1. 17-1 CHAPTER 17 Financial Planning and Forecasting Forecasting sales Projecting the assets and internally generated funds Projecting outside funds needed Deciding how to raise funds

2. 17-2 Preliminary financial forecast: Balance sheets (Assets) 20052006E Cash and equivalents$ 20$ 25 Accounts receivable240300 Inventories240300 Total current assets$ 500$ 625 Net fixed assets500625 Total assets$1,000$1,250

3. 17-3 Preliminary financial forecast: Balance sheets (Liabilities and equity) 20052006E Accts payable & accrued liab.$ 100$ 125 Notes payable100190 Total current liabilities200315 Long-term debt100190 Common stock500 Retained earnings200245 Total liabilities & equity$1,000$1,250

4. 17-4 Preliminary financial forecast: Income statements 20052006E Sales$2,000.0$2,500.0 Less: Variable costs1,200.01,500.0 Fixed costs700.0875.0 EBIT$100.0$125.0 Interest16.0 EBT$84.0$109.0 Taxes (40%)33.643.6 Net income$50.4$65.40 Dividends (30% of NI)$15.12$19.62 Addition to retained earnings$35.28$45.78

5. 17-5 Key financial ratios 20052006EInd AvgComment Basic earning power10.00% 20.00%Poor Profit margin2.52%2.62%4.00%Poor Return on equity7.20%8.77%15.60%Poor Days sales outstanding43.8 days 32.0 daysPoor Inventory turnover8.33x 11.00xPoor Fixed assets turnover4.00x 5.00xPoor Total assets turnover2.00x 2.50xPoor Debt/assets30.00%40.34%36.00%OK Times interest earned6.25x7.81x9.40xPoor Current ratio2.50x1.99x3.00xPoor Payout ratio30.00% OK

6. 17-6 Key assumptions in preliminary financial forecast for NWC Operating at full capacity in 2005. Each type of asset grows proportionally with sales. Payables and accruals grow proportionally with sales. 2005 profit margin (2.52%) and payout (30%) will be maintained. Sales are expected to increase by $500 million. (%  S = 25%)

7. 17-7 Determining additional funds needed, using the AFN equation AFN= (A*/S 0 )ΔS – (L*/S 0 ) ΔS – M(S 1 )(RR) = ($1,000/$2,000)($500) – ($100/$2,000)($500) – 0.0252($2,500)(0.7) = $180.9 million.

8. 17-8 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 10x, without affecting sales. These changes will lead to adjustments in the firm’s assets and will have no effect on the firm’s liabilities on equity section of the balance sheet or its income statement.

9. 17-9 Revised (final) financial forecast: Balance sheets (Assets) 20052006E Cash and equivalents$ 20$ 67 Accounts receivable240233 Inventories240250 Total current assets$ 500$ 550 Net fixed assets500700 