1. MVA and EVA ► Market Value Added (MVA) = Market value of common equity – book value of common equity  2006 Best Buy MVA = $21.34 billion  2006 Circuit City MVA = $2.24 billion ► Economic Value Added (EVA) = NOPAT – Annual dollar cost of capital = true economic profit for a given period ► EVA = EBIT(1-T) – [Total investor supplied operating capital x After-tax percentage cost of capital]

2. Chapter 16 Financial Planning and Forecasting

3. Financial Forecasting Steps ► Forecast Sales ► Project the Assets Needed to Support Sales ► Project Internally Generated Funds ► Project Outside Funds Needed ► Decide How to Raise Funds ► See Effects of Plan on Ratios

4. Our Problem: Zippy Drives, Inc. ► 2006 Sales 10,000,000 ► 2006 Total Assets 8,000,000 ► Want to project 2007 financial statements based on a 30% increase in sales. ► Projected 2007 Sales 10,000,000(1.30) = $13,000,000

5. Zippy Drives Inc. 2006 Balance Sheet ($000)

6. Zippy Drives 2006 Income Statement

7. AFN formula Key Assumptions: Known as percentage of sales approach. ► Zippy is operating at full capacity in 2006. ► Each type of asset grows proportionally with sales. ► Accounts payable and accruals grow proportionally with sales. ► 2006 profit margin (15%) and payout (30%) will be maintained. ► Sales are expected to increase by $3 million. (%  S = 30%)

8. Income Statement Projection

9. Balance Sheet Projection: The Assets

10. Projected Liabilities & Equity

11. Oh no! Here come the Accounting Police! Projected 2007 Assets 10,400 Projected 2007 Liab&Eq 9,815 External Financing Needed 585 ► Assume Zippy will raise 40% of external financing needed through Notes Payble and the rest (60%) through Long-term Debt. ► Addition to Notes Payable 234 ► Addition to Long-term Debt351

12. Projected Liab & Eq to keep away the accounting police.

13. AFN equation: When you just need to know additional financing needed. AFN= (A*/S)  S - (L*/S)  S - M(S 1 ) (RR) RR = retention ratio = 1 – dividend payout AFN= ($8,000 / $10,000) ($3,000) - ($1,500 / $10,000) ($3,000) - ($1,500 / $10,000) ($3,000) - 0.15($13,000) (1- 0.3) - 0.15($13,000) (1- 0.3) = $585.

14. Key Zippy Ratios 2006 Current1.67 Quick1.04 DSO73.00 InvTurn6.67 debt/assets50.0% FAT2.50 TAT1.25 ROA18.8% ROE37.5% Proj2007 Current1.69 Quick1.05 DSO73.00 InvTurn6.67 debt/assets48.4% FAT2.50 TAT1.25 ROA18.8% ROE36.3%

15. Key Determinants of External Funds Requirements (AFN) ► Sales growth: higher growth leads to more AFN ► Capital Intensity Ratio (A/S): higher A/S leads to more AFN ► Spontaneous liabilities to sales ratio (L/S): higher ratio means more internal financing and less AFN ► Profit Margin (M): higher profit margin means higher net income and less AFN ► Retention Ratio: higher ratio means more retained earnings and less AFN

16. Forecasting with less than Full Capacity ► Assume Zippy’s net fixed assets were operating at 80% capacity and current assets at 100% capacity in 1997. ► How would Zippy’s additional financing needed change? ► Need to know what level of sales Zippy’s existing net fixed assets can support or produce = Full Capacity Sales

17. Zippy’s Full Capacity Sales and projected new fixed assets ► Full Capacity Sales (FCS) = Current Sales/% of Capacity ► Zippy’s 2006 Sales = 10,000 ► 80% Capacity ► Full Capacity Sales = 10,000/0.8 = 12,500 ► Target FA Ratio = 2006 FA/ FCS ► 4000/12,500 = 0.32 = 32% ► Proj FA = 0.32(proj sales) = 0.32(13,000) = 4,160

18. Projected Assets with 80% capacity

19. ► New AFN is -455 ► This means Zippy can reduce debt to make the projected balance sheet balance or just add the surplus financing to the cash account.

20. Caveats ► We have assumed a constant profit margin which means interest expense is assumed to increase proportionally with sales. ► A company’s financing decision may cause the actual interest expense to be higher or lower than this projection. ► If the additional financing decision causes interest expense to be higher, then even more financing will be needed.

21. Other Financial Forecasting Approaches ► Instead of assuming individual assets will remain a constant percentage of sales, a company can modify their forecast by:  using regression analysis to project individual asset accounts.  using target financial ratios to project individual asset accounts.

22. 1 Financial Forecasting Summary ► Unless stated otherwise, all expenses are assumed to increase proportionally with sales, yielding the same profit margin ► At full capacity, all assets increase proportionally with sales ► Only accounts payable and accrued taxes and wages(accruals) increase proportionally with sales ► Forecasted Retained Earnings are added to the previous year’s b/s acct.

23. 2 Chapter 16 Summary (cont.) ► With financial statement forecast, AFN = projected total assets - projected liab&eq ► Proj. spontaneous assets and liabilities = last year’s ratio of each account to sales times forecasted sales ► AFN is plug amount that makes the balance sheet balance ► With AFN equation, AFN = projected change in assets - proj. change in liabilities - projected new retained earnings

24. 3 End of Chapter 16 Summary ► If fixed assets are operating at less than 100% capacity, determine full capacity sales  Full capacity sales = old sales/ % of capacity ► If projected sales < full capacity sales, no increase in fixed assets is needed ► If projected sales > full capacity sales, then proj. FA = old FA/Full capacity sales times projected sales