1. Financial Planning and Forecasting What is a forecast? – A forecast is a prediction about a situation at some future point in time. – Financing related business decisions are heavily dependent on forecasting. Why do firms forecast? – Firms spend consid. fortune plan for uncertain future

2. Financial Planning and Forecasting The need to plan – Successful business managers know the importance of planning – Efficient planning assists managers in controlling their firm Financial Forecasting – Process of projecting future financial requirement of firm – Financial forecasting – an integral part of financial manager’s job – In the process of financial forecasting Fin. Manager develops projected financial statements.

3. Steps in Financial Forecasting Sales Forecast – The key ingredient of firm’s planning process is sales forecast. Project the assets needed to support the sales – Projecting change in CA & FA along with change in level of sales Project internally generated funds Project outside funds needed Decide how to raise funds

4. Sales Forecast Sales forecasts are usually based on the analysis of historic data. An accurate sales forecast is critical to the firm’s profitability: Under-optimistic Too much inventory and/or fixed assets Low turnover ratio High cost of depreciation and storage Write-offs of obsolete inventory Low profit Low rate of return on equity Low free cash flow Depressed stock price Over-optimistic Company will fail to meet demand Market share will be lost Sales Forecast

5. Forecasting the Income Statement

6. Forecast Sales Prior yr. sales x growth rate 3000 x 1.10 3300 million COGS 2008 sales x COGS 2007 /Sales 2007 3300 x 2616/3000 2877. 6 million Depreciation Expense 2008 net P&E x Dep 2007 /Net P&E 2007 1100 x 100/1000 110 million 123 Actual 2007Forecast BasisForecast for 2008 Sales3000 2007 sales x 1.10 3300 Cost except depreciation2616.2 2008 sales x COGS/Sales 2877 Depreciation expense100 2008 Net P&E x Dep./NetP&E 110 Total operating cost$2,716.20$2,987.60 EBIT$283.80$312.40 Less interest88 See explanation 92.8 EBT$195.80$219.60 Taxes (40%)78.387.8 NI before preferred dividends$117.50$131.80 Preferred dividends 4 Pref. divd.= Pref. stock at beg. of year x divid. % 4 NI available to common$113.50$127.80 Shares of common equity50 Dividends per share$1.15$1.25 Dividends to common$57.50$62.50 Additions to retained earnings$56.00$65.30

7. Forecasting the Income Statement Other Operating Expenses Salaries of executives, marketing cost – co’s size – tied to sales EBIT – Subtract COGS, depreciation, op. expenses from sales to give EBIT. Interest Expense The interest expense on N/P is projected as interest rate on N/P multiplied by avg. value of N/P outstanding during the year. Preferred Stock 2008 Pref. stock at beg. of yr. x dividend % $40 x 0.10 Total Preferred dividend = $4 m 123 Actual 2007Forecast BasisForecast for 2008 Sales3000 2007 sales x 1.10 3300 Cost except depreciation2616.2 2008 sales x COGS/Sales 2877 Depreciation expense100 2008 Net P&E x Dep./NetP&E 110 Total operating cost$2,716.20$2,987.60 EBIT$283.80$312.40 Less interest88 See explanation 92.8 EBT$195.80$219.60 Taxes (40%)78.387.8 NI before preferred dividends$117.50$131.80 Preferred dividends 4 Pref. divd.= Pref. stock at beg. of year x divid. % 4 NI available to common$113.50$127.80 Shares of common equity50 Dividends per share$1.15$1.25 Dividends to common$57.50$62.50 Additions to retained earnings$56.00$65.30

8. Forecasting the Income Statement Dividend Forecasted DPS: Current DPS x Increase 1.15 x 1.08 = 1.25 Forecasted Dividend = 1.25 x 50 = 62.5 m Forecasted addition to retained earnings Forecasted N.I. available to common – Forecasted total dividends = Forecasted addition to R.E. 127.8 – 62.5 = $65.3 m 123 Actual 2007Forecast BasisForecast for 2008 Sales3000 2007 sales x 1.10 3300 Cost except depreciation2616.2 2008 sales x COGS/Sales 2877 Depreciation expense100 2008 Net P&E x Dep./NetP&E 110 Total operating cost$2,716.20$2,987.60 EBIT$283.80$312.40 Less interest88 See explanation 92.8 EBT$195.80$219.60 Taxes (40%)78.387.8 NI before preferred dividends$117.50$131.80 Preferred dividends 4 Pref. divd.= Pref. stock at beg. of year x divid. % 4 NI available to common$113.50$127.80 Shares of common equity50 Dividends per share$1.15$1.25 Dividends to common$57.50$62.50 Additions to retained earnings$56.00$65.30

