Ch05 PPT Brighamfm1ce

PowerPoint Presentation
prepared by
Traven Reed Canadore College
chapter 5
Financial Planning and Forecasting Financial Statements
Corporate Valuation and Financial Planning

CH5
Copyright 2011 by Nelson Education Ltd. All rights reserved.
5-3
Topics in Chapter
CH5
Financial planning Additional Funds Needed (AFN) formula Pro forma financial statements
Sales forecasts Percent of sales method
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Overview of Financial Planning

CH5
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
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Financial Planning Process

CH5
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
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Sales Forecast
CH5
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
2009 Balance Sheet (Millions of $)

CH5
Cash $ 10 ST-invest 0 375 Accounts rec. 615 Inventories Total CA $1,000 Net fixed assets 1,000 Total assets $2,000
$ 60 Accts. pay. Accruals $ 140 Notes payable 110 Total CL $ 310 L-T bonds 754 40 Pref. stk 130 Com. stk Ret. earnings 766 Total claims $2,000
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2009 Income Statement (Millions of $)

CH5
Sales Costs except Depr (60%) Depreciation EBIT Interest EBT Taxes (40%) NI before pref. div preferred dividends Net income for com. Dividends (50.7%) Addn to RE
$3,000.00 2,616.20 100.00 $ 283.80 88.00 $ 195.80 78.30 117.50 4.00 $ 113.50 $57.50 $56.00
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AFN (Additional Funds Needed): Key Assumptions

CH5
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.
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Definitions of Variables in AFN

CH5
A*/S0: assets required to support sales; called capital intensity ratio. S: change in sales. L*/S0: spontaneous liabilities-tosales ratio M: profit margin (Net income/sales) RR: retention ratio; percent of net income not paid as dividend.
5-11
Assets vs. Sales

CH5
Assets
2,200 2,000
Assets = 0.67 sales

( Assets = (A*/S0)(Sales = 0.67($300) = $200.
0 3,000 3,300 A*/S0 = $2,000/$3,000 = 0.67 = $2,200/$3,300

Sales
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If sales increase by $300 million, what is the AFN?

CH5
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
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How would increases in these items affect the AFN?

CH5
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.
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How would increases in these items affect the AFN? (contd)

CH5
Higher profit margin:

Increases funds available internally, decreases AFN.
Pay suppliers sooner:

Decreases spontaneous liabilities, increases AFN.
5-15
Forecasted Financial Statement (FFS) Method

CH5
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
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Projecting Pro Forma Statements with the Percent of Sales Method

CH5
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
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CH5
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
Sources of Financing Needed to Support Asset Requirements

CH5
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
5-19
Implications of AFN
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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.
5-20
How to Forecast Interest Expense

CH5
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
5-21
Basing Interest Expense on Debt at End of Year

CH5
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.
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Basing Interest Expense on Debt at Beginning of Year

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Will under-estimate interest expense if debt is added throughout the year instead of all on December 31. But doesnt cause problem of circularity.
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Basing Interest Expense on Average of Beginning and Ending Debt

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Will accurately estimate the interest payments if debt is added smoothly throughout the year. But has problem of circularity.
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A Solution that Balances Accuracy and Complexity

CH5
Base interest expense on beginning debt, but use a slightly higher interest rate.
Easy to implement Reasonably accurate
5-25
Percent of Sales: Inputs

CH5
Costs ex Depr/Sales
Cash/Sales Acct. rec./Sales Inv./Sales Net FA/Sales AP/Sales Accruals/sales
2009 Actual 87.2% 0.33% 12.5% 20.5% 33.3% 2% 4.67%
2010 Proj. 87.2% 0.33% 12.5% 20.5% 33.3% 2% 4.67%

5-26
Other Inputs
CH5
Percent growth in sales Interest rate on debt Tax rate Dividend payout rate
10% 11% 40% 50.7%
5-27
2010 Preliminary Forecasted Income Statement

CH5
Calculations
Sales Less: Costs ex. depreciation Depre. expenses EBIT Interest EBT Taxes (40%) NI before pref. dividend Pref. dividend Net income to com. (50,000,000 shares) Dividend Add to RE # of shares 108%DPS09 0.09(STD09) + 0.11(LTD09) = 1.10 Sales09 = 87.2% Sales10 = 10% FA10 =
2010 Preliminary
$3,300.0 2,877.6 110.0 $312.4 92.8 $219.6 87.8 $131.8 4.0 $127.8 $62.5 $65.3*
5-28
2010 Balance Sheet (Assets)

CH5
Cash Accts Rec. Inventories Total CA Net FA Total Assets
Calcuations 0.33% Sales10 = 12.5%Sales10 = 20.5%Sales10 = 33.3% Sales10 =
2010 $11.0 412.5 676.5 $1,100.0 1,100.0 $2,200.0
5-29
2010 Preliminary Balance Sheet (Liabilities & Equity)

CH5
2009 AP Accruals Nt. pay. Total CL L-T debt Pref. stk Com. stk Ret earn T. L & E. 754 40 130 766 60 140 110
Calculations 2% Sales10 = 4.67% Sales10 = Plug technique Carried over Carried over Carried over +65.3*
Forecast for 2010 $66.0 $154.0 224.7 $444.7 754.0 40.0 130.0 831.3 $2,200.0
5-30
What are the additional funds needed (AFN)?

