MVA and EVA
► Market
Value Added (MVA) = Market value
of common equity – book value of common
equity
 2006 Best Buy MVA = $21.34 billion
 2006 Circuit City MVA = $2.24 billion
► Economic
Value Added (EVA) = NOPAT –
Annual dollar cost of capital = true
economic profit for a given period
► EVA = EBIT(1-T) – [Total investor supplied
operating capital x After-tax percentage cost
of capital]
Chapter 16
Financial Planning and Forecasting
Financial Forecasting Steps
► Forecast
Sales
► Project the Assets Needed to Support Sales
► Project Internally Generated Funds
► Project Outside Funds Needed
► Decide How to Raise Funds
► See Effects of Plan on Ratios
Our Problem: Zippy Drives, Inc.
► 2006
Sales 10,000,000
► 2006 Total Assets 8,000,000
► Want to project 2007 financial statements
based on a 30% increase in sales.
► Projected 2007 Sales 10,000,000(1.30) =
$13,000,000
Zippy Drives Inc. 2006 Balance
Sheet ($000)
Assets
Cash
Receivables
Inventory
2006
$ 500
$ 2,000
$ 1,500
Liabilities and Equity
Accounts payable
Accruals
Notes payable
Total Current Assets $ 4,000 Total Current Liabilities
Long-term debt
Net fixed assets
$ 4,000 Common stock
Retained earnings
Total Assets
$ 8,000 Total Liabilities and Equity
2006
$ 1,000
$ 500
$ 900
$ 2,400
$ 1,600
$ 1,700
$ 2,300
$ 8,000
Zippy Drives 2006 Income
Statement
Income Statement
2006
Sales
10000
Operating Expenses(72.5%)
7250
Operating Income
2750
Interest Expense
250
Income before taxes
2500
Taxes (40%)
1000
Net Income
1500
Dividends (30%)
450
Addition to Retained Earnings 1050
AFN formula Key Assumptions:
Known as percentage of sales approach.
► Zippy is operating at full capacity in 2006.
► Each type of asset grows proportionally with sales.
► Accounts payable and accruals grow proportionally
with sales.
► 2006 profit margin (15%) and payout (30%) will
be maintained.
► Sales are expected to increase by $3 million.
(%S = 30%)
Income Statement Projection
Income Statement
2006 times = 2007 Proj
Sales
10000
1.3
13000
Operating Expenses(72.5%)
7250
1.3
9425
Operating Income
2750
3575
Interest Expense
250
1.3
325
Income before taxes
2500
1.3
3250
Taxes (40%)
1000
1.3
1300
Net Income
1500
1.3
1950
Dividends (30%)
450
585
Addition to Retained Earnings 1050
1365
Balance Sheet Projection: The
Assets
Assets
Cash
Receivables
Inventory
Total Current Assets
Net fixed assets
Total Assets
2006 times = 2007 Proj
500
1.3
650
2000
1.3
2600
1500
1.3
1950
4000
5200
4000
1.3
5200
8000
10400
Projected Liabilities & Equity
Liabilities and Equity
Accounts payable
Accruals
Notes payable
Total Current Liabilities
Long-term debt
Common stock
Retained earnings
Total Liabilities and Equity
2006
1000
500
900
2400
1600
1700
2300
8000
times = 2007 Proj
1.3
1300
1.3
650
same
900
2850
same
1600
same
1700
+proj RE
3665
9815
Oh no! Here come the
Accounting Police!
Projected 2007 Assets
10,400
Projected 2007 Liab&Eq
9,815
External Financing Needed
585
► Assume Zippy will raise 40% of external
financing needed through Notes Payble and
the rest (60%) through Long-term Debt.
► Addition to Notes Payable
234
► Addition to Long-term Debt 351
Projected Liab & Eq to keep away
the accounting police.
Liabilities and Equity
Accounts payable
Accruals
Notes payable
Total Current Liabilities
Long-term debt
Common stock
Retained earnings
Total Liabilities and Equity
2006
1000
500
900
2400
1600
1700
2300
8000
times = Proj2007
1.3
1300
1.3
650
+ 234 =
1134
3084
+ 351 =
1951
same
1700
+ 1365 =
3665
10400
AFN equation: When you just need
to know additional financing needed.
