Financial News Discussion
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CF5e_PPT_Ch12Updated.pptxCHAPTER 12
Corporate Valuation and
Financial Planning
Textbook Readings: 487-504 (i.e. Sections Intro; 12-1 through 12-5)
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Topics in Chapter
Financial planning
Additional funds needed (AFN) equation
Forecasted financial statements
Operating input data
Financial policy issues
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Value = + + ··· +
FCF1
FCF2
FCF∞
(1 + WACC)1
(1 + WACC)∞
(1 + WACC)2
Free cash flow
(FCF)
Weighted average
cost of capital
(WACC)
Projected
income
statements
Projected
balance
sheets
Intrinsic Value: Financial Forecasting
Projected
financing
surplus or
deficit
Forecasting:
Operating
assumptions
Forecasting:
Financial policy
assumptions
Financial Planning Process
Forecast financial statements under alternative operating plans.
Forecast the free cash flows to determine the estimated intrinsic stock price.
Determine amount of financing needed to support the plan.
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Income Statement, Hatfield, 2013
| Sales | $2,000 | Dividends | $20 |
| Op. costs (excl. depr.) | $1,800 | Add. to RE | $46 |
| Depreciation | $50 | Common shares | 10 |
| EBIT | $150 | EPS | $6.60 |
| Interest | $40 | DPS | $2.00 |
| Pretax earnings | $110 | Ending stock price | $52.80 |
| Taxes (40%) | $44 | ||
| Net income | $66 |
Balance Sheet, Hatfield, 12/31/13
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| Assets | Liab. & Equity | ||
| Cash | $ 20 | Accts. pay. & accruals | $80 |
| Accts. rec. | 280 | Line of credit | 0 |
| Inventories | 400 | Total CL | $80 |
| Total CA | $700 | Long-term debt | 500 |
| Net fixed assets | 500 | Total liabilities | $580 |
| Total assets | $1,200 | Common stock | 420 |
| Retained earnings | 200 | ||
| Total common equ. | $620 | ||
| Total liab. & equity | $1,200 |
Selected Additional Data
| Hatfield | Industry | Hatfield | Industry | ||
| Op. costs/Sales | 90.0% | 88.0% | Total liability/Total assets | 48.3% | 36.7% |
| Depr./FA | 10.0% | 12.0% | Times interest earned | 3.8 | 8.9 |
| Cash/Sales | 1.0% | 1.0% | Return on assets (ROA) | 5.5% | 10.2% |
| Receivables/Sales | 14.0% | 11.0% | Profit margin (PM) | 3.30% | 4.99% |
| Inventories/Sales | 20.0% | 15.0% | Sales/Assets (TAT) | 1.67 | 2.04 |
| Fixed assets/Sales | 25.0% | 22.0% | Assets/Equity (Eq. Mult.) | 1.94 | 1.58 |
| Acc. pay. & accr. / Sales | 4.0% | 4.0% | Return on equity (ROE) | 10.6% | 16.1% |
| Tax rate | 40.0% | 40.0% | P/E ratio | 8.0 | 16.0 |
| ROIC | 8.0% | 12.5% | |||
| NOPAT/Sales | 4.5% | 5.6% | |||
| Total op. capital/Sales | 56.0% | 45.0% |
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Comparison of Hatfield to Industry Using DuPont Equation
ROE = PM × TAT × EM
ROEHatfield = 3.30% × 1.67 × 1.94
= 10.6%.
ROEIndustry = 4.99% × 2.04 × 1.56
= 16.1
PM: The profit margin formula is net income divided by sales
TAT: Total Asset turnover is the ratio of total sales (or revenue) to assets
EM: The equity multiplier is a financial leverage ratio that measures the portion of company's assets that are financed by stockholder's equity. It is calculated by dividing a company's total asset value by total equity.
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Comparison (Continued)
Profitability ratios lower because of lower operating profits and higher interest expense.
Lower asset management ratios due to high levels of receivables, inventory, and fixed assets.
Higher leverage (debt) than industry.
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The Additional Funds Needed (AFN) Equation
AFN equation forecasts the additional financing needed by the operating plan.
Basic idea:
Estimate new assets required
Subtract new spontaneous liabilities (i.e., accounts payable and accruals)
Subtract reinvested profit (i.e., net income minus dividends which is retained earnings)
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AFN (Additional Funds Needed) Equation: Key Assumptions
Operating at full capacity in 2013.
Sales are expected to increase by 10%.
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Data Needed for AFN Equation
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| Data for AFN Equation | |
| Growth rate in sales (g) | 10% |
| Sales (S0) | $2,000 |
| Assets need to support sales (A0*) | $1,200 |
| Spont. Liab. due to sales (L0*) | $80 |
| Forecasted sales (S1) | $2,200 |
| Increase in sales (ΔS = gS0) | $200 |
| Profit margin (PM) | 3.30% |
| Assets/Sales (A0*/S0) | 60.0% |
| Payout ratio (POR) | 30.3% |
| Spont. Liab./Sales (L0*/S0) | 4.0% |
Definitions of Variables in AFN
A0*/S0: Assets required to support sales: called capital intensity ratio.
S: Increase in sales. 10 percent
L0*/S0: Spontaneous liabilities ratio.
PM: Profit margin (Net income/Sales)
POR: Payout ratio (Dividends/Net income)
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Hatfield’s AFN Using AFN Equation
AFN = Additional assets
– Additional spontaneous liabilities
– Reinvested profit
AFN = (A0*/S0)∆S – (L0*/S0)∆S
– PM(S1)(1 – Payout)
= (0.6)($200) – (0.04)($200)
– (0.033)($2,200)(0.697)
= $120 – $8 – $50.6 = $61.4
In simple terms if they cannot obtain $61.4 in financing (debt or equity) they cannot increase sales!
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AFN Key Factors (Continued)
Profit margin (Net income/Sales): The higher the profit margin, the smaller AFN will be—other things held constant.
Payout ratio (DPS/EPS): The lower the payout ratio, the smaller AFN will be if other things held constant.
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Forecasted Financial Statements: The Basic Approach
Forecast the operating items (e.g., sales, costs, inventory, etc.).
Choose a preliminary financial policy and use it to forecast the financial items (e.g., long-term debt, interest expense, etc.).
Identify any financing surplus or deficit and eliminate it.
Repeat until satisfied that the plan is achievable and is the best possible.
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