CH5
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.
5-31
Assumptions about how AFN will be raised

CH5
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
5-32
2010 Balance Sheet (Liabilities and Equity)

CH5
w/o AFN
AP Accruals Notes payable Total CL L-T Debt Preferred stk Common stk Ret earnings Total claims $66.0 154.0 110.0 $330.0 754.0 40.0 130.0 831.3 $2,085.3
AFN
With AFN
$66.0 154.0 224.7 $444.7 754.0 40.0 130.0 831.3 $2,200.0
5-33
+114.7
Equation AFN = $118.42 vs. Pro Forma AFN = $114.7

CH5
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.
5-34
Forecasted Ratios
CH5
Actual 2009 Forecast 2010
Industry
Current ratio Inv turnover DSO (days) TA turnover Debt ratio Profit Margin ROA ROE ROIC
3.2x 4.9x 45.6 1.5x 53.2% 3.8% 5.7% 12.7% 9.5%
2.5x 4.9x 45.6 1.5x 40.98% 3.9% 5.8% 13.3% 9.5%
4.2x 9.0x 36.0 1.8x 40.0% 5.0% 9.0% 15.0% 11.4%

5-35
What are the forecasted free cash flow and ROIC?

CH5
Net operating WC (CA - AP & accruals) Total operating capital (Net op. WC + net FA) NOPAT (EBITx(1-T)) Less Inv. in op. capital Free cash flow ROIC (NOPAT/Capital)
2009 $800.0
2010 $880.0
$1,800.0 $1,980.0 $170.3 -$174.7 $187.4 $180.0 $7.4 9.5%

5-36
Proposed Improvements
CH5
Before Tight up credit policy: Accts. rec./Sales Control inventory: Inventory/Sales Lay off workers: Op. costs (excluding depreciation)/Sales 12.5% 20.5% 87.2%
After 11.8% 16.7% 86.0%
5-37
Impact of Improvements
CH5
Before
DSO (days) Inventory turnover NOPAT Net Op. WC Tot. Op. capital Free cash flows AFN ROIC ROE 45.6 4.9x $187.4 $880.0 $1,980.0 $7.4 $114.7 9.5% 13.3%
After
43.1 6.0x $211.2 $731.5 $1,831.5 $179.7 -$57.5 11.5% 15.4%
5-38
Economies of Scale
CH5
400 300
a
0
Assets
Base Stock 200 400
Declining A/S Ratio Sales
$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.
5-39
Lumpy Assets
CH5
Assets
1,500 1,000 500 Sales 500 1,000 2,000
A/S changes if assets are lumpy. Generally will have excess capacity, but eventually a small (S leads to a large (A.
5-40
CH5
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
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
Summary: How different factors affect the AFN forecast.

CH5
Excess capacity: lowers AFN. Economies of scale: leads to lessthan-proportional asset increases. Lumpy assets: leads to large periodic AFN requirements, recurring excess capacity.
5-43

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PowerPoint Presentation

Traven Reed Canadore College

Corporate Valuation and Financial Planning

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Overview of Financial Planning

Three important purposes:

Financial Planning Process

2009 Balance Sheet (Millions of $)

Copyright 2011 by Nelson Education Ltd. All rights reserved.

2009 Income Statement (Millions of $)

Copyright 2011 by Nelson Education Ltd. All rights reserved.

AFN (Additional Funds Needed): Key Assumptions

Definitions of Variables in AFN

Assets vs. Sales

Assets = 0.67 sales

0 3,000 3,300 A*/S0 = $2,000/$3,000 = 0.67 = $2,200/$3,300

If sales increase by $300 million, what is the AFN?

How would increases in these items affect the AFN?

Higher dividend payout ratio:

Higher capital intensity ratio, A*/S0:

How would increases in these items affect the AFN? (contd)

Higher profit margin:

Pay suppliers sooner:

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Forecasted Financial Statement (FFS) Method

Projecting Pro Forma Statements with the Percent of Sales Method

Projecting Pro Forma Statements with the Percent of Sales Method

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Sources of Financing Needed to Support Asset Requirements

Given the previous assumptions and choices, we can estimate:

Additional funds needed (AFN) is:

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Copyright 2011 by Nelson Education Ltd. All rights reserved.

How to Forecast Interest Expense

Basing Interest Expense on Debt at End of Year

Basing Interest Expense on Debt at Beginning of Year

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Basing Interest Expense on Average of Beginning and Ending Debt

Copyright 2011 by Nelson Education Ltd. All rights reserved.

A Solution that Balances Accuracy and Complexity

Copyright 2011 by Nelson Education Ltd. All rights reserved.

Percent of Sales: Inputs

Cash/Sales Acct. rec./Sales Inv./Sales Net FA/Sales AP/Sales Accruals/sales

2009 Actual 87.2% 0.33% 12.5% 20.5% 33.3% 2% 4.67%

2010 Proj. 87.2% 0.33% 12.5% 20.5% 33.3% 2% 4.67%

Copyright 2011 by Nelson Education Ltd. All rights reserved.

10% 11% 40% 50.7%

Copyright 2011 by Nelson Education Ltd. All rights reserved.

2010 Preliminary Forecasted Income Statement

Copyright 2011 by Nelson Education Ltd. All rights reserved.

2010 Balance Sheet (Assets)

Cash Accts Rec. Inventories Total CA Net FA Total Assets

Calcuations 0.33% Sales10 = 12.5%Sales10 = 20.5%Sales10 = 33.3% Sales10 =

2010 $11.0 412.5 676.5 $1,100.0 1,100.0 $2,200.0

Copyright 2011 by Nelson Education Ltd. All rights reserved.

2010 Preliminary Balance Sheet (Liabilities & Equity)

Copyright 2011 by Nelson Education Ltd. All rights reserved.

What are the additional funds needed (AFN)?

Assumptions about how AFN will be raised

2010 Balance Sheet (Liabilities and Equity)

Copyright 2011 by Nelson Education Ltd. All rights reserved.