McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.CHAPTER3Financial Planning and Growth1McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.Chapter Outline3.1 What is Financial Planning?3.2 A Financial Planning Model: The Ingredients3.3 The Percentage Sales Method3.4 What Determines Growth?3.5 Some Caveats of Financial Planning Models3.6 Summary and Conclusions2McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.3.1 What is Corporate Financial Planning?It formulates the method by which financial goals are to be achieved.There are two dimensions:A Time Frame Short run is probably anything less than a year. Long run is anything over that; usually taken to be a two-year to five- year period.A Level of Aggregation Each division and operational unit should have a plan. As the capital-budgeting analyses of each of the firms divisions are added up, the firm aggregates these small projects as a big project.3McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.3.1 What is Corporate Financial Planning?Scenario AnalysisEach division might be asked to prepare three different plans for the near term future:A Worst CaseA Normal CaseA Best Case4McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.What Will the Planning Process Accomplish?InteractionsThe plan must make explicit the linkages between investment proposals and the firms financing choices.OptionsThe plan provides an opportunity for the firm to weigh its various options.FeasibilityAvoiding SurprisesNobody plans to fail, but many fail to plan.5McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.3.2 A Financial Planning Model: The IngredientsSales forecastPro forma statementsAsset requirementsFinancial requirementsPlugEconomic assumptions6McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.Sales ForecastAll financial plans require a sales forecast. Perfect foreknowledge is impossible since sales depend on the uncertain future state of the economy.Businesses that specialize in macroeconomic and industry projects can be help in estimating sales.7McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.Pro Forma StatementsThe financial plan will have a forecast balance sheet, a forecast income statement, and a forecast sources-and-uses-of-cash statement.These are called pro forma statements or pro formas.8McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.Asset RequirementsThe financial plan will describe projected capital spending. In addition it will discuss the proposed uses of net working capital.9McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.Financial RequirementsThe plan will include a section on financing arrangements. Dividend policy and capital structure policy should be addressed.If new funds are to be raised, the plan should consider what kinds of securities must be sold and what methods of issuance are most appropriate.10McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.PlugCompatibility across various growth targets will usually require adjustment in a third variable. Suppose a financial planner assumes that sales, costs, and net income will rise at g1. Further, suppose that the planner desires assets and liabilities to grow at a different rate, g2. These two rates may be incompatible unless a third variable is adjusted. For example, compatibility may only be reached is outstanding stock grows at a third rate, g3. Read example on p46-4711McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.Economic AssumptionsThe plan must explicitly state the economic environment in which the firm expects to reside over the life of the plan. Interest rate forecasts are part of the plan.12McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.The Steps in Estimation of Pro Forma Balance Sheet:(p50)Express balance-sheet items that vary with sales as a percentage of sales.Multiply the percentages determine in step 1 by projected sales to obtain the amount for the future period.When no percentage applies, simply insert the previous balance-sheet figure into the future period.13McGraw-Hill/Irwin Corporate Finance, 7/e 2005 The McGraw-Hill Companies, Inc. All Rights Reserved.The Steps in Estimation of Pro Forma Balance Sheet: (continued)Present retained earnings + Projected net income Cash dividends Projected retained earnings5. Add the asset accounts to determine