Lecture 2

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FINANCE 7311
CORPORATE FINANCIAL
PLANNING
1
FINANCIAL 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)
2
Financial Planning, cont.

PERFORMANCE MEASUREMENT
 OJBECTIVE;
SPECIFIC
 WERE GOALS ACHIEVED?
(% MARKET SHARE)

BUSINESS PLAN => FINANCIAL
PLAN
 Operating
& marketing strategies underlie a
financial plan
3
USES OF FINANCIAL PLAN

PROJECTION OF FINANCIAL NEEDS
Financial implications of corporate
strategies

PERFORMANCE MEASUREMENT
A benchmark which reflects strategies
4
FINANCIAL MODEL
 EQUATIONS
A=D+ E
End Balance = Beg. Bal. + Add - Subtract
 PARAMETERS
Tax rate; NWC requirements
 DECISION VARIABLES
Investment; Financing
5
COMPONENTS
 PRO-FORMA FINANCIAL STMTS
 CASH
BUDGET
 SPECIFIC BUDGETS
Production
Personnel
Marketing; distribution
Capital
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PRO-FORMA B/S & I/S
 STEP 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.
7
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
8
% 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
 Method
of Last Resort
 Assets / Sales ratio is optimal
 Assumes Full Capacity
 Assumes Assets / Sales relation is linear
Economies of Scale
Less than full capacity
Sales decreases
10
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
11
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 BUDGET



Projection of future cash flows
Performance benchmark
Useful for seasonal companies


More specific information
Provides same ‘financing’ need as proforma financial statements
13
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?
14
Cash Budget, cont.
 STEP 3:
Project amount & timing of cash
outflows
Purchases
Labor
Capital Expenditures
Dividends & interest
Other Expenses
15
Cash Budget, cont.
 STEP 4:
NET CASH FLOW
 STEP 5: FINANCING NEED/SURPLUS
NET CASH FLOW
+ BEGINNING CASH
= ‘ENDING’ CASH
- DESIRED CASH
= FINANCING NEED (= B/S PLUG)
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GROWTH

SOURCE OF SALES GROWTH:
QUANTITY
PRICE
COMBINATION OF BOTH

QUANTITY
INDUSTRY GROWTH (Pie)
MARKET SHARE GROWTH (Piece of Pie)
17
Two 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
18
IGR example

Wal-Mart 1994: ROA = 13.9%
 Income = $1.02 : Dividends = $0.13
 IGR = 13.9% x .8725 = 12.3%
 Suppose expected growth is 23%
 => 10% will have to be financed
externally
 10% x 16,800MM = $1.68MM financing
need
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Sustainable Growth Rate
 No
external equity issued
 Debt 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
20
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 VALUE





Growth should be Value Enhancing
EXAMPLE:
Suppose EPS = $5.00
R = 12.5% (Investors’ required return)
ROE = 15%
r = 0 (No reinvestment)
22
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)
23
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!
24
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
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