Chapter 4: Long-Term Financial Planning and Corporate Growth

Question 1

What is financial planning?

Answer 1

Formulates the way financial goals are to be achieved- statement of what is to be done in the future.

Question 2

planning horizon

Answer 2

The long-range time period the financial planning process focuses on, usually the next two to five years.

All individual projects and investments that the firm undertakes are combined to determine the total needed investment

Question 3

Aggregation process

Answer 3

the process by which smaller investments proposals of each of a firm’s operational units are added up and treated as one big project

Question 4

In a financial plan:

Answer 4

1. All individual projects and investments that the firm undertakes are combined to determine the total needed investment (planning horizon)
   2. Aggregation process –> the process by which smaller investments proposals of each of a firm’s operational units are added up and treated as one big project
   3. Would need inputs in the form of alternative sets of assumptions about important variables (worst case, normal case, best case)

Question 5

What can planning accomplish ?

Answer 5

Examining interactions
Exploring options
Avoiding surprises
Ensuring Feasibility and Internal Consistency
Communication with investors and lenders

Question 6

Examining interactions

Answer 6

Financial plan must show the linkage between investment proposals for the different operating activities of the firm and the financing choices or options available to the firm.

Question 7

Exploring options

Answer 7

Financial plan provides the opportunity for the firm to develop, analyze, and compare many different scenarios in a consistent way. Various financing options can be explored

Question 8

Avoiding surprises

Answer 8

○ Financial planning should identify what may happen to the firm if different events take place.
○ What actions should be taken if things go wrong
○ If assumptions made today about the future are an error

Question 9

Ensuring Feasibility and

Answer 9

Financial planning is a way of checking that the goals and plans made with regard to specific areas of a firm’s operations are feasible and internally consistent

Question 10

Communication with investors and lenders

Answer 10

They require a financial plan as a prospectus describing the firms plans

Question 11

Almost all financial plans have the following elements

Answer 11

• sales forecast
• pro forma statements
• Assets requirements
• Financial Requirements
• Cash Surplus or Shortfall
• Economic Assumptions

Question 12

-sales forecast

Answer 12

§ This value is provided, and all other values are base off it
§ Usually presented as a growth rate– projected future sales

Question 13

-pro forma statements

Answer 13

§ Forecasted statements of comprehensive income and financial position, and a statement of cash flows.

Question 14

-Assets requirements

Answer 14

Projected capital spending

Question 15

-Financial Requirements

Answer 15

Financial arrangements that are necessary- dividend policy or debt policy . If the company plans make money by selling shares, this tells you which securities need to be sold and how to issue.

Question 16

-Cash Surplus or Shortfall

Answer 16

After capital spending the assets may be more than the liabilities and assets so some additional financing may be necessary ( a financial “plug” ) . (EFN)

Question 17

-Economic Assumptions

Answer 17

§ Plan needs to describe the economic environment in which the firm expects to reside over the life of the plan
□ Interest rates
□ The firm’s tax rates
□ Sales forecasts

Question 18

Percentage of sales approach–>

Answer 18

Financial planning method in which accounts are projected depending on a firm’s predicted sales level.

Question 19

Dividend payout ratio–>

Answer 19

Amount of Cash Paid out to shareholder’s divided by net income

Question 20

Retention or plowback ratio

Answer 20

Retained earnings divided by net income

1=retention ratio+ payout ration

Question 21

Capital intensity ratio

Answer 21

a firm’s total assets divided by sales, or the amount of assets needed to generate $1 in sales. Also the reciprocal of total asset turnover ratio

Question 22

External financing Needed (EFN)-

Answer 22

the amount of financing required to balance both sides of the statement of financial position

Question 23

Debt capacity–

Answer 23

the ability to borrow to increase firm value.

Question 24

Sustainable Growth Rate (SGR)

Answer 24

The growth rate a firm can maintain given its debt capacity, ROE, and retention ratio.

Question 25

Determinants of Growth

Answer 25

• Profit Margin
• Dividend Policy
• Financial Policy
• Total Asset Turnover

Question 26

1. Profit margin–>

Answer 26

increase in profit margin, p, increases the firms ability to generate funds internally and thereby increase its sustainable growth

Question 27

2. Dividend policy–>

.

Answer 27

A decrease in the percentage of net income paid out as dividends increases the retention ratio, R. This increase internally generated equity and thus increases sustainable growth

Question 28

Financial policy

Answer 28

–> an increase in the debt/equity ratio, D/E, increase the firms financial leverage. Since this makes additional debt financing available, it increases the sustainable growth rate.

Question 29

Total Asset Turnover–

Answer 29

> An increase in the firm’s total asset turnover, S/A, increase the sales generated for each dollar in assets. This decreases the firms need for new assets as sales grow and thereby increases the sustainable growth rate. Notice that increasing total asset turnover is the same thing as the decreasing capital intensity.

Question 30

Caveats on Financial planning models

Answer 30

• Do not always as the right questions–>tend to rely on accounting relationships and not financial relationships–> the basic elements of firm value tend to get left out (cash flow size, risk, timing
  
  • Sometimes this misleads firms away from strategies that can help increase value, but side track them with things like debt/equity and firm growth.
  • Long-term financial plans are sometimes too top-down–> management gives expectations and those beneath scramble to get them done, in the end not enough sales are made to service debt
  • As a negotiated result, a plan will implicitly contain different goals in different areas and also satisfies many constraints.