Chapter 9 - Corporate Valuation and Financial Planning Fin 365

forecast operating items>forecast debt, equity, and dividends>ensure company has sufficient (but not excess) financing to fund the operating plan

3 steps in projecting financial statements

targeted

WACC is theoretically calculate based on your ____________ capital structure

more

a higher profit margin means that is ______________ net income available to support increases in assets

sales

accounts receivable should be proportional to _____________

external sources like bank loans, equity, long term bonds, etc.

additional funds needed comes from these sources

idendity additional funding required by additional assets due to increase in sales>identify amount of spontaneous assets>identify amount of internal financing available>assume no new external financing

additional funds needed equation method identifies the financing surplus or deficit in these 4 steps:

capital intensity ratio

amount of assets required per dollar of sales companies with relatively high assets to sales ratios require a large number of new assets for any given increase in sales

inventory

as sales increase, firms generally have to carry more ______________

smoothly

basing interest expense on the average amount of debt outstanding during the year implies that debt is added _______________ during the year

financial duress

companies usually only reduce their dividends to reduce the need for external capital when they are experiencing ___________ _________

more

companies with a higher payout ratio need more or less external financing

net property, plant, and equipment

depreciation depends on an asset's depreciable basis, so it's more reasonable to forecast depreciation as a % of ______________________________ rather than sales

dividend policy

determines size and method of cash distributions to shareholders incorporate into financial plan

capital structure

determines targeted mix of debt and equity used to finance the firm, which determines relative mix of distributions to shareholders and payments to debtholders incorporate into financial plan

marginal

discounted cash flow approach uses the expected dividends growth rate of the _____________ investor

more

do people with a higher capital intensity ratio need more or less external financing

additional funds needed equation

equation that provides ballpark estimate of additional external financing that will be required

economic order quantity (inventories are square root of sales so very large increases in sales require little additional inventory)

example of a nonlinear relatinoship that shows that accounts for assets, spontaneous liabilities, and operating costs are not always proportional to sales

amoun of ash flows generated from operating capital will be less than that amount invested in operating capital

explain cash flows if ROIC is <WACC/(1+g)

some flexibility if you can increase or decrease the amount of dividends you pay, but very little flexibility if you want fixed dividends

explain the flexibility of using net income to finance expansion of assets

sales growth, capital intensity, spontaneous liabilities to sales ratio, profit margin, payout ratio

external financing requirements depend on these 5 key factors that are part of the additional financing needed equation

dividend policy, capital structure

financial plan also has to incorporate the company's ___________ ___________ and ___________ ____________

less detailed

firm's operating plan is usually developed for a 5 year time horizon. Does it becomes more or less detailed after each progressive year?

spontaneous liabilities

first source of expansion funding for funding additional assets

lumpy assets

fixed assets added in large discrete units have a major effect on the ratio of fixed assets to sales and different sales levels and on financial requirements

financial plan

forecasts the additional sources of funds needed to finance the operating plan

nopat-investment in total operating capital

formula for FCF

required increase in assets-spontaneous liabilities income-increase in retained earnings

formula for additional financing needed equation

rs=D1/P0+g

formula for discounted cash flow approach to calculating cost of common equity

actual sales/% of capacity at which fixed assets are operated

formula for full capacity sales

(target fixed assets/sales)projected fixed assets

formula for required level of fixed assets

difference between increase in financing and increase in projected assets

how do you calculate the financing surplus or deficit

interest expense increase due to line of credit>net income decreases because of increased interest expense>internal financing decreases because net income decreases>financing deficit increases because internally generated financing decreases>additional LOC is used to make balance sheet balance>repeat the loop

how does the financing feedback loop work

total net operating working capital

if ROIC is < WACC/(1+g), then the value of operations is less than the

less

if a firm increases their profit margin, do they need more or less external financing

debt at the beginning of the year

if debt is not added until the end of the year, that year's interest expense should be based on what

