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Session 3 Chapter 4 Long Term Financial Planning and Growth
Session 3 Chapter 4 Long Term Financial Planning and Growth
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Learning Objectives
Financial Planning
2
Financial Planning
Anticipating Establish
problems before guidelines for
they arrive change and growth
3
Elements of Financial Planning
Investment in new assets – determined by capital budgeting
decisions
4
Financial Planning Process
5
Role of Financial Planning
Examine interactions
• help management see the interactions between decisions
Explore options
• give management a systematic framework for exploring its opportunities
Avoid surprises
• help management identify possible outcomes and plan accordingly
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Financial Planning Model Ingredients
• Sales Forecast – many cash flows depend directly on the level of sales (often
estimated using sales growth rate)
• Asset Requirements – the additional assets that will be required to meet sales
projections
• The effect of this approach imply that the profit margin remain
constant 13.2% (look at book RWJ 2nd edition page 100).
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Rosengarten Income Statement
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Rosengarten Balance sheet- Unbalanced
• Inspecting our pro forma balance sheet reveals a discrepancy: Assets and liabilities and equity not
balanced, which we know that it should be balance!!
• The shortfall is called external financing needed “EFN” or the plug variable
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Percentage of Sales Approach
• Some items vary directly with sales, while others do not
• Income Statement
Costs may vary directly with sales - if this is the case, then the profit margin is
constant
Depreciation and interest expense may not vary directly with sales – if this is the
case, then the profit margin is not constant
Dividends are a management decision and generally do not vary directly with sales
– this influences additions to retained earnings
• Balance Sheet
Initially assume all assets, including fixed, vary directly with sales
Accounts payable will also normally vary directly with sales
Notes payable, long-term debt and equity generally do not vary directly with
sales because they depend on management decisions about capital structure
The change in the retained earnings portion of equity will come from the dividend
decision 12
Example 2: Hoffman Company
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Hoffman Income Statement
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Hoffman Balance sheet - unbalances
• After adding the $52.8 into retained earnings, the balance sheet is not balance
• But it should be!
• Thus the plug variable is 47.2
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Financing Policy and Growth
• The internal growth rate tells us how much the firm can
grow assets using retained earnings as the only source of
financing.
• The internal growth rate assumes that the dividend
payout ratio is constant.
• Using the information from Tasha’s Toy Emporium
ROA = 1200 / 9500 = .1263
b = retention ratio = (1 – dividend payout ratio) = .5
ROA b
Internal Growth Rate
1 - ROA b
.1263 .5
.0674
1 .1263 .5
6.74%
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The Sustainable Growth Rate
• The sustainable growth rate tells us how much the firm can
grow by using internally generated funds and issuing debt to
maintain a constant debt-equity ratio.
• Assumptions:
• The sustainable growth rate also assumes that the dividend payout ratio is
constant
• No new external equity is issued, but debt increases with growth
• Using Tasha’s Toy Emporium
ROE = 1200 / 4100 = .2927
b = .5
ROE×b
Sustainable Growth Rate =
1−ROE×b 17
Determinants of Growth
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