long-term financial planning and growth

Chapter

McGraw-Hill/Irwin Copyright © 2006 by The McGraw-Hill Companies, Inc. All rights reserved.

4•Long-Term Financial Planning and Growth•Long-Term Financial Planning and Growth

Chapter 04– Index of Sample Problems

• Slide # 02 - 05 Plowback and dividend payout ratios • Slide # 06 - 08 Constant growth planning• Slide # 09 - 13 Percentage of sales planning• Slide # 14 - 16 External financing need• Slide # 17 - 23 Pro forma with external financing• Slide # 24 - 27 Capacity level• Slide # 28 - 29 Internal growth• Slide # 30 - 34 Sustainable growth

Dimensions of Financial planning

• Planning horizon• Aggregation

• Scenario approach: worst, normal, best cases

Accomplishment

• Examining interaction• Exploring options• Avoiding surprises• Ensuring feasibility and internal consistcy

Ingredients of financial planning model

• Sales forecast• Pro forma statement• Asset requirement• Financial requirement• The plug• Economic assumption (interest rate, tax rate)

2: Plowback and dividend payout ratios

Your company has net income of $1,600 for the year. You paid out $400 in dividends to your stockholders.

What is the dividend payout ratio?

What is the plowback ratio?

What is the dollar increase in retained earnings?


Your company has net income of $1,600 for the year. You paid out $400 in dividends to your stockholders.

25.

600,1$

400$incomeNet

dividendsCash ratiopayout Dividend

.75

.25-1

ratiopayout dividend - 1 ratioPlowback

$1,200

.75 $1,600

ratioplowback incomeNet earnings retained oAddition t


This year your company expects net income of $2,800. You now adhere to a 60% plowback ratio.

What is the expected dollar increase in retained earnings?

How much do you expect to pay in dividends?

What is the dividend payout ratio?


This year your company expects net income of $2,800. You now adhere to a 60% plowback ratio.

120,1$

680,1$800,2$

earnings retained oAddition t incomeNet paid Dividends

40%

$2,800

$1,120

incomeNet


$1,680

.60$2,800

ratioplowback incomeNet earnings retained oAddition t

6: Constant growth planning

Income StatementCurrent Projected

Sales $800 $_______Costs $700 $_______Taxable income $100 $_______Taxes (34%) $ 34 $_______Net income $ 66 $_______

Balance SheetCurrent Projected Current Projected

Assets $400 $_______ Debt $150 $_______ Equity $250 $_______

Total $400 $_______ Total $400 $_______

You expect your sales, costs and assets to grow by 10% next year. You will not pay any dividends. Can you complete the pro forma statement? Round all amounts to whole dollars.


Income StatementCurrent Projected

Sales $800 $880Costs $700 $770Taxable income $100 $110Taxes (34%) $ 34 $ 37Net income $ 66 $ 73

Balance SheetCurrent Projected Current Projected

Assets $400 $440 Debt $150 $117 Equity $250 $323

Total $400 $440 Total $400 $440

The computations are shown on the next slide.


$323

$73 $250

incomenet Projected equity Current equity Projected

$440

assets Total equity sliabilitie Total

$117

$323 - $440

equity - equity) sliabilitie (Total Debt

$440 $400(1.10) Assets

)($37 $34(1.10) Taxes

$770 $700(1.10) Costs

$880 $800(1.10) Sales

rounded

Step 1

Step 2

Step 3

Step 4

9: Percentage of sales planning

The assets and current liabilities of Jennings, Inc. vary in direct proportion to the increase in sales. The current sales are $2,000 and you expect them to increase by 20% next year. Net income is projected at 5% of sales. The firm is not planning on issuing any more common stock nor paying any dividends.

Using this information, can you compile the pro forma balance sheet shown on the next slide?


Current % of sales Projected

Cash $ 120 _____% $_______Accounts receivable $ 500 _____% $_______Inventory $ 840 _____% $_______Fixed assets $2,600 _____% $_______Total assets $4,060 _____% $_______

Accounts payable $ 600 _____% $_______Long-term debt $ 700 _____% $_______Common stock and paid in surplus $1,000 _____% $_______Retained earnings $1,760 _____% $_______Total liabilities and equity $4,060 _____% $_______

Refer to the prior slide for information pertaining to this problem.Enter n/a where the % of sales does not apply.


