CHAPTER 29 29 1 FINANCIAL PLANNING Brealey Myers
CHAPTER 29 29 -1 FINANCIAL PLANNING Brealey, Myers, and Allen Principles of Corporate Finance 13 th Edition Slides by Matthew Will Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Topics Covered 29 -2 • Links between Short-Term and Long-Term Financing Decisions • Tracing Changes in Cash • Cash Budgeting • Dynamic’s Short-Term Financial Plan • Long-Term Financial Planning • Growth and External Financing Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Figure 29. 1 Cumulative Capital Requirement 29 -3 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Figure 29. 2 Median Ratio of Cash to Assets for U. S. Nonfinancial Firms, (1980– 2017) 29 -4 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Table 29. 1 Income Statement for Dynamic Mattress Company, 2018 (Figures in $ Millions) 29 -5 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Table 29. 2 Year-End Balance Sheets for 2018 and 2017 for Dynamic Mattress Company (Figures in $ Millions) 29 -6 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Table 29. 3 Statement of Cash Flows for Dynamic Mattress Company, 2018 (Figures in $ Millions) 29 -7 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Tracing Changes in Cash 29 -8 Example: Dynamic Mattress Company (generated cash) 1. It earned $73. 3 million of net income (operating activity). 2. It set aside $23. 5 million as depreciation. It reduced inventory, releasing $11. 4 million (operating activity). 3. It increased its accounts payable, in effect borrowing an additional $25 million from its suppliers (operating activity). 4. It issued $30 million of long-term debt (financing activity). Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Tracing Changes in Cash Continued 29 -9 Example: Dynamic Mattress Company (used cash) 1. It allowed accounts receivable to expand by $26 million (operating activity). 2. It invested $30 million (investing activity). 3. It paid a $46. 8 million dividend (financing activity). 4. It purchased $25 million of marketable securities (financing activity). 5. It repaid $25 million of short-term bank debt (financing activity). Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
The Cash Cycle 29 -10 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Figure 29. 3 Operating and Cash Cycles 29 -11 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
The Cash Cycle Continued 29 -12 Cash cycle (days) = inventory period + accounts receivable period – accounts payable period Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Table 29. 4 Data Used to Calculate the Cash Cycle for U. S. Manufacturing Firms in 2017 (in Billions) 29 -13 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Cash Budgeting 29 -14 Steps to preparing a cash budget: Step 1: Forecast the sources of cash Step 2: Forecast the uses of cash Step 3: Calculate whether the firm is facing a cash shortage or surplus Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Step 1: Forecast the Sources of Cash 29 -15 Example: Dynamic Mattress Company Dynamic forecasted sources of cash Ending accounts receivable = beginning accounts receivable + sales – collections Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Table 29. 5 Dynamic Mattress Cash Budgeting 29 -16 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Step 2: Forecast the Uses of Cash 29 -17 Example: Dynamic Mattress Company 1. 2. 3. 4. 5. Payments of accounts payable Increase in inventories Labor, administration, and other expenses Capital expenditures Taxes, interest, and dividend payments Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Table 29. 6 Dynamic Mattress’s Cash Budget for 2019 ($ Millions) 29 -18 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Dynamic’s Short-Term Financial Plan 29 -19 Dynamic’s financial manager must find short-term financing to cover the firm’s forecast cash requirements. Dynamic has two options: 1. Bank loan: borrow up to $100 million at 10% interest per year, or 2. 5% per quarter. 2. Stretching payables: can raise capital by putting off payment of bills. Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Table 29. 7 Dynamic Mattress’s Financial Plan for 2019 ($ Millions) 29 -20 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Evaluating the Plan 29 -21 Financial manager would ask several questions: 1. Does Dynamic need a larger reserve of cash or marketable securities to guard against customers stretching their payables? 2. Does the plan yield satisfactory current and quick ratios? 3. Are there intangible costs to stretching payables? Will suppliers begin to double Dynamic’s creditworthiness? Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Evaluating the Plan Continued 29 -22 4. Does the plan for 2019 leave Dynamic in good financial shape for 2020? 5. Should Dynamic try to arrange long-term financing for the major capital expenditure in the first quarter? 6. Is there an easy way of deferring the first quarter’s large cash outflow? 7. Should Dynamic release cash by reducing the level of other current assets? Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Table 29. 8 Dynamic Mattress Condensed Year-End Balance Sheets for 2018 and 2017 (Figures in $ Millions) 29 -23 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Table 29. 9 Dynamic Mattress Actual (2018) and Forecasted Cash Flows—Panel A 29 -24 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Table 29. 9 Dynamic Mattress Actual (2018) and Forecasted Cash Flows—Panel B 29 -25 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Table 29. 9 Dynamic Mattress Actual (2018) and Forecasted Cash Flows—Panel C 29 -26 Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Pitfalls in Model Design 29 -27 • Many models ignore realities such as depreciation, taxes, etc. • Percent of sales methods are not realistic because fixed costs exist. • Most models generate accounting numbers, not financial cash flows • Adjustments must be made to consider these and other factors. Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Growth and External Financing 29 -28 Sustainable growth rate: Highest growth rate a firm can maintain without increasing its financial leverage Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
Growth and External Financing Continued 29 -29 Example: Dynamic Mattress Sustainable growth rate = plowback ratio × return on equity For Dynamic Mattress, Sustainable growth rate =. 40 ×. 1815 =. 0726, or 7. 26% Copyright © 2020 Mc. Graw-Hill Education. All rights reserved. No reproduction or distribution without the prior written consent of Mc. Graw-Hill Education.
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