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Long-Term Financial Planning and Corporate Growth

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Title: Long-Term Financial Planning and Corporate Growth Author: Cole Computer Centre Last modified by: mike Created Date: 8/18/2002 8:07:42 PM Document presentation ... – PowerPoint PPT presentation

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Title: Long-Term Financial Planning and Corporate Growth


1
Long-Term Financial Planning and Corporate Growth
  • Adapted from Fundamentals of Corporate Finance
    RWJR, Fourth Canadian Edition (Chapter 4)

2
Definition
  • 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.

3
How 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

4
Exemplification Rosengarten Corp. Balance sheet
() Income Statement
5
Assumption
  • Sales are forecasted to increase by 25

6
Pro-forma income statement ()
7
Pro-forma balance sheet ()
8
Pro-forma balance sheet ()
9
Pro-forma balance sheet ()
10
Implication
  • We need 565 in external financing!

11
External 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

12
Internal 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

13
Sustainable 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)

14
Growth 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.

15
Case (i) Pro-forma balance sheet at 25 growth
16
Case (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.

17
Case (ii) Pro-forma balance sheet at 25 growth
18
Case (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.
19
Comment
  • 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.

20
Determinants 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.
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