1. MGT 3470 survey Name; major Prerequisites MGT3040;
Level of Interest in Corporate Finance
I would like to learn ………(what topics; skills).
I will put (a lot, little, minimum..etc.) work
I will prepare for a career in ….. This course will help (or not)……
Tell me if you would rather prefer not to take this course…..why, what can I do to make it interesting?

2. Corporation
LO2
A business created as a distinct legal entity owned by one or more individuals or entities.
Advantages
Limited liability
Unlimited life
Separation of ownership and management
Transfer of ownership is easy
Easier to raise capital
Disadvantages
Separation of ownership and management
Double taxation (income is taxed at the corporate rate and then dividends are taxed at the personal rate)
Discuss how separation of ownership and management can be both an advantage and a disadvantage:
Advantages
You can benefit from ownership in several different businesses (diversification)
You can take advantage of the expertise of others (comparative advantage)
Easier to transfer ownership
Disadvantage
Agency problems if management goals and owner goals are not aligned.
More expensive form of organization to establish and maintain (corporate taxes have to be filed every year).
Lenders sometimes require the owners of small corporations to make personal guarantees on any credit/loans extended to the corporation, thereby eliminating the limited liability benefit.

3. Financial Management Decisions
LO1
Capital budgeting
What long-term investments or projects should the business take on?
Capital structure
How should we pay for our assets?
Should we use debt or equity?
Working capital management
How do we manage the day-to-day finances of the firm?
Provide some examples of capital budgeting decisions, such as what product or service will the firm sell, should we replace old equipment with newer, more advanced equipment, etc.
Be sure and define debt and equity.
Provide some examples of working capital management, such as who should we sell to on credit, how much inventory should we carry, when should we pay our suppliers, etc.

4. Corporation’s Financial Situation

5. Financial Manager
LO1
Financial managers try to answer some or all of these questions
The top financial manager within a firm is usually the Chief Financial Officer (CFO)
Treasurer – oversees cash management, capital expenditures and financial planning
Controller – oversees taxes, cost accounting, financial accounting and data processing

6. Cash Flows to and from the Firm

7. Long-term Financial Planning and Corporate Growth
Chapter 4
Long-term Financial Planning and Corporate Growth

8. Chapter 4 Outline What is financial planning Financial planning models
The percentage of sales approach
External financing and growth
Caveats in financial planning

9. What is Financial Planning?
Financial planning formulates the way financial goals are to be achieved
Financial plan – a statement of what is to be done in the future
What is the goal of financial management?

10. Short vs. Long-term Financial Planning
Short-term planning – analysis of decisions that affect current assets and current liabilities:
Cash and liquidity management
Credit and inventory management
Long-term planning – focuses on the “big picture”:
Capital budgeting
Dividend policy
Financial structure

11. Dimensions of Financial Planning
Financial horizon – the long-range time period the financial planning process focuses on, usually the next 2-5 years
Aggregation – process by which smaller investment proposals of each of a firm’s operational units are added up and treated as one big unit
Alternative set of assumptions about important variables (scenario analysis)

12. Aims of Financial Planning (1)
Examining interactions – make explicit the linkages between investment proposals for the different operating activities of the firm and financing choices available to the firm
Exploring options – develop, analyze and compare many different scenarios in a consistent way
Avoiding surprises – identify what may happen to the firm if different events take place

13. Aims of Financial Planning (2)
Ensuring feasibility and internal consistency – are the company’s goals compatible?
Communication with investors and lenders

14. Financial Planning Model: Elements (1)
Sales forecast – given as a growth rate in sales
Pro forma statements – a financial plan has a forecasted balance sheet, an income statement, and a statement of cash flows
Asset requirements – firms’ total capital budget consists of changes in total fixed assets and net working capital

15. Financial Planning Model: Elements (2)
Financial requirements – how to raise the capital; dividend policy and debt policy
Cash surplus or shortfall (“plug”) – the designated source of external financing needed to deal with any shortfall in financing and to bring the balance sheet into balance
Economic assumptions – level of interest rates, the firm’s tax rate and sales forecast

16. Framework for long term FP

17. Simple Financial Planning Model
All variables are tied to sales and this relationship is optimal
The growth in assets requires the management to decide how to finance the growth (debt vs. equity)
Dividend policy
Financing policy

18. 1.Dividend policy 2.Financing policy

19. Simple Financial Planning Model: example (1)
COMPUTERFIELD CORPORATION
Financial Statements
Income statement
Balance sheet
Sales
$1,000
Assets
$500
Debt
$250
Costs
800
Equity
250
Net Income
$200
Total

20. (2) If sales 20% - Inc. St. and B. S. 20%
Pro forma income statement
Sales
Costs
Net Income

21. (3) If sales increase by 20% - balance sheet
Last balance sheet
Assets
Debt
250
500
Equity
Total
Pro forma balance sheet
Assets
Debt
300
600
Equity
(RE?)
Total

22. (3) If sales increase by 20% - BS
Pro forma balance sheet (dividends as the plug variable)
Assets
Debt
300
600
Equity
(+50)
Total
Pro forma balance sheet (debt as the plug variable)
Assets
Debt
110
(-140)
600
Equity
490
(+all NI)
Total

23. The Percentage of Sales Approach
A financial planning method in which accounts are projected depending on a firm’s predicted sales level
Not all of the items vary directly with sales

24. Percentage of sales approach:
example (1)
ROSENGARTEN CORPORATION
Initial income statement
Sales
$1,000
Costs
800
(80%)
Taxable Income
$200
Taxes 68
Net Income
$132
(13.2%)
Addition to retained earnings
$88
Dividends
$44

