FINANCIAL MANAGEMENT PART 16

1. Financial Planning Chapter 16

10. Figure 16.2: The Business Planning Spectrum

15. Planning Assumptions—Example A: There are three inter-related planning assumptions: (1) a management action regarding pricing; (2) the expected customer response to the price change; and (3) and change in collection efforts. The first two assumptions establish the revenue forecast. Next year, the firm expects to sell 15 million coffee cakes at $0.90 each, for total revenue of $13,500,000. The third assumption regarding receivables requires the use of the total revenue forecast. Receivables are expected to decrease from two months of revenue to only one month; thus receivables are expected to be $13,500,000  12, or $1,125,000. Example

18. Figure 16.5: The Debt/Interest Planning Problem

20. An Iterative Numerical Approach—Example Q: The following partial financial forecast has been done for Graybarr Inc. Complete the financial plan, assuming that Graybarr pays interest at 10% and has a flat income tax rate of 40% including federal and state taxes. Also assume no dividends are to be paid and no new stock is to be sold. Example

21. An Iterative Numerical Approach—Example A: The huge increase in assets will cause the company’s debt to increase at a dramatic rate. The first iteration is represented below, with the steps enumerated. Example 1: Guess at the firm’s interest expense. Most firms use last year’s value as a guess. 2: Compute EAT. 3: Calculate Ending equity as beginning equity plus EAT less dividends. 4: Calculate Ending debt as total L&E less ending equity less ending current liabilities.

22. An Iterative Numerical Approach—Example A: Now we check to see if the the interest implied by our calculated debt (average debt x interest rate) [which is (($100,000 + $1,220,000)  2)  10% = $66,000] is significantly different from the initial guess. Our original guess of $200,000 is much higher than the calculated interest of $66,000. Thus, a second iteration is performed. Example Given these results the average debt is $620,000 and interest is $62,000. The second iteration and the calculated result differ by only $4,000.

24. Plans with Simple Assumptions—Example Q: The Overland Manufacturing Company expects next year’s revenues to increase by 15% over this year’s. The firm has some excess factory capacity, so no new fixed assets beyond normal replacements will be needed to support the growth. This year’s income statement and ending balance sheet are estimated as follows: Example

25. Plans with Simple Assumptions—Example Assume the firm pays state and federal income taxes at a combined flat rate of 42%, borrows at 12% interest, and expects to pay no dividends. Project next year’s income statement and balance sheet by using the modified percentage of sales method. A: We’ll increase everything except net fixed assets by 15%. Example All highlighted items were increased by 15%. At this point we are at the debt/interest impasse. We’ll guess at interest (using last year’s interest of $150,000 as a starting point) and work through the procedure.

26. Plans with Simple Assumptions—Example Taking the average debt at 12% yields a calculated interest of $86,000 which is considerably less than the $150,000 assumed. Additional iterations should yield a more accurate projection. Example EAT was computed using an Interest of $150,000. The resulting EAT was added to Equity and the Debt figure was a plug, calculated by subtracting Equity and Current Liabilities from Total L&E.

30. The Percentage of Sales Method—A Formula Approach—Example Q: Forecast the external financing requirements of the Overland Manufacturing Company assuming net fixed assets and EAT grow at the same rate as sales. However, also assume the firm plans to pay a dividend equal to 25% of earnings next year. Example The items needed to apply the EFR equation are highlighted. We also need the ROS figure of 11% (EAT  sales, or $1,488  $13,580) and the expected dividend payout ratio of 25%. Revenues are expected to increase by 15%.

40. Receivables and Payables—Forecasting with Time Lags—Example Q: A firm has discerned that its collections exhibit the following pattern: The firm expects its credit sales from January through March to be: Determine the company’s expected cash collections from receivables. A: Example 8% 30% 60% % collected 3 2 1 Months after sale $700 $600 $500 Credit sales Mar Feb Jan $56 $258 $640 $510 $300 Total collections $56 $210 $420 Mar $48 $180 $360 Feb $40 $150 $300 Jan Collections from sales made in May Apr Jun $700 Mar $600 $500 Credit sales Feb Jan

42. The Cash Budget—Example Q: The Pulmeri Company’s revenues tend to go through a quarterly cycle. It’s now mid-March and management expects the first quarter’s pattern to be repeated in the second quarter. The six-month period is as follows ($000). Historically, Pulmeri collects its receivables according to the following pattern. No prompt payment discount is offered, and there are virtually no bad debts. The firm purchases and receives inventory one month in advance of sales. Materials cost about half of sales revenue. Invoices for inventory purchases are paid 45 days after receipt of material. Payroll runs a constant $2.5M per month, and other expenses such as rent, utilities, and supplies are a fairly steady $1.5M per month. A $0.5M tax payment is scheduled for mid-April. Pulmeri has a short-term loan outstanding that is expected to stand at $5M at the end of March. Monthly interest is 1% of the previous month end balance. Prepare Pulmeri’s cash budget for the second quarter. Example $9,000 Mar $8,000 Feb $5,000 Jan $9,000 $8,000 $5,000 Revenue Jun May Apr 10% 25% 65% % collected 3 2 1 Months after sale

43. The Cash Budget—Example A: First lay out revenue and lag in collections according to the historical pattern. $7,350 $6,300 $8,350 Second quarter collections $5,200 May $1,250 $3,250 Apr $900 $2,250 $5,850 Mar $800 $2,000 $5,200 Feb $500 $1,250 $3,250 Jan Collections from sales made in $8,000 May $5,000 Apr $9,000 Jun $9,000 Mar $8,000 $5,000 Revenue Feb Jan Example

44. The Cash Budget—Example A: Next, lag inventory purchases (half of sales dollars) back one month from the date of sale and then lag the payment two months forward in two equal parts. $4,250 $3,250 $3,500 Payment for materials $2,250 May $2,000 $2,000 Apr $1,250 $1,250 Mar $2,250 $2,250 Feb Payment $4,500 May $4,000 Apr Jun $2,500 Mar $4,500 Purchases Feb Jan Example

45. The Cash Budget—Example A: Finally, summarize these results along with payroll and other disbursement and work through the interest charges. Pulmeri Company Cash Budget Second Quarter 20x1 ($000) $500 Tax payment $1,500 $1,500 $1,500 General expenses $2,500 $2,500 $2,500 Payroll $4,250 $3,250 $3,500 Materials purchases Disbursements $7,350 $6,300 $8,350 Collections $8,000 May $5,000 Apr $9,000 Jun $9,000 Mar $8,000 $5,000 Revenue Feb Jan Example

46. The Cash Budget—Example $(6,654) $(5,697) $(4,700) $(5,000) Cumulative cash flow (loan) $(957) $(997) $300 Net cash flow $(57) $(47) $(50) Interest $(900) $(950) $350 Cash flows before interest $8,250 $7,250 $8,000 Disbursements before interest Pulmeri Company Cash Budget Second Quarter 20x1 ($000) May Apr Jun Mar Feb Jan Example