FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN Chapter 6 Financial Planning and Forecasting Forecasted Financial Statements AFN Equation Reviewing Forecasted Statements Excess Capacity Factors Impacting AFN 6 -1 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN Preliminary Financial Forecast: Balance Sheets (Assets) Cash and equivalents Accounts receivable Inventories Total current assets Net fixed assets Total assets 2015 2016 E $ 20 $ 25 240 300 $ 500 $ 625 500 625 $1, 000 $1, 250 6 -2 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN Preliminary Financial Forecast: Balance Sheets (Liabilities and Equity) A/P & accrued liabilities Notes payable Total current liabilities Long-term debt Common stock Retained earnings Total liabilities & equity 2015 $ 100 $ 200 100 500 200 $1, 000 2016 E $ 125 190 $ 315 190 500 245 $1, 250 6 -3 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN Preliminary Financial Forecast: Income Statements Sales Variable costs Fixed costs EBIT Interest EBT Taxes (40%) Net income Dividends (30% of NI) Addition to retained earnings 2015 $2, 000. 0 1, 200. 0 700. 0 $ 100. 0 16. 0 $ 84. 0 33. 6 $ 50. 4 2016 E $2, 500. 0 1, 500. 0 875. 0 $ 125. 0 16. 0 $ 109. 0 43. 6 $ 65. 4 $15. 12 $35. 28 $19. 62 $45. 78 6 -4 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN Key Financial Ratios Basic earning power Profit margin Return on equity 2015 2016 E Ind Avg Comment 10. 00% 2. 52% 10. 00% 2. 62% 20. 00% 4. 00% Poor 7. 20% 8. 77% 15. 60% Poor Days sales outstanding 43. 8 days 32. 0 days Inventory turnover 8. 33 x 11. 00 x Fixed assets turnover 4. 00 x 5. 00 x Total assets turnover 2. 00 x 2. 50 x Liabilities/Assets 30. 00% 40. 40% 36. 00% Times interest earned 6. 25 x 7. 81 x 9. 40 x Current ratio 2. 50 x 1. 99 x 3. 00 x Payout ratio 30. 00% Poor OK Poor OK 6 -5 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN Key Assumptions in Preliminary Financial Forecast for NWC • • Operating at full capacity in 2016. • Payables and accruals grow proportionally with sales. • • Each type of asset grows proportionally with sales. 2016 profit margin (2. 52%) and payout (30%) will be maintained. Sales are expected to increase by $500 million. (% S = 25%). 6 -6 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

Additional Financing Needed • Financing Capital Needed (FCN): financial funds needed to acquire assets necessary to support a firm’s sales growth • Spontaneously Generated Funds: increases in accounts payables and accruals (wages and taxes) that occur with a sales increase 7 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

Additional Funds Needed • Additional Funds Needed (AFN): gap remaining between the financial capital needed and that funded by spontaneously generated funds and retained earnings, or, AFN = Required Increase in Assets – Spontaneously Generated Funds – Increase in Retained Earnings 8 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

AFN Equation 9 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN Determining Additional Funds Needed Using the AFN Equation AFN = (A 0*/S 0) S – (L 0*/S 0) S – M(S 1)(1 – Payout) = ($1, 000/$2, 000)($500) – ($100/$2, 000)($500) – 0. 0252($2, 500)(0. 7) = $180. 9 million 6 -10 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

AFN Equation 11 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN Management’s Review of the Financial Forecast • Consultation with some key managers has yielded the following revisions: – Firm expects customers to pay quicker next year, thus reducing DSO to 34 days without affecting sales. – A new facility will boost the firm’s net fixed assets to $700 million. – New inventory system to increase the firm’s inventory turnover to 10 x, without affecting sales. 6 -12 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN Management’s Review of the Financial Forecast • These changes will lead to adjustments in the firm’s assets and will have no effect on the firm’s liabilities and equity section of the balance sheet or its income statement. 6 -13 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN Revised (Final) Financial Forecast: Balance Sheets (Assets) Cash and equivalents Accounts receivable Inventories Total current assets Net fixed assets Total assets 2015 $ 20 240 $ 500 $1, 000 2016 F $ 67 233 250 $ 550 700 $1, 250 6 -14 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN Key Financial Ratios: Final Forecast 2015 2016 F Ind Avg Comment Basic earning power Profit margin 10. 00% 2. 52% 10. 00% 2. 62% 20. 00% 4. 00% Poor Return on equity 7. 20% 8. 77% 15. 60% Poor Days sales outstanding Inventory turnover Fixed assets turnover Total assets turnover Liabilities/Assets Times interest earned Current ratio Payout ratio 43. 8 days 34. 0 days 32. 0 days 8. 33 x 10. 00 x 11. 00 x 4. 00 x 3. 57 x 5. 00 x 2. 50 x 30. 00% 40. 40% 36. 00% 6. 25 x 7. 81 x 9. 40 x 2. 50 x 1. 98 x 3. 00 x 30. 00% OK OK Poor OK 6 -15 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN What was the net investment in capital? 6 -16 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN How much free cash flow is expected to be generated in 2016? FCF = EBIT(1 – T) – Net investment in capital = $125(0. 6) – $225 = $75 – $225 = -$150 6 -17 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN Suppose Fixed Assets Had Been Operating at Only 85% of Capacity in 2015 • The maximum amount of sales that can be supported by the 2015 level of assets is: • 2016 forecast sales exceed the capacity sales, so new fixed assets are required to support 2016 sales. 6 -18 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN How can excess capacity affect the forecasted ratios? • • • Sales wouldn’t change but assets would be lower, so turnovers would improve. Less new debt, hence lower interest and higher profits EPS, ROE, liabilities-to-assets ratio, and TIE would improve. 6 -19 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.

FORECASTED STMTS AFN EQUATION REVIEWING STMTS EXCESS CAPACITY IMPACTING AFN How would the following items affect the AFN? • Higher dividend payout ratio? • Higher profit margin? • • – Increase AFN: Less retained earnings. – Decrease AFN: Higher profits, more retained earnings. Higher capital intensity ratio? – Increase AFN: Need more assets for a given level of sales. Pay suppliers in 60 days, rather than 30 days? – Decrease AFN: Trade creditors supply more capital (i. e. , L 0*/S 0 increases). 6 -20 © 2018 Cengage Learning. All Rights Reserved. May not be scanned, copied, or duplicated, or posted to a publicly accessible website, in whole or in part.