CHAPTER 9

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
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Income statement (2002), in millions of dollars

Sales Less: Var. costs (60%) Fixed costs $2,000.00 1,200.00 700.00 $ 100.00 16.00 $ 84.00 33.60 $ 50.40 $15.12 $35.28
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EBIT Interest EBT Taxes (40%) Net income

Dividends (30%) Addn to RE

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%)
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Determining additional funds needed, using the AFN equation

AFN = (A*/S0)S (L*/S0) S M(S1)(RR) = ($1,000/$2,000)($500) ($100/$2,000)($500) 0.0252($2,500)(0.7) = $180.9 million.

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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.

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Forecasted Income Statement (2003)

2002 Forecast Basis 2003 Forecast

Sales Less: VC FC EBIT Interest EBT Taxes (40%) Net income Div. (30%) Addn to RE

$2,000 1,200 700 $ 100 16 $ 84 34 $ 50 $15 $35

1.25 0.60 0.35

$2,500 1,500 875 $ 125 16 $ 109 44 $ 65 $19 $46

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Forecasted Balance Sheet (2003) Assets

2002 Forecast Basis 2003 1st Pass

Cash Accts. rec. Inventories Total CA Net FA Total assets

20 240 240 $ 500 500 $1,000

0.01 0.12 0.12 0.25

25 300 300 $ 625 625 $1,250

17-9

Forecasted Balance Sheet (2003) Liabilities and Equity

2002 Forecast Basis 2003 1st Pass

AP/accruals Notes payable Total CL L-T debt Common stk. Ret.earnings Total claims

$ 100 100 $ 200 100 500 200 $1,000

0.05

+46*

$ 125 100 $ 225 100 500 246 $1,071

* From income statement.

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What is the additional financing needed (AFN)?

Required increase in assets = $ 250 Spontaneous increase in liab. =$ 25 Increase in retained earnings =$ 46 Total AFN = $ 179 NWC must have the assets to generate forecasted sales. The balance sheet 17-11 must balance, so we must raise $179

How will the AFN be financed?

Additional N/P

0.5 ($179) = $89.50 0.5 ($179) = $89.50

Additional L-T debt

But this financing will add to interest expense, which will lower NI and retained earnings. We will generally ignore financing feedbacks.
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Forecasted Balance Sheet (2003) Assets 2nd pass

2003 1st Pass AFN 2003 2nd Pass

Cash Accts. rec. Inventories Total CA Net FA Total assets

25 300 300 $ 625 625 $1,250

25 300 300 $ 625 625 $1,250

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(2003) Liabilities and Equity 2nd pass

2003 1st Pass AFN 2003 2nd Pass

AP/accruals Notes payable Total CL L-T debt Common stk. Ret.earnings Total claims

$ 125 100 $ 225 100 500 246 $1,071

+89.5 +89.5 -

$ 125 190 $ 315 189 500 246 $1,250

* From income statement.

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Why do 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.
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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.
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What was the net investment in operating capital?

OC2003

= NOWC + Net FA = $625 - $125 + $625 = $1,125

OC2002

= $900

Net investment in OC = $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.

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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 more than 2003 forecasted sales, no additional fixed assets are 17-19 needed.

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.

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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

FA = 0.1875 ($333) = $62.4

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