10. Forecasting the Balance Sheet 123 Actual 2007 Forecast Basis Forecast for 2008 Assets Cash $10 2008 sales x Cash/Sales $11 Short term investments 00 Accounts receivable 375 2008 sales x AR/Sales 412.5 Inventories 615 2008 sales x Inv./Sales 676.5 Total current assets $1,000$1,100 Net plant and equipment 1000 2008 sales x Net P&E/Sales 1100 Total assets $2,000$2,200 Liabilities and Equity Accounts payable $60 2008 sales x AP/Sales $66 Accruals 140 2008 sales x Accruals/Sales 154 Notes payable 110 110 + 114.7 224.7 Total current liabilities $310$444.7 Long term bonds 754 same: no new issue 754 Total liabilities $1,064$1,198.7 Preferred stock 40 same: no new issue 40 Common stock 130 same: no new issue 130 Retained earnings 766 2007 R.E. + 2008 Add. To R.E. 831.3 Total common equity $896$961.3 Total liabilities and equity $2,000$2,200 Required assets $2,200 Specified sources of financing 2085.3 AFN $114.70 Required add. Notes payable $114.70 Additional short-term invst. 0 Assets Cash 2008 sales x Cash 2007 /Sales 2007 3300 x 10/3000 11 million A/R 2008 sales x A/R. 2007 /Sales 2007 3300 x 375/3000 412.5 million Inventories 2008 sales x Inv. 2007 / Sales 2007 3300 x 615/3000 676.5 million

11. Forecasting the Balance Sheet 123 Actual 2007 Forecast Basis Forecast for 2008 Assets Cash $10 2008 sales x Cash/Sales $11 Short term investments 00 Accounts receivable 375 2008 sales x AR/Sales 412.5 Inventories 615 2008 sales x Inv./Sales 676.5 Total current assets $1,000$1,100 Net plant and equipment 1000 2008 sales x Net P&E/Sales 1100 Total assets $2,000$2,200 Liabilities and Equity Accounts payable $60 2008 sales x AP/Sales $66 Accruals 140 2008 sales x Accruals/Sales 154 Notes payable 110 110 + 114.7 224.7 Total current liabilities $310$444.7 Long term bonds 754 same: no new issue 754 Total liabilities $1,064$1,198.7 Preferred stock 40 same: no new issue 40 Common stock 130 same: no new issue 130 Retained earnings 766 2007 R.E. + 2008 Add. To R.E. 831.3 Total common equity $896$961.3 Total liabilities and equity $2,000$2,200 Required assets $2,200 Specified sources of financing 2085.3 AFN $114.70 Required add. Notes payable $114.70 Additional short-term invst. 0 Assets Fixed Assets 2008 sales x Net P&E 2007 /Sales 2007 3300 x 1000/3000 1,100 million

12. Forecasting the Balance Sheet 123 Actual 2007 Forecast Basis Forecast for 2008 Assets Cash $10 2008 sales x Cash/Sales $11 Short term investments 00 Accounts receivable 375 2008 sales x AR/Sales 412.5 Inventories 615 2008 sales x Inv./Sales 676.5 Total current assets $1,000$1,100 Net plant and equipment 1000 2008 sales x Net P&E/Sales 1100 Total assets $2,000$2,200 Liabilities and Equity Accounts payable $60 2008 sales x AP/Sales $66 Accruals 140 2008 sales x Accruals/Sales 154 Notes payable 110 110 + 114.7 224.7 Total current liabilities $310$444.7 Long term bonds 754 same: no new issue 754 Total liabilities $1,064$1,198.7 Preferred stock 40 same: no new issue 40 Common stock 130 same: no new issue 130 Retained earnings 766 2007 R.E. + 2008 Add. To R.E. 831.3 Total common equity $896$961.3 Total liabilities and equity $2,000$2,200 Required assets $2,200 Specified sources of financing 2085.3 AFN $114.70 Required add. Notes payable $114.70 Additional short-term invst. 0 Liabilities Current Liabilities Accounts Payable * 2008 sales x AP 2007 /Sales 2007 3300 x 60/3000 66 million Accrued wages * 2008 sales x Accruals. 2007 /Sales 2007 3300 x 140/3000 154 million Notes payable Current level of NP are maintained Company’s policy is to obtain any additional funds as notes payable * Spontaneously generated funds: With increase in Sales these increase simultaneously,

