1. Chapter 29 Principles of Corporate Finance Tenth Edition Financial Planning Slides by Matthew Will McGraw-Hill/Irwin Copyright © 2011 by the McGraw-Hill Companies, Inc. All rights reserved.

2. 29-2 Topics Covered  Links Between Long-Term and Short-Term Financing Decisions  Tracing Changes in Cash  Cash Budgeting  Short-Term Financing Plan  Long-Term Financing Plan  Growth and External Financing

3. 29-3 Firm’s Cumulative Capital Requirement Lines A, B, and C show alternative amounts of long-term finance. Strategy A: A permanent cash surplus Strategy B: Short-term lender for part of year and borrower for remainder Strategy C: A permanent short-term borrower A B C Year 2Year 1 Dollars Cumulative capital requirement Time

4. 29-4 Balance Sheet Example - Dynamic Mattress Company

5. 29-5 Income Statement Example - Dynamic Mattress Company

6. 29-6 Changes in Cash Flows Example - Dynamic Mattress Company

7. 29-7 Changes in Cash Flows Example - Dynamic Mattress Company  Dynamic sources of cash flows 1.It earned $60 million of net income (operating activity). 2.It set aside $20 million as depreciation. Remember that depreciation is not a cash outlay. Thus, it must be added back in order to obtain Dynamic’s cash flow (operating activity). 3.It reduced inventory, releasing $5 million (operating activity). 4.It increased its accounts payable, in effect borrowing an additional $25 million from its suppliers (operating activity). 5.It issued $30 million of long-term debt (financing activity).

8. 29-8 Changes in Cash Flows Example - Dynamic Mattress Company  Dynamic uses of cash flows 1.It allowed accounts receivable to expand by $25 million (operating activity). In effect, it lent this additional amount to its customers. 2.It invested $30 million (investing activity). This shows up as the increase in gross fixed assets in Table 29.2. 3.It paid a $30 million dividend (financing activity). (Note: The $30 million increase in Dynamic’s equity in Table 29.2 is due to retained earnings: $60 million of equity income, less the $30 million dividend.) 4.It purchased $25 million of marketable securities (financing activity). 5.It repaid $25 million of short-term bank debt (financing activity)).

9. 29-9 Working Capital Simple Cycle of operations Cash Finished goods Receivables Raw materials

10. 29-10 The Cash Cycle

11. 29-11 Cash Budgeting  Steps to preparing a cash budget Step 1 - Forecast the sources of cash. Step 2 - Forecast uses of cash. Step 3 - Calculate whether the firm is facing a cash shortage or surplus.

12. 29-12 Cash Budgeting Example - Dynamic Mattress Company Dynamic forecasted sources of cash AR ending balance = AR beginning balance + sales - collections

13. 29-13 Cash Budgeting Example - Dynamic Mattress Company Dynamic collections on AR

14. 29-14 Cash Budgeting Example - Dynamic Mattress Company Dynamic forecasted uses of cash  Payment of accounts payable  Labor, administration, and other expenses  Capital expenditures  Taxes, interest, and dividend payments

15. 29-15 Cash Budgeting Example Dynamic cash budget

16. 29-16 A Short Term Financing Plan Example - Dynamic Mattress Company- Financing Plan continued

17. 29-17 A Short Term Financing Plan Example - Dynamic Mattress Company- Financing Plan

18. 29-18 Financial Planning Planning Horizon - Time horizon for a financial plan. Departments are often asked to submit 3 alternatives –Optimistic case = best case –Expected case = normal growth –Pessimistic case = retrenchment  Financial plans help managers ensure that their financial strategies are consistent with their capital budgets. They highlight the financial decisions necessary to support the firm’s production and investment goals.

19. 29-19 Financial Planning Why Build Financial Plans?  Contingency planning  Considering options  Forcing consistency

20. 29-20 Financial Planning Steps Inputs Outputs Outputs - Projected financial statements (pro forma). Financial ratios. Sources and uses of funds. Planning Model Planning Model - Equations specifying key relationships. Inputs - Current financial statements. Forecasts of key variables (such as sales or interest rates).

21. 29-21 Dynamic Mattress Financial Plan Condensed year-end balance sheets for 2009 and 2008 for Dynamic Mattress Company (figures in $ millions).

22. 29-22 Dynamic Mattress Financial Plan Latest and forecasted operating cash flows for Dynamic Mattress Company (figures in $ millions).

23. 29-23 Dynamic Mattress Financial Plan Latest and forecasted amounts of external capital required for Dynamic Mattress Company (figures in $ millions).

24. 29-24 Dynamic Mattress Financial Plan Latest and pro forma balance sheets for Dynamic Mattress Company (figures in $ millions).

25. 29-25 Financial Planning Models Pro Formas - Projected or forecasted financial statements. Percentage of Sales Model - Planning model in which sales forecasts are the driving variable and most other variables are proportional to sales. Balancing Item - Variable that adjusts to maintain the consistency of a financial plan. Also called plug.

26. 29-26 Planners Beware  Many models ignore realities such as depreciation, taxes, etc.  Percent of sales methods are not realistic because fixed costs exist.  Most models generate accounting numbers not financial cash flows  Adjustments must be made to consider these and other factors.

27. 29-27 Growth & External Financing Sustainable growth rate - Steady rate at which a firm can grow without changing leverage

28. 29-28 Web Resources Click to access web sites Internet connection required www.directpayment.org www.nacha.org www.phoenixhecht.com www.gecfosolutions.com www.federalreserve.gov