0

if the self sustaining growth rate is use in the AFN equation, it results in an AFN of

less

if you can lower your capital intensity ratio, then you can achieve a given level of growth with _______________ assets and new external capital

lower (less profitable and less efficient)

if you have a lower NOPAT/Sales ratio or higher capital/sales ratio, your roic may be ______________

large

if you have lumpy assets and you're already operating at full capacity, small projected sales increases would require ___________ increases in capacity

free cash flow

important part of operating plan is forecast of the firm's ________ _____ ______

self supporting growth rate

maximum growth rate the firm could achieve if it had no access to external capital

forecasted financial statements

method of financial planning that forecasts entire financial statements as part of planning process

lines of credit

preliminary financial plan assumes no __________ ___ _________

free cash flow

primary source of a company's value

payout ratio

proportion of income that is distributed as dividends the less income a company distributes as dividends the larger its addition to retained earnings and less need for external capital

operating plan

provides detailed implementation guidance for a firm's operations-logistics, product lines, etc.

balance

realistic projection requires balance sheets to ____________

retail

sales and plant, property, and equipment has a close relationship for ___________ stores

net income/reinvested earnings

second source of funding for expansion of additional assets

identify net additional financing>identify required additional assets>identify resulting financing deficit or surplus>eliminate surplus or deficit

steps in identifying and eliminating the financial deficit or surplus in the projected balance sheets

deficit

there is a financing _________ if additional assets are less than additional financing

surplus

there is a financing _________ if additional financing is greater than additional assets

economies of scale, nonlinear relationships, lumpy asses (and excess capacity)

three different examples og when assumptions of constant ratios and identical growth rates are not always valid

spontaneous liabilities, external financing like new bonds or equity, internal financing like reinvested earnings

three sources of preliminary additional financing

true

true/false both fixed and current assets must increase if sales are to increase

true

true/false if the firm has any positive earnings and pays less than 100% in dividends, then it will have some addition to retained earnings, which can be combined with spontaneous funds to allow the company to grow at some rate without raising external capital

false (they may have one)

true/false in short run, sales and plants property and equipment always have a close relationship

true

true/false rapidly growing companies require large increases in assets and external financing

false

true/false the assumption of constant ratios and identical growth rates of % of sales forecasting methods and the AFN method is always valid

spontaneous liabilities

type of liabilities that grow in proportion to sales

will me meet our goals, what if analysis, anticipate financing needs

what are a couple uses of financing financial statements

improved technology

what can you use to make your inventory/sales ratio decrease

whether to issue stock or debt

what does the financial plan decide on when the fcf is negative

how much fcf to allocate among investors, how much fcf to put in marketable securities (for future needs)

what does the financial plan decide on when the fcf is positive

draw on a line of credit

what is a way that you can handle a financing deficit

pay a special dividend

what is a way that you can handle a financing surplus

accrued taxes and wages

what is an example of spontaneous liabilities

use as much as possible, but little flexibility in their usage (can't just add more when you need to)

what is the main limitation of using spontaneous liabilities

difference between net income and dividends

what is the preliminary amount of internal financing available

operating plan generates the fcf, financial plan decides how to allocate fcf

what is the relationship between operating plan, financial plan, and fcf

economies of scale

when _________ ____ __________ occur, ratios are likely to change over time as the size of the firm increases ex-retailers need to maintain base stocks of different inventory items even if current sales are low AS SALES EXPAND, INVENTORY MAY GROW LESS RAPIDLY THAN SALES SO THE RATIO OF INVENTORY TO SALES DECREASES

financing feedback loop

when additional financing feeds back and causes a need for even more financing

sales

when doing the forecasted financial statement method, spontaneous liabilities increase with

full capacity

when excess capacity exists, sales can grow to the ___________ ___________ sales without increasing fixed assets, but sales beyond that levels require additional fixed assets

growing rapidly

when may a company's fcf be negative (not related to just being a garbage company)

need to increase capacity to increase sales

why is there a close relationship between sales and net PP&E for all companies