CHAPTER 17 Financial Planning and ForecastingBalance sheet (2002), in millions of dollarsIncome statement (2002), in millions of dollarsKey ratiosKey assumptionsDetermining additional funds needed, using the AFN equationHow shall AFN be raised?Forecasted Income Statement (2003)Forecasted Balance Sheet (2003) AssetsForecasted Balance Sheet (2003) Liabilities and EquityWhat is the additional financing needed (AFN)?How will the AFN be financed?Forecasted Balance Sheet (2003) Assets – 2nd passForecasted Balance Sheet (2003) Liabilities and Equity – 2nd passWhy do the AFN equation and financial statement method have different results?Forecasted ratios (2003)What was the net investment in operating capital?How much free cash flow is expected to be generated in 2003?Suppose fixed assets had only been operating at 75% of capacity in 2002How would the excess capacity situation affect the 2003 AFN?If sales increased to $3,000 instead, what would be the fixed asset requirement?How would excess capacity affect the forecasted ratios?Forecasted ratios (2003) with projected 2003 sales of $2,500How is NWC managing its receivables and inventories?How would the following items affect the AFN?17-1CHAPTER 17Financial Planning and ForecastingForecasting salesProjecting the assets and internally generated fundsProjecting outside funds neededDeciding how to raise funds17-2Balance sheet (2002),in millions of dollarsCash & sec. $ 20 Accts. pay. & accruals $ 100Accounts rec. 240 Notes payable 100Inventories 240 Total CL $ 200Total CA $ 500 L-T debt 100Common stock 500Net fixed Retained assets 500 earnings 200Total assets $1,000 Total claims $1,00017-3Income statement (2002),in millions of dollarsSales $2,000.00Less: Var. costs (60%) 1,200.00Fixed costs 700.00EBIT $ 100.00Interest 16.00EBT $ 84.00Taxes (40%) 33.60Net income $ 50.40Dividends (30%) $15.12Add’n to RE $35.2817-4Key ratios NWC Industry ConditionBEP 10.00% 20.00% PoorProfit margin 2.52% 4.00% ”ROE 7.20% 15.60% ”DSO 43.80 days 32.00 days ”Inv. turnover 8.33x 11.00x ”F. A. turnover 4.00x 5.00x ”T. A. turnover 2.00x 2.50x ”Debt/assets 30.00% 36.00% GoodTIE 6.25x 9.40x PoorCurrent ratio 2.50x 3.00x ”Payout ratio 30.00% 30.00% O. K.17-5Key assumptionsOperating at full capacity in 2002.Each type of asset grows proportionally with sales.Payables and accruals grow proportionally with sales.2002 profit margin (2.52%) and payout (30%) will be maintained.Sales are expected to increase by $500 million. (%S = 25%)17-6Determining additional funds needed, using the AFN equationAFN = (A*/S0)ΔS – (L*/S0) ΔS – M(S1)(RR)= ($1,000/$2,000)($500) – ($100/$2,000)($500) – 0.0252($2,500)(0.7)= $180.9 million.17-7How shall AFN be raised?The payout ratio will remain at 30 percent (d = 30%; RR = 70%).No new common stock will be issued.Any external funds needed will be raised as debt, 50% notes payable and 50% L-T debt.17-8Forecasted Income Statement (2003)Sales $2,000 1.25 $2,500Less: VC 1,200 0.60 1,500FC 700 0.35 875 EBIT $ 100 $ 125Interest 16 16 EBT $ 84 $ 109Taxes (40%) 34 44Net income $ 50 $ 65Div. (30%) $15 $19Add’n to RE $35 $46ForecastBasis2003Forecast200217-920031st PassForecasted Balance Sheet (2003)Assets2002ForecastBasisCash $ 20 0.01 $ 25Accts. rec. 240 0.12 300Inventories 240 0.12 300 Total CA $ 500 $ 625Net FA 500 0.25 625 Total assets $1,000 $1,25017-1020031st Pass2002ForecastBasisForecasted Balance Sheet (2003)Liabilities and EquityAP/accruals $ 100 0.05 $ 125Notes payable 100 100 Total CL $ 200 $ 225L-T debt 100 100Common stk. 500 500Ret.earnings 200 +46* 246 Total claims $1,000 $1,071* From income statement.17-11What is the additional financing needed (AFN)?Required increase in assets = $ 250Spontaneous increase in liab. = $ 25Increase in retained earnings = $ 46Total AFN = $ 179NWC must have the assets to generate forecasted sales. The balance sheet must balance, so we must raise $179 million externally.17-12How will the AFN be financed?Additional N/P0.5 ($179) = $89.50Additional L-T debt0.5 ($179) = $89.50But this financing will add to interest expense, which will lower NI and retained earnings. We will generally ignore financing feedbacks.17-1320032nd Pass20031st PassAFNForecasted Balance Sheet (2003)Assets – 2nd passCash $ 25 - $ 25Accts. rec. 300 - 300Inventories 300 - 300 Total CA $ 625 $ 625Net FA 625 - 625 Total assets $1,250 $1,25017-1420032nd Pass20031st PassAFNForecasted Balance Sheet (2003)Liabilities and Equity – 2nd passAP/accruals $ 125 - $ 125Notes payable 100 +89.5 190 Total CL $ 225 $ 315L-T debt 100 +89.5 189Common stk. 500 - 500Ret.earnings 246 - 246 Total claims $1,071 $1,250* From income statement.17-15Why do the AFN equation and financial statement method have different results?Equation method assumes a constant profit margin, a constant dividend payout, and a constant capital structure.Financial statement method is more flexible. More important, it allows different items to grow at different rates.17-16Forecasted ratios (2003) 2002 2003(E) IndustryBEP 10.00% 10.00% 20.00% PoorProfit margin 2.52% 2.62% 4.00% ”ROE 7.20% 8.77% 15.60% ”DSO (days) 43.80 43.80 32.00 ”Inv. turnover 8.33x 8.33x 11.00x ”F. A. turnover 4.00x 4.00x 5.00x ”T. A. turnover 2.00x 2.00x 2.50x ”D/A ratio 30.00% 40.34% 36.00% ”TIE 6.25x 7.81x 9.40x ”Current ratio 2.50x 1.99x 3.00x ”Payout ratio 30.00% 30.00% 30.00% O. K.17-17What was the net investment in operating capital?OC2003 = NOWC + Net FA= $625 - $125 + $625 = $1,125OC2002 = $900Net investment in OC = $1,125 - $900= $22517-18How much free cash flow is expected to be generated in 2003?FCF = NOPAT– Net inv. in OC= EBIT (1 – T) – Net inv. in OC= $125 (0.6) – $225= $75 – $225= -$150.17-19Suppose fixed assets had only been operating at 75% of capacity in 2002Additional sales could be supported with the existing level of assets.The maximum amount of sales that can be supported by the current level of assets is:Capacity sales = Actual sales / % of capacity= $2,000 / 0.75 = $2,667Since this is less than 2003 forecasted sales, no additional assets