25. (2)
Dividend payout ratio = Cash dividends/Net income = $ 44/$132 *100= 331/3% Retention ratio (plowback ratio) = Retained earnings/Net income = $88/$132*100 = 662/3% or retention ratio = 1- dividend payout ratio = = 0.667

26. Pro forma income statement (25% sales increase)
(3)
Pro forma income statement (25% sales increase)
Sales
$1,250
Costs
1000
(80%)
Taxable income
$250
Taxes 85
Net income
$165
(13.2%)
Projected addition to retained earnings = 165*0.667
Projected dividends paid to shareholders =165*0.333
Net income =165

27. ROSENGARTEN CORPORATION
(4)
ROSENGARTEN CORPORATION
Balance sheet
Assets
Liabilities and Owner's Equity
Current assets
Current liabilities
Cash
$160
(16%)
A/P
$300
(30%)
A/R
440
(44%)
Notes payable
100
n/a
Inventory
600
(60%)
Total
$400
$1,200
(120%)
Long-term debt
$800
Fixed assets
Owner's equity
Net plant and
Common stock
equipment
$1,800
(180%)
Retained earnings
1,000
Total assets
$3,000
(300%)
Total liabilities and shareholder's equity

28. Pro forma balance sheet after 25% sales increase
(5)
ROSENGARTEN CORPORATION
Pro forma balance sheet after 25% sales increase
($)
(Δ,$)
Assets
Liabilities and Owner's Equity
Current assets
Current liabilites
Cash
$200
$40
A/P
$375
$75
A/R
550
110
Notes payable
100
Inventory
750
150
Total
$475
$1,500
$300
Long-term debt
$800 $0
Fixed assets
Owner's equity
Net plant and
Common stock
equipment
$2,250
$450
Retained earnings
1,110
$1,910
$110
Total assets
$3,750
$750
Total liabilities and shareholder's equity
$3,185
$185
External financing
needed
$565

29. EFN=565 D=207.7 ; E = 357.3 To keep existing D/E = 800/1800 = 0.444
RE = 110; EFN =565
Set a system of two linear equations with two unknown D and E
D + E = 3, (EFN + D + E + RE)
D/E = 0.444
E= 2, (3,275/1.444)
D = (3,275-2,267.30)

30. Framework for long term FP

31. 1.Dividend policy 2.Financing policy

32. External Financing
External financing needed (EFN) = the amount of financing required to balance both sides of the balance sheet
For Rosengarten Corporation: Assets-(Liability + Equity) = $3,750 – $3,185 = $565 In order to have a 25% increase in sales the corporation has to raise $565 in new financing Possible sources of financing : - short-term borrowing - long-term borrowing - new equity

33. Capital Intensity Ratio
A firm’s total assets divided by its sales
The amount of assets needed to generate $1 sales (3000/1000=3)

34. EFN and Capacity Usage
Suppose Rosengarten is operating at 80% capacity:
1. What would be sales at full capacity?
2. What is the capital intensity ratio at full capacity?
3. What is EFN?

35. Capital Intensity Ratios =3300/1250 =2.64 3. EFN =300 -185 =115
Answers: (homework)
/.8=1250
2.Only $300 of new assets (no need for new FA). Therefore TA=3,300 Sales=1250
Capital Intensity Ratios =3300/1250 =2.64
(previously 3000/1000=3)
3. EFN = =115
Conclusion: excess capacity reduces the need for external financing; capital intensity ratio at full capacity is lower

36. operating at 80% capacity:

37. Forecasted sales growth 25%
Full capacity=1000/.8=1250 (no need for new FA)

38. EFN=115 D=45.76 ; E = 69.24 To keep existing D/E = 800/1800 = 0.444
RE = 110; EFN =115
Set a system of two linear equations with two unknown D and E
D + E = 2, (EFN + D + E + RE)
D/E = 0.444
E= 1, (2,825/1.444)
D = (2,825-1,955.76)

39. operating at 80% capacity:

40. Forecasted sales growth 50%
Full capacity=1000/.8=1250 ( =$250 sales should be produced on new FA)

41. EFN=678 D=242.46 ; E = 435.54 To keep existing D/E = 800/1800 = 0.444
RE = 110; EFN =678
Set a system of two linear equations with two unknown D and E
D + E = 3, (EFN + D + E + RE)
D/E = 0.444
E= 2, (3,388/1.444)
D = (3,388-2,345.54)

42. Internal growth rate = ROA×R/(1-ROA×R)
EFN and Growth
Increase in total assets is financed internally and externally
Increase in total assets = assets (A) × sales growth (g)
Internal financing = Addition to retained earnings = Projected net income × retention ratio (R) = Profit margin (p) × projected sales[S×(1+g)] × retention ratio or
EFN = A×g – p×S×R×(1+g)
Internal growth rate = ROA×R/(1-ROA×R)

43. Financial Policy and Growth
A firm may not wish to sell any new equity
If a firm borrows to its debt capacity sustainable growth rate can be achieved
Debt capacity = the ability to borrow to increase firm value
g* = ROE×R/(1-ROE×R)

44. Internal vs. Sustainable Growth Rates
Internal growth rate – the maximum growth rate a firm can maintain with only internal financing
Sustainable growth rate – the maximum growth rate a firm can achieve with no external equity financing

45. From intro finance course… Using Du Pont Analysis

46. Determinants of Growth
g* = [p (S/A) (1+D/E)×R]/[1-p(S/A)(1+D/E)×R]
Profit margin
Dividend policy
Financial policy
Total asset turnover

47. Caveats of Financial Planning Models
Rely on accounting relationships
Need to be modified over time
Objectivity of financial plans