1. 1 FINANCE 7311 CORPORATE FINANCIAL PLANNING

2. 2 FINANCIAL PLANNING l Long-Run CORPORATE OBJECTIVES Maximize the Value of the Firm Sub -objectives (INCREASE MARKET SHARE) l STRATEGIES (STEPS) SPECIFIC ACTION PLAN SWOT ANALYSIS; 4 P’S –(PRICE STRATEGY)

3. 3 Financial Planning, cont. l PERFORMANCE MEASUREMENT  OJBECTIVE; SPECIFIC  WERE GOALS ACHIEVED? (% MARKET SHARE) l BUSINESS PLAN => FINANCIAL PLAN  Operating & marketing strategies underlie a financial plan

4. 4 USES OF FINANCIAL PLAN l PROJECTION OF FINANCIAL NEEDS Financial implications of corporate strategies l PERFORMANCE MEASUREMENT  A benchmark which reflects strategies

5. 5 FINANCIAL MODEL  EQUATIONS A = D + E End Balance = Beg. Bal. + Add - Subtract  PARAMETERS Tax rate; NWC requirements  DECISION VARIABLES Investment; Financing

6. 6 COMPONENTS  PRO-FORMA FINANCIAL STMTS  CASH BUDGET  SPECIFIC BUDGETS Production Personnel Marketing; distribution Capital

7. 7 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.

8. 8 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

9. 9 % OF SALES EXAMPLE S Last Year Sales:10,000 S Last Year Acct. Rec. 1,000 S Forecast Sales Growth: 20% S Forecast Sales: 10,000 X 1.2 = 12,000 S Forecast Acct. Rec.1,000 X 1.2 = 1,200 S OR: 1,000/10,000 X 12,000 = 1,200

10. 10 % of SALES - COMMENTS Þ Method of Last Resort Þ Assets / Sales ratio is optimal Þ Assumes Full Capacity Þ Assumes Assets / Sales relation is linear Economies of Scale Less than full capacity Sales decreases

11. 11 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

12. 12 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

13. 13 CASH BUDGET s Projection of future cash flows s Performance benchmark s Useful for seasonal companies s More specific information s Provides same ‘financing’ need as pro- forma financial statements

14. 14 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?

15. 15 Cash Budget, cont.  STEP 3: Project amount & timing of cash outflows Purchases Labor Capital Expenditures Dividends & interest Other Expenses

16. 16 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)

17. 17 GROWTH SOURCE OF SALES GROWTH: QUANTITY PRICE COMBINATION OF BOTH QUANTITY INDUSTRY GROWTH (Pie) MARKET SHARE GROWTH (Piece of Pie)

18. 18 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

19. 19 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

20. 20 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

21. 21 Sustainable Growth, cont. DuPont:  ROE x r = Profitability x turnover x leverage x r Management choices: 3 Squeeze more sales $ out of existing assets 3 Squeeze more income out of existing sales $ 3 Retain more earnings in the firm 3 Be willing to accept more leverage 3 Settle for less growth

22. 22 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)

23. 23 Growth Example, cont. 3 P = D/(R - g) 3 g = ROE x r = 15% x 0 = 0 3 P = 5 / (12.5% - 0) = $40.00 3 P/E = 8( = 1/R)

24. 24 Growth Example, cont.  Now, suppose r=60% (reinvest 60%) 3 g = ROE x r = 15% x 60% = 9% 3 D = 40% x 5.00 = $2.00 3 P = 2 / (12.5% - 9%) = $57.14 3 P/E = 11.43 3 Growth has increased Price and P/E!

25. 25 Growth example, cont.  Suppose r = 60% as before  ROE = 10% 3 g = 10% x 60% = 6% 3 P = $2 / (12.5% - 6%) = $30.77 3 P/E = 6.2 3 Growth has decreased both price and P/E! 3 Growth creates Value when: ROE > R