Current % of sales Projected

Cash $ 120 6% $ 144Accounts receivable $ 500 25% $ 600Inventory $ 840 42% $1,008Fixed assets $2,600 130% $3,120Total assets $4,060 203% $4,872

Accounts payable $ 600 30% $ 720Long-term debt $ 700 n/a $1,272Common stock and paid in surplus $1,000 n/a $1,000Retained earnings $1,760 n/a $1,880Total liabilities and equity $4,060 n/a $4,872

See the next slide for the computations


%3030.$2,000

$600 payable Accounts

%20303.2$2,000

$4,060 assets Total

%13030.1$2,000

$2,600 assets Fixed

%4242.$2,000

$840 Inventory

%2525.$2,000

$500receivable Accounts

%606.$2,000

$120 Cash

$720 $2,400.30 payable Accounts

$3,120 $2,4001.30 assets Fixed

$1,008 $2,400.42 Inventory

$600 $2,400.25 receivable Accounts

$144 $2,400.06 Cash

$2,400 1.20$2,000 Sales

Step 1 Step 2

Computations continued on next slide


$4,872 assets Total equity owners' and sliabilitie Total

$1,880 $2,400).05 ( $1,760 earnings Retained

$1,000 $0 $1,000 stock Common

Total liabilities and owners’ equity $4,872

Accounts payable -$ 720

Common stock and paid in surplus -$1,000

Retained earnings -$1,880

Long-term debt $1,272

Step 3

Step 4

14: External financing need

You project your sales will increase by $3,000 next year. Net income is 10% of sales and accounts payable is 25% of sales. The capital intensity ratio is 2.5. No dividends are anticipated.

How much external financing is needed to fund this growth?

Try to solve this problem without looking at the hints on the next slide.


You project your sales will increase by $3,000 next year. Net income is 10% of sales and accounts payable is 25% of sales. The capital intensity ratio is 2.5. No dividends are anticipated.How much external financing is needed to fund this growth?

Hints:Step 1: Compute the increase in total assetsStep 2: Compute the increase in accounts payableStep 3: Compute the increase in retained earningsStep 4: Compute the additional long-term debt and equity financing that is needed


Step 2

$750

$3,000.25

Sales.25 payable Accounts

Step 3

$300

$3,000.10

0 -sales).10 (

paid Dividends - incomeNet earnings retained oAddition t

Step 4

$6,450

$300 - $750 - $7,500

earnings retained toAdditions - payable Accounts - assets Total need financing External

Step 1

17: Pro forma with external financing

Your firm currently has long-term debt of $4,400, common stock and paid in surplus of $10,000 and retained earnings of $4,600. The capital intensity ratio is 2.2 and the tax rate is 35%. Costs are 72% of sales and accounts payable are 30% of sales. Sales currently are $10,000 and are expected to increase by 10% next year. The dividend payout ratio is 20%. Long-term debt will be used to fund 40% of the external funding need.

Given this information, can you complete the pro forma financial statements on the next slide?


Pro forma Income Statement

Sales $______ Costs $______Taxable income $______Taxes (35%) $______Net Income $______

Pro forma Balance SheetAssets $______ Accounts payable $______

Long-term debt $______Common stock $______

Retained earnings $______Total $______ Total $______

Round all amounts to whole dollars.


Pro forma Income Statement

Sales $11,000Costs $ 7,920Taxable income $ 3,080Taxes (35%) $ 1,078Net Income $ 2,002

Pro forma Balance SheetAssets $24,200 Accounts payable $ 3,300

Long-term debt $ 4,519Common stock $10,179

_______ Retained earnings $ 6,202Total $24,200 Total $24,200

The computations are shown on the next four slides.


