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Corporate Financial Planning for Long-Run Objectives

Maximize the value of the firm by creating a financial plan that includes specific action plans, strategies, and performance measurement. Use projections of financial needs and implications of corporate strategies to guide decision-making.

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Corporate Financial Planning for Long-Run Objectives

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  1. FINANCE 7311 CORPORATE FINANCIAL PLANNING

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

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

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

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

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

  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. 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 • Ratioanalysis from before helpful

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

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

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

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

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

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

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

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

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

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