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Long-Term Financial Planning and Growth: Mcgraw-Hill/Irwin Corporate Finance, 7/E
Long-Term Financial Planning and Growth: Mcgraw-Hill/Irwin Corporate Finance, 7/E
CHAPTER
3
Long-Term Financial
Planning and Growth
McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
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Chapter Outline
3.1 What is Financial Planning?
3.2 A Financial Planning Model: The Ingredients
3.3 The Percentage Sales Method
3.4 What Determines Growth?
3.5 Some Caveats of Financial Planning Models
3.6 Summary and Conclusions
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Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
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Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
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Scenario Analysis
Each division might be asked to prepare three
different plans for the near term future:
A Worst Case
A Normal Case
A Best Case
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Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
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Interactions
The plan must make explicit the linkages between investment
proposals and the firm’s financing choices.
Options
The plan provides an opportunity for the firm to weigh its
various options.
Feasibility
Avoiding Surprises
Nobody plans to fail, but many fail to plan.
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Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
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Sales Forecast
All financial plans require a sales forecast.
Perfect foreknowledge is impossible since sales
depend on the uncertain future state of the
economy.
Businesses that specialize in macroeconomic and
industry projects can be help in estimating sales.
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Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
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Asset Requirements
The financial plan will describe projected capital
spending.
In addition it will the discuss the proposed uses
of net working capital.
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Financial Requirements
The plan will include a section on financing
arrangements.
Dividend policy and capital structure policy
should be addressed.
If new funds are to be raised, the plan should
consider what kinds of securities must be sold
and what methods of issuance are most
appropriate.
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Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
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Plug
Compatibility across various growth targets will usually
require adjustment in a third variable.
Suppose a financial planner assumes that sales, costs,
and net income will rise at g 1. Further, suppose that the
planner desires assets and liabilities to grow at a
different rate, g 2. These two rates may be incompatible
unless a third variable is adjusted. For example,
compatibility may only be reached is outstanding stock
grows at a third rate, g3.
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Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.
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Economic Assumptions
The plan must explicitly state the economic
environment in which the firm expects to
reside over the life of the plan.
Interest rate forecasts are part of the plan.
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A Brief Example
The Rosengarten Corporation is think of acquiring a new
machine. The machine will increase sales from $20
million to $22 million—10% growth.
The firm believes that its assets and liabilities grow directly
with its level of sales. Its profit margin on sales is 10%,
and its dividend-payout ratio is 50%.
Will the firm be able to finance growth in sales with
retained earnings and forecast increases in debt?
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A Brief Example
Current Balance Sheet Pro forma Balance Sheet
(millions) (millions) Explanation
Current assets $6 $6.6 30% of sales
Assets Debt
Sales ΔSales ( p Projected Sales) (1 d )
Sales Sales
(1.5 $2m) (0.80 $2m) (0.10 $22m 0.5)
$1.4m $1.1m
$300,000
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D
p (1 d ) (1 )
S E
S 0 T ( p (1 d ) (1 D )
E
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The Sustainable
Growth Rate in Sales
D
p (1 d ) (1 )
S E
S 0 T ( p (1 d ) (1 D )
E
T = ratio of total assets to sales
p = net profit margin on sales
d = dividend payout ratio
A good use of the sustainable growth rate is to compare a
firm’s sustainable growth rate with their actual growth
rate to determine if there is a balance between growth and
profitability.
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McGraw-Hill/Irwin
Corporate Finance, 7/e © 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.