Review Ch. 4, Ch. 12, Ch. 13
Chapter 4 Outline
1.
2.
3.
4.
5.
What is financial planning
Financial planning models
The percentage of sales approach
External financing and growth
Caveats in financial planning
2
Percentage of sales approach:
COMPUTERFIELD CORPORATION
Financial Statements
Income statement
Balance sheet
Sales
$8,000
CA
$5000
Debt
$8250
Costs
5,800
FA
$7000
Equity
$3750
Total
$12000
Total
$12000
Net Income $2,200
3
EFN and Capacity Usage
• Suppose COMPUTERFIELD is operating at 80%
capacity:
1. What would be sales at full capacity? (1p)
2. What is the capital intensity ratio at full
capacity? (1p)
3. What is EFN at full capacity and Dividend
payout ratio is 15%? (1p)
What is EFN to increase sales to 12000 and
Dividend payout ratio is 35%?
4
Q 1:8,000/.8=10,000; Full capacity as increase
10,000/8,000 = 1.25 (25%)
•
•
•
•
Income statement
Sales $8,000
Costs $5,800
N I $2,200
• Ret earnings 2,200*.85=1,870
• New Ret earnings 1,870*1.25=2,337.5
• There is no indication that any changes took
place in % cost for the proforma income
statement, we can get the same result by
increasing RE or by creating proforma IS
13-5
New assets needed
•
•
•
•
CA
5000*1.25=6,250 C A
TA =6,250+7000 FA
Total
13,250
Balance sheet
$5000
Debt
$8250
$7000
Equity
$3750
$12000
Total
$12000
• capital intensity ratio at full capacity
• =13,250/10,000 =1.325
• EFN =0 change in TA = 1250 which is less than
the retained earnings, we can fully finance
internally full capacity operation.
13-6
What is EFN to increase sales to 12,000 (50%) and
Dividend payout ratio is 35%?
•
•
•
•
Income statement
Sales $8,000
Costs $5,800
N I $2,200
• Ret earnings 2,200*.65=1,430
• New Ret earnings 1,430*1.5=2,145
• There is no indication that any changes took
place in % cost for the proforma income
statement, we can get the same result by
increasing RE or by creating proforma IS
13-7
Recent Sales 8,000; Proj. Sales 12,000
Increase 50%
• CA 5,000*1. 5=7,500
• FA=7,000+1,400
• TA =15,900
Balance sheet
CA
$5000
Debt
$8250
FA
$7000
Equity
$3750
Total
$12000
Total $12000
• FA=7000/10000 per unit of sales=.7
• Inv . Need for 2000 more units of sales
=.7*2000=1,400
• EFN=1,755 change in TA = 3,900 from RE=2,145
13-8
EFN=1,755
•
•
•
•
D/E ratio =3/2
EFN=1,755
How much debt should be issued?
How much equity?
• If they issue only debt (all 1,755 in bonds)
what will be the D/E ratio on the proforma BS?
• D=8,250+1,755=10,005
• E=3,750+2,145=5,895 D/E=1.69
13-9
Please, Review also
• Internal Growth Rate
• Sustainable Growth Rate
Chapter 12 Overview
• Return of an investment: arithmetic and geometric
• The variability of returns
• Efficiency of capital markets
11
Arithmetic vs. Geometric
Averages (1)
• Geometric return = the average compound
return earned per year over multiyear period
Geometric average return =
 T (1  R1 ) * (1  R2 ) *...* (1  RT ) 1
• Arithmetic average return = the return earned
in an average (typical) year over a multiyear
period
12
The Variability of Returns
• Variance = the average squared deviation
between the actual return and the average
return
(R  R )

Var ( R) 
2
i
T 1
• Standard deviation = the positive square root
of the variance
  Var
13
The Normal Distribution (2)
14
Z-score
• For any normal random variable:
X 
Z

• Z – z-score
• X – normal random variable
•
- mean

15
Chapter 13 Outline
• Expected Returns and Variances of a portfolio
• Announcements, Surprises, and Expected
Returns
• Risk: Systematic and Unsystematic
• Diversification and Portfolio Risk
• Systematic Risk and Beta
• The Security Market Line (SML)
Portfolios
Portfolio = a group of assets held by an
investor
• The risk-return trade-off for a portfolio is measured
by the portfolio expected return and standard
deviation, just as with individual assets
Portfolio weights = Percentage of a
portfolio’s total value in a particular asset
17
Portfolio Expected Returns (1)
• The expected return of a portfolio is the weighted
average of the expected returns for each asset in the
portfolio
m
E ( RP )   w j E ( R j )
j 1
• You can also find the expected return by finding the
portfolio return in each possible state and computing
the expected value
18
Calculate Portfolio Variance
• Portfolio variance can be calculated using
the following formula:
  x   x   2 xL xU CORRL,U L U
2
P
2
L
2
L
2
U
2
U
• Correlation is a statistical measure of how 2 assets
move in relation to each other
• If the correlation between stocks A and B = -1,
what is the standard deviation of the portfolio?
1
Portfolio Diversification
20
Measuring Systematic Risk
• Beta (β) is a measure of systematic risk
• Interpreting beta:
– β = 1 implies the asset has the same systematic
risk as the overall market
– β < 1 implies the asset has less systematic risk
than the overall market
– β > 1 implies the asset has more systematic risk
than the overall market
21
Portfolio Expected Returns and Betas
Rf
Reward-to-Risk Ratio:
• The reward-to-risk ratio is the slope of the line
illustrated in the previous slide
– Slope = (E(RA) – Rf) / (A – 0)
– Reward-to-risk ratio =
• If an asset has a reward-to-risk ratio = 8?
• If an asset has a reward-to-risk ratio = 7?
23
The Fundamental Result
• The reward-to-risk ratio must be the same for
all assets in the market
E ( RA )  R f
A

E ( RM  R f )
M
• If one asset has twice as much systematic risk
as another asset, its risk premium is twice as
large
24
Security Market Line (2)
25