AFN = (A*/S)S - (L*/S)S - M(S1) (RR)
RR = retention ratio = 1 – dividend payout
AFN = ($8,000 / $10,000) ($3,000)
- ($1,500 / $10,000) ($3,000)
- 0.15($13,000) (1- 0.3)
= $585.
Key Zippy Ratios
2006
Current
1.67
Quick
1.04
DSO
73.00
InvTurn
debt/assets
6.67
50.0%
Proj2007
Current
1.69
Quick
1.05
DSO
73.00
InvTurn
debt/assets
6.67
48.4%
FAT
2.50
FAT
2.50
TAT
1.25
TAT
1.25
ROA
18.8%
ROA
18.8%
ROE
37.5%
ROE
36.3%
Key Determinants of External
Funds Requirements (AFN)
► Sales
growth: higher growth leads to more AFN
► Capital Intensity Ratio (A/S): higher A/S leads to
more AFN
► Spontaneous liabilities to sales ratio (L/S):
higher ratio means more internal financing and
less AFN
► Profit Margin (M): higher profit margin means
higher net income and less AFN
► Retention Ratio: higher ratio means more
retained earnings and less AFN
Forecasting with less than Full
Capacity
► Assume
Zippy’s net fixed assets were
operating at 80% capacity and current
assets at 100% capacity in 1997.
► How would Zippy’s additional financing
needed change?
► Need to know what level of sales Zippy’s
existing net fixed assets can support or
produce = Full Capacity Sales
Zippy’s Full Capacity Sales and
projected new fixed assets
► Full
Capacity Sales (FCS)
= Current Sales/% of Capacity
► Zippy’s 2006 Sales = 10,000
► 80% Capacity
► Full Capacity Sales = 10,000/0.8 = 12,500
► Target FA Ratio = 2006 FA/ FCS
► 4000/12,500 = 0.32 = 32%
► Proj FA = 0.32(proj sales) = 0.32(13,000)
= 4,160
Projected Assets with 80%
capacity
Assets
Cash
Receivables
Inventory
Total Current Assets
Net fixed assets
Total Assets
2006 % of Sales Pro.Sales
500
5%
13000
2000
20%
13000
1500
15%
13000
4000
40%
13000
4000
32%
13000
8000
Proj2007
650
2600
1950
5200
4160
9360
Liabilities and Equity
Accounts payable
Accruals
Notes payable
Total Current Liabilities
Long-term debt
Common stock
Retained earnings
Total Liabilities and Equity
2006
1000
500
900
2400
1600
1700
2300
8000
Proj2007
1300
650
900
2850
1600
1700
3665
9815
-455
9360
% of Sales
10%
5%
same
13000
13000
same
same
+ 1365 =
AFN
Total
► New
AFN is -455
► This means Zippy can reduce debt to make
the projected balance sheet balance or just
add the surplus financing to the cash
account.
Caveats
► We
have assumed a constant profit margin
which means interest expense is assumed to
increase proportionally with sales.
► A company’s financing decision may cause
the actual interest expense to be higher or
lower than this projection.
► If the additional financing decision causes
interest expense to be higher, then even
more financing will be needed.
Other Financial Forecasting
Approaches
► Instead
of assuming individual assets will
remain a constant percentage of sales, a
company can modify their forecast by:
 using regression analysis to project individual
asset accounts.
 using target financial ratios to project individual
asset accounts.
Financial Forecasting
Summary
► Unless
stated otherwise, all expenses are assumed
to increase proportionally with sales, yielding the
same profit margin
► At full capacity, all assets increase proportionally
with sales
► Only accounts payable and accrued taxes and
wages(accruals) increase proportionally with sales
► Forecasted Retained Earnings are added to the
previous year’s b/s acct.
1
Chapter 16 Summary (cont.)
► With
financial statement forecast, AFN = projected
total assets - projected liab&eq
► Proj. spontaneous assets and liabilities = last
year’s ratio of each account to sales times
forecasted sales
► AFN is plug amount that makes the balance sheet
balance
► With AFN equation, AFN = projected change in
assets - proj. change in liabilities - projected new
retained earnings
2
End of Chapter 16 Summary
► If
fixed assets are operating at less than
100% capacity, determine full capacity sales
 Full capacity sales = old sales/ % of capacity
► If
projected sales < full capacity sales, no
increase in fixed assets is needed
► If projected sales > full capacity sales, then
proj. FA = old FA/Full capacity sales times
projected sales
3