13. Spontaneously generated funds

14. Forecasting the Balance Sheet Equity Common stock – Most companies rarely issue new common stock so the forecast for CS is usually prev. year’s CS. Preferred stock – Most companies rarely issue PS and those that do further infrequently issue new stock. Retained Earnings 2008: Forecasted addition to R.E. = Forecasted N.I. – Forecasted Dividends = 127.8 – 62.5 = 65.3 million 2008: Forecasted level of R.E. = 2007 R.E. + Forecasted Add. to R.E. = 766 – 65.3 = 831.3 million 1234 Actual 2007 Forecast Basis Forecast for 2008 Assets Cash $10 2008 sales x Cash/Sales $11 Short term investments 000 Accounts receivable 375 2008 sales x AR/Sales 412.5 Inventories 615 2008 sales x Inv./Sales 676.5 Total current assets $1,000$1,100 Net plant and equipment 1000 2008 sales x Net P&E/Sales 1100 Total assets $2,000$2,200 Liabilities and Equity Accounts payable $60 2008 sales x AP/Sales $66 Accruals 140 2008 sales x Accruals/Sales 154 Notes payable 110 224.7 Total current liabilities $310$330.0$444.7 Long term bonds 754 same: no new issue 754 Total liabilities $1,064$1,084.0$1,198.7 Preferred stock 40 same: no new issue 40 Common stock 130 same: no new issue 130 Retained earnings 766 2007 R.E. + 2008 Add. To R.E. 831.3 Total common equity $896$961.3 Total liabilities and equity $2,000$2,085$2,200 Required assets $2,200 Specified sources of financing 2085.3 AFN $114.70 Required add. Notes payable $114.70 Additional short-term invst. 00

15. Forecasting the Balance Sheet 1234 Actual 2007 Forecast Basis Forecast for 2008 Assets Cash $10 2008 sales x Cash/Sales $11 Short term investments 000 Accounts receivable 375 2008 sales x AR/Sales 412.5 Inventories 615 2008 sales x Inv./Sales 676.5 Total current assets $1,000$1,100 Net plant and equipment 1000 2008 sales x Net P&E/Sales 1100 Total assets $2,000$2,200 Liabilities and Equity Accounts payable $60 2008 sales x AP/Sales $66 Accruals 140 2008 sales x Accruals/Sales 154 Notes payable 110 224.7 Total current liabilities $310$330.0$444.7 Long term bonds 754 same: no new issue 754 Total liabilities $1,064$1,084.0$1,198.7 Preferred stock 40 same: no new issue 40 Common stock 130 same: no new issue 130 Retained earnings 766 2007 R.E. + 2008 Add. To R.E. 831.3 Total common equity $896$961.3 Total liabilities and equity $2,000$2,085$2,200 Required assets $2,200 Specified sources of financing 2085.3 AFN $114.70 Required add. Notes payable $114.70 Additional short-term invst. 00 Additional Funds Needed (AFN) MD needs $2200 m of operating assets to support forecasted $3300 m of sales. Specified Sources of Financing (2008) A/P66 Accruals154 N/P (carryover)110 LTB (same, no new issue)754 PS (same, no new issue)40 CS (same, no new issue)130 RE (same, no new issue)831.3 Total$2,085.30 Required assets =Specified sources of financing $2,200.00 =$2,085.30 AFN = Required assets - SSOFAFN = 2200 - 2085.3 = $114.7 million MicroDrive needs 114.7 m of add. financing. Its intitial financing policy is to obtain these add. funds as notes payable bringing forecasted total to 110 + 114.7 = $224.7 million

16. Problem 14-5

17. H.W. Problem 14-8

18. Problem 14-9

19. H.W. Problem 14-7 You can check the notes below for help.