Title: Long-Term Financial Planning and Corporate Growth
1Long-Term Financial Planning and Corporate Growth
- Adapted from Fundamentals of Corporate Finance
RWJR, Fourth Canadian Edition (Chapter 4)
2Definition
- Financial planning establishes guidelines for
change and growth in a firm. - It focuses on the major elements of a firm's
financial and investment policies without
examining the individual components of those
policies in detail.
3How it works
- Forecasted growth in assets has to be matched
with a corresponding growth in financing - Start with forecasting the growth in assets
- Determine how much additional financing is needed
- Determine whether internal funds are sufficient
- If necessary, plan for external financing
4Exemplification Rosengarten Corp. Balance sheet
() Income Statement
5Assumption
- Sales are forecasted to increase by 25
6Pro-forma income statement ()
7Pro-forma balance sheet ()
8Pro-forma balance sheet ()
9Pro-forma balance sheet ()
10Implication
- We need 565 in external financing!
11External financing and growth
- EFN Increase in TA - Addition to RE
- EFN (A)(sg) - (p)(S)(R)(1sg)
- EFN 750 - 110 640
- The difference between 565 and 640 75, the
increase in accounts payable. - If you consider accounts payable internal
financing, then - EFN Increase in TA - Addition to RE - Increase
in Acc. payable - where
- A total assets
- S current sales
- p profit margin net income/sales
- R retention ratio
- sg rate of growth in sales
12Internal growth rate
- The growth rate a firm can maintain with internal
financing only (ignore increase in accounts
payable) - IGR (p)(S)(R) / A - (p)(S)(R)
- IGR ROA(R) / 1-ROA(R)
- IGR (0.132)(1,000)(2/3) / 3,000 -
(0.132)(1,000)(2/3) 3.02
13Sustainable growth rate
- The growth rate a firm can maintain given its
capital structure, ROE, and retention ratio. - EFN Increase in TA - Addition to RE - New
borrowing - SGR (ROE)(R) / 1 - (ROE)(R) (0.0734)(2/3) /
1 - (0.073)(2/3) - SGR 5.14
- SGR (p)(S/A)(1D/E)(R)/1- (p)(S/A)(1D/E)(R)
14Growth and capacity usage
- What happens if the firm is not operating at full
capacity? - Case (i) Firm operates at 70 capacity
- Case (ii) Firm operates at 90 capacity
- Additional information when reaching full
capacity the firm will have to expand production
by building additional operating plants. Each
plant has the potential to increase output/sales
by 30 percentage points.
15Case (i) Pro-forma balance sheet at 25 growth
16Case (i) EFN
- We need 3,300 - 3,185 115 in external
financing. - We could borrow 115 in the short term by issuing
commercial paper or short-term notes.
17Case (ii) Pro-forma balance sheet at 25 growth
18Case (ii) EFN
We need 3,840 - 3,185 655 in external
financing. We need to borrow in the long-run
and/or issue additional equity.
19Comment
- Calculating EFN, IGR, SGR with the help of
formulas makes the implicit assumption that the
firm is operating at full capacity. In reality
this is seldom the case. - Forecasting financial growth with the help of
pro-forma financial statements is always
preferable.
20Determinants of growth
- Profit margin An increase in the profit margin,
increases the firm's ability to generate funds
internally and thereby increases its sustainable
growth. - Dividend policy A decrease in the payout ratio
increases internally generated equity, and thus
increases sustainable growth. - Capital structure An increase in the firm's
leverage makes additional debt financing
available, and hence increases the sustainable
growth rate. - Total asset turnover An increase in S/A
decreases the firm's need for new assets as sales
grow. Hence it increases the sustainable growth
rate.