1 FINANCE 7311 CORPORATE FINANCIAL PLANNING. 2 FINANCIAL PLANNING l Long-Run CORPORATE OBJECTIVES Maximize the Value of the Firm Sub -objectives (INCREASE.

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FINANCE 7311FINANCE 7311

CORPORATE FINANCIAL PLANNING

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FINANCIAL PLANNINGFINANCIAL PLANNING

Long-Run CORPORATE OBJECTIVES Maximize the Value of the Firm

Sub-objectives (INCREASE MARKET SHARE)

STRATEGIES (STEPS) SPECIFIC ACTION PLAN SWOT ANALYSIS; 4 P’S

– (PRICE STRATEGY)

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Financial Planning, cont.Financial Planning, cont.

PERFORMANCE MEASUREMENTOJBECTIVE; SPECIFICWERE GOALS ACHIEVED?

(% MARKET SHARE)

BUSINESS PLAN => FINANCIAL PLANOperating & marketing strategies underlie a

financial plan

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USES OF FINANCIAL PLANUSES OF FINANCIAL PLAN

PROJECTION OF FINANCIAL NEEDS Financial implications of corporate

strategies

PERFORMANCE MEASUREMENT A benchmark which reflects strategies

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FINANCIAL MODELFINANCIAL MODEL

EQUATIONS A = D + E End Balance = Beg. Bal. + Add - Subtract

PARAMETERS Tax rate; NWC requirements

DECISION VARIABLES Investment; Financing

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COMPONENTSCOMPONENTS

PRO-FORMA FINANCIAL STMTS CASH BUDGET SPECIFIC BUDGETS

Production Personnel Marketing; distribution Capital

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PRO-FORMA B/S & I/SPRO-FORMA B/S & I/SSTEP 1: SALES FORECAST

Historical data Growth (size of pie & piece of pie) Capabilities (prod., mgmt, distrib.)

STEP 2: OTHER INFORMATION? YES ==> Use it Capital spending; Debt Schedule; ETC.

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Pro-Forma’s, cont.Pro-Forma’s, cont.

NO => Does Account Vary With Sales? NO ==> SAME BALANCE AS LAST YEAR YES ==> PERCENTAGE OF SALES

PERCENTAGE OF SALES APPROACH

Increase account by % change in sales Keeps acct/sales ratio constant Ratio analysis from before helpful

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% OF SALES EXAMPLE% OF SALES EXAMPLE

Last Year Sales: 10,000 Last Year Acct. Rec. 1,000 Forecast Sales Growth: 20% Forecast Sales: 10,000 X 1.2 = 12,000 Forecast Acct. Rec. 1,000 X 1.2 = 1,200 OR: 1,000/10,000 X 12,000 = 1,200

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% of SALES - COMMENTS% of SALES - COMMENTS

Method of Last ResortAssets / Sales ratio is optimalAssumes Full CapacityAssumes Assets / Sales relation is linear

Economies of Scale Less than full capacity Sales decreases

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Pro-Forma F/S, cont.Pro-Forma F/S, cont.STEP 3: EXTERNAL FINANCING

NEED

Balance Sheet Does Not Balance Plug is the Financing Need May use Cash or Debt as a Plug

STEP 4: B/S & I/S RELATIONS Net Income and Retained Earnings Depreciation Expense and Accumulated Depreciation Interest Expense and Debt

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Pro-Forma F/S, cont.Pro-Forma F/S, cont.

STEP 5: WHAT-IF ANALYSIS Use well-planned spreadsheet Put variables in separate cells

PRO-FORMA EXAMPLE: SAMPLE APPAREL COMPANY

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CASH BUDGETCASH BUDGET

Projection of future cash flowsPerformance benchmarkUseful for seasonal companies

More specific information

Provides same ‘financing’ need as pro-forma financial statements

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Cash Budget, cont.Cash Budget, cont.

STEP 1: Obtain a Sales Forecast Weekly, Monthly, etc.

STEP 2: Project Amount & Timing of Cash Inflows

Primarily collection of sales How do we estimate timing? What are other inflows?

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Cash Budget, cont.Cash Budget, cont.

STEP 3: Project amount & timing of cash outflows

Purchases Labor Capital Expenditures Dividends & interest Other Expenses

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Cash Budget, cont.Cash Budget, cont.

STEP 4: NET CASH FLOWSTEP 5: FINANCING NEED/SURPLUS NET CASH FLOW

+ BEGINNING CASH = ‘ENDING’ CASH - DESIRED CASH = FINANCING NEED (= B/S PLUG)

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GROWTHGROWTH

SOURCE OF SALES GROWTH: QUANTITY PRICE COMBINATION OF BOTH

QUANTITY INDUSTRY GROWTH (Pie) MARKET SHARE GROWTH (Piece of Pie)

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Two Growth RatesTwo Growth Rates

INTERNAL GROWTH RATE

Rate of growth without resorting to external funds

∆ Assets = ∆ Equity ∆ Equity = Net income x retention ratio IGR = ROA x r The above computes ROA using BEGINNING

assets

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IGR exampleIGR example

Wal-Mart 1994: ROA = 13.9%Income = $1.02 : Dividends = $0.13IGR = 13.9% x .8725 = 12.3%Suppose expected growth is 23%=> 10% will have to be financed

externally10% x 16,800MM = $1.68MM financing

need

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Sustainable Growth RateSustainable Growth Rate

No external equity issuedDebt issued such that D/E is constant

What happens to D/E with IGR?

Want %∆ in equity = %∆ in debt ==> SGR = ROE x r Note: ROE is computed using

BEGINNING equity

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Sustainable Growth, cont.Sustainable Growth, cont.

DuPont: ROE x r = Profitability x turnover x leverage x r Management choices: Squeeze more sales $ out of existing assets Squeeze more income out of existing sales $ Retain more earnings in the firm Be willing to accept more leverage Settle for less growth

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GROWTH & FIRM VALUEGROWTH & FIRM VALUE

Growth should be Value Enhancing EXAMPLE: Suppose EPS = $5.00 R = 12.5% (Investors’ required return) ROE = 15% r = 0 (No reinvestment)

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Growth Example, cont.Growth Example, cont.

P = D/(R - g) g = ROE x r = 15% x 0 = 0 P = 5 / (12.5% - 0) = $40.00 P/E = 8 ( = 1/R)

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Growth Example, cont.Growth Example, cont.

Now, suppose r=60% (reinvest 60%) g = ROE x r = 15% x 60% = 9% D = 40% x 5.00 = $2.00 P = 2 / (12.5% - 9%) = $57.14 P/E = 11.43 Growth has increased Price and P/E!

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Growth example, cont.Growth example, cont.

Suppose r = 60% as before ROE = 10% g = 10% x 60% = 6% P = $2 / (12.5% - 6%) = $30.77 P/E = 6.2 Growth has decreased both price and P/E! Growth creates Value when: ROE > R