Chapter 4

Question 1

Growth

Answer 1

The growth of something such as industry, organization, or an idea is its development in size, wealth, or importance

Question 2

Financial planning

Answer 2

Systematically thinking about future to avoid financial distress and failures in the future.
Establishment of guidelines in relation to investment and financing decisions

Question 3

Parts of a business plan

Answer 3

Executive summary, Competitive analysis, Company description, Organization and management, Summary of products/services, Sales and marketing plan, Financial projection and needs

Question 4

Elements of Financial Planning

Answer 4

1. Investment in new assets - determined by capital budgeting decisions
2. Degree of financial leverage - determined by capital structure decisions
3. Cash paid to shareholders - determined by dividend policy decisions
4. Liquidity requirements - determined by net working capital decisions

Question 5

Financial Planning Process (Dimensions)

Answer 5

Planning horizon: short-term (next 12months), long-term (2-5 years)
Aggregation - combine capital budgeting decisions into large project.
Assumptions and Scenarios: make realistic assumptions about important variables; run several scenarios where vary the assumptions by reasonable amounts; determine worst case, normal case, best case scenarios.

Question 6

Role of financial planning

Answer 6

Examine interactions - help management see the interactions between decisions;
Explore options - give management a systematic framework for exploring its opportunities;
Avoid surprises - help management identify possible outcomes and plan accordingly;
Ensure feasibility and internal consistency

Question 7

Financial planning model ingredients

Answer 7

Sales forecast; Pro forma statements; Asset requirements; Financial requirements; Plug variable; Economic assumptions

Question 8

Capital intensity ratio

Answer 8

Capital intensity ratio = Sales / Total assets (how much total assets generate $1 in sales)

Question 9

% of sales approach

Answer 9

1. as sales grow by a certain %, the underlying expenses and items also increase by the same %
2. start with the items’ % of sales –> based on the prejected sales calculate the pro formas

Question 10

Retention ratio

Answer 10

Addition to retained earnings / Net income

Question 11

Dividend payout ratio

Answer 11

Cash dividends / Net income

Question 12

Profit margin

Answer 12

Net income / Sales

Question 13

Internal growth rate (IGR)

Answer 13

The maximum amount of growth that can bee achieved without external funding, using only internal resources:

IGR = (ROA * b) / (1-ROA * b)

ROA: return on assets = Net income / Total assets
b: retention ratio

Question 14

Sustainable growth rate (SGR)

Answer 14

The maximum growth rate that a company can achieve without external equity financing:

SGR = (ROE * b) / (1-ROE * b)

ROE: return on equity = net income / total equity
b: retention ration

Question 15

ROE

Answer 15

ROE = Profit margin * Total asset turnover * Equity turnover

ROE = (net income/sales) * (sales/total assets) * (total assets/total equity)

Anything that increases ROE, will increase the SGR

Question 16

Determinants of growth

Answer 16

Profit margin: the larger it is, the greater the ability to generate funds internally, shows operational efficiency.

Total asset turnover: the higher it is, the higher the sales generated for each dollar in assets, shows the efficiency of asset utilization, the reciprocal/inverse of the capital intensity ratio.

Financial policy: increase debt/equity ratio, increase financial leverage.

Dividend policy: paying out less cash dividends increases the retention ration and increases the internally generated equity, therefore increases SGR.

Question 17

Growth rate

Answer 17

If sales grow at a rate higher than the sustainable growth rate, the company must increase profit margin, total asset turnover, financial leverage, earnings retention or sell new shares