$2,002 $1,078 - $3,080 incomeNet

$1,078$3,080.35 Tax

$3,080 $7,920 - $11,000 income Taxable

$7,920 $11,000.72 Costs

$11,000 1.10$10,000 Sales


$24,200 assets Total equity owners' and sliabilitie Total

)( $6,202 $2,002)(.80 $4,600 income)Net ratio(Plowback $4,600 earnings Retained

.80.20-1 ratiopayout Dividend - 1 ratioback Plow

$3,300 $11,000.30 payable Accounts

$24,200 $11,0002.2 assets Total

rounded


Total liabilities and owners’ equity $24,200

Accounts payable -$ 3,300

Retained earnings -$ 6,202

Current long-term debt -$ 4,400

Current common stock -$10,000

External financing need $ 298


$4,519

$119 $4,400

$298)(.40 $4,400

need) financing External(.40 debt term-longCurrent debt term-long forma Pro

(rounded)

$10,179

$179 $10,000

$298)(.60 $10,000

need) financing External(.60 stock common Current stock common forma Pro

(rounded)

24: Capacity level

Your firm has fixed assets of $28,000 and is operating at 80% of capacity. Current sales are $18,000.

What is the full-capacity sales level?

What is the capital intensity ratio at the full-capacity sales level?

25: Capacity level

Your firm has fixed assets of $28,000 and is operating at 80% of capacity. Current sales are $18,000.

500,22$.80

$18,000

level operatingCurrent

salesCurrent salescapacity -Full

)( 24.1

500,22$

000,28$

salescapacity -Full

assets Fixed ratiointensity capitalcapacity Full

rounded

26: Capacity level

Your firm has projected sales of $1,600. The capital intensity ratio at the full-capacity sales level of $1,900 is 1.20. Ignoring the capacity level, you have projected net fixed assets at $2,100 and the external financing need at $1,000.

What is the external financing need if the capacity level is considered?

27: Capacity level

Your firm has projected sales of $1,600. The capital intensity ratio at the full-capacity sales level of $1,900 is 1.20. Ignoring the capacity level, you have projected net fixed assets at $2,100 and the external financing need at $1,000. What is the external financing need if the capacity level is considered?

$1,920

1.2$1,600

ratiointensity Capital Sales needed assets Fixed

$180

$1,920 - $2,100

needed assets Fixed - projected assets Fixed estimate Excess

$820

$180 - $1,000

estimate Excess - need financing external Projected need financing external Actual

28: Internal growth

Your firm has net income of $6,000 and total assets of $30,000.

The dividend payout ratio is 40%.

What is the internal growth rate?

29: Internal growth

Your firm has net income of $6,000 and total assets of $30,000. The dividend payout ratio is 40%. What is the internal growth rate?

20.

000,30$

000,6$assets Total

incomeNet assetson Return

.60

.40 - 1

ratiopayout Dividend - 1 ratioPlowback

%64.13

)(1364.88.

12.60.20.1

60.20.bROA-1

bROA rategrowth Internal

rounded

30: Sustainable growth

A firm has net income of $2,000 and pays $400 in dividends. Total equity is $8,000.

What is the sustainable growth rate?


A firm has net income of $2,000 and pays $400 in dividends. Total equity is $8,000. What is the sustainable growth rate?

20.

000,2$

400$incomeNet


.80

.20-1


25.

000,8$

000,2$

equity Total

incomeNet equity on Return

%25

25.80.

20.80.25.1

80.25.bROE-1

bROE rategrowth eSustainabl

Step 1

Step 2

Step 3

Step 4


Your firm has a 10% net profit margin and a dividend payout ratio of 25%. The debt-equity ratio is 40% and the total asset turnover rate is 2.

What is the sustainable rate of growth?


Your firm has a 10% net profit margin and a dividend payout ratio of 25%. The debt-equity ratio is 40% and the total asset turnover rate is 2. What is the sustainable rate of growth?

Hints:

Step 1. Find the equity multiplier using the debt-equity ratio

Step 2. Compute the ROE using the DuPont formula

Step 3. Find the plowback ratio using the dividend payout ratio

Step 4. Compute the sustainable growth rate


Your firm has a 10% net profit margin and a dividend payout ratio of 25%. The debt-equity ratio is 40% and the total asset turnover rate is 2.

1.40

.401

ratioequity -Debt 1 multiplierEquity

Step 1

Step 2

Step 3

Step 4

28.

40.12.10

EMTATPM ROE

.75

.25-1


%58.26

)(2658.79.

21.75.28.1

75.28.bROE-1

bROE rategrowth eSustainabl

rounded

long-term financial planning and growth

Documents

net income

plowback ratio

current sales

taxable income

total assets

dividend payout ratios

total liabilities

constant growth planningslide