracy and Complexity
• Base interest expense on beginning debt, but use a slightly higher interest rate.– Easy to implement– Reasonably accurate
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-26
Percent of Sales: Inputs
2009 Actual 2010 Proj.Costs ex Depr/Sales 87.2% 87.2%Cash/Sales 0.33% 0.33%Acct. rec./Sales 12.5% 12.5%Inv./Sales 20.5% 20.5%Net FA/Sales 33.3% 33.3%AP/Sales 2% 2%Accruals/sales 4.67% 4.67%
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-27
Other Inputs
Percent growth in sales 10%
Interest rate on debt 11%
Tax rate 40%
Dividend payout rate 50.7%
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-28
2010 Preliminary Forecasted Income Statement
Calculations 2010 PreliminarySales 1.10 Sales09 = $3,300.0
Less: Costs ex. depreciation 87.2% Sales10 = 2,877.6
Depre. expenses 10% FA10 = 110.0
EBIT $312.4
Interest 0.09(STD09) + 0.11(LTD09) =
92.8
EBT $219.6
Taxes (40%) 87.8
NI before pref. dividend $131.8
Pref. dividend 4.0
Net income to com. (50,000,000 shares) $127.8
Dividend # of shares ×108%DPS09
$62.5
Add to RE $65.3*
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-29
2010 Balance Sheet (Assets)
Calcuations 2010Cash 0.33% Sales10 = $11.0
Accts Rec. 12.5%Sales10 = 412.5
Inventories 20.5%Sales10 = 676.5
Total CA $1,100.0Net FA 33.3% Sales10 = 1,100.0
Total Assets $2,200.0
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-30
2010 Preliminary Balance Sheet (Liabilities & Equity)
2009 Calculations Forecast for 2010
AP 60 2% Sales10 = $66.0
Accruals 140 4.67% Sales10 = $154.0
Nt. pay. 110 Plug technique 224.7
Total CL $444.7
L-T debt 754 Carried over 754.0
Pref. stk 40 Carried over 40.0
Com. stk 130 Carried over 130.0
Ret earn 766 +65.3* 831.3
T. L & E. $2,200.0
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-31
What are the additional funds needed (AFN)?
• Required assets = $2,200.0• Specified sources of fin. = $2,085.3• Forecast AFN: $2,200 - $2,085.3 =
$114.7• NWC must have the assets to make
forecasted sales, and so it needs an equal amount of financing. So, we must secure another $114.7 of financing.
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-32
Assumptions about how AFN will be raised
• No new long-term bond, preferred stock or stock will be issued.
• Any external funds needed must be raised as notes payable.
• Additional notes payable = $114.7 giving a forecasted notes payable for 2010 as $224.7 = $110 + $114.7
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-33
2010 Balance Sheet (Liabilities and Equity)
w/o AFN AFN With AFNAP $66.0 $66.0
Accruals 154.0 154.0
Notes payable 110.0 +114.7 224.7
Total CL $330.0 $444.7
L-T Debt 754.0 754.0
Preferred stk 40.0 40.0
Common stk 130.0 130.0
Ret earnings 831.3 831.3
Total claims $2,085.3 $2,200.0
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-34
Equation AFN = $118.42 vs. Pro Forma AFN = $114.7
• Method using the AFN equation assumes a constant profit margin.
• Pro forma (FFS) method is more flexible. Importantly, the approach allows different items to grow at different rates. Use the plug technique to make sure the balance sheet is in order.
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-35
Forecasted RatiosActual 2009 Forecast 2010 Industry
Current ratio 3.2x 2.5x 4.2x
Inv turnover 4.9x 4.9x 9.0x
DSO (days) 45.6 45.6 36.0
TA turnover 1.5x 1.5x 1.8x
Debt ratio 53.2% 40.98% 40.0%
Profit Margin 3.8% 3.9% 5.0%
ROA 5.7% 5.8% 9.0%
ROE 12.7% 13.3% 15.0%
ROIC 9.5% 9.5% 11.4%
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-36
What are the forecasted free cash flow and ROIC?
2009 2010Net operating WC(CA - AP & accruals)
$800.0 $880.0
Total operating capital(Net op. WC + net FA)
$1,800.0 $1,980.0
NOPAT (EBITx(1-T))Less Inv. in op. capital
$170.3 $187.4$180.0
Free cash flow -$174.7 $7.4ROIC (NOPAT/Capital) 9.5%
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-37
Proposed Improvements
Before After
Tight up credit policy:Accts. rec./Sales 12.5% 11.8%Control inventory:Inventory/Sales 20.5% 16.7%Lay off workers:Op. costs (excluding depreciation)/Sales
87.2% 86.0%
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-38
Impact of ImprovementsBefore After
DSO (days) 45.6 43.1
Inventory turnover 4.9x 6.0x
NOPAT $187.4 $211.2
Net Op. WC $880.0 $731.5
Tot. Op. capital $1,980.0 $1,831.5
Free cash flows $7.4 $179.7
AFN $114.7 -$57.5
ROIC 9.5% 11.5%
ROE 13.3% 15.4%
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-39
Ass
ets
Sales0
400300
200 400
Declining A/S Ratio
$300/$200 = 1.5; $400/$400 = 1.0. Declining ratio shows economies of scale. Going from S = $0 to S = $200 requires $300 of assets. Next $200 of sales requires only $100 of assets.
BaseStock
Economies of Scale
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-40
Ass
ets
Sales1,000 2,000500
A/S changes if assets are lumpy. Generally will have excess capacity, but eventually a small S leads to a large A.
500
1,000
1,500
Lumpy Assets
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved.
If 2009 fixed assets had been operated at 96% of capacity:
• With the existing fixed assets, sales could be $3,125 million.
• Target fixed assets/sales = Actual fixed assets/full capital sales = $1,000/$3,125 = 0.32
• New required fixed assets = (target fixed assets/sales)(projected sales) = (0.32)($3,300) = $1,056 million
5-41
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved.
How would the excess capacity situation affect the 2010 AFN?
• With full capacity, the previously projected increase in fixed assets is $100m.
• The excess capacity makes the actual required increase be $56m only, with $44m less than before
• Projected AFN will fall to $70.7m = $114.7m - $44m
5-42
CH5
Copyright © 2011 by Nelson Education Ltd. All rights reserved. 5-43
Summary: How different factors affect the AFN forecast.
• Excess capacity: lowers AFN.• Economies of scale: leads to less-
than-proportional asset increases.• Lumpy assets: leads to large
periodic AFN requirements, recurring excess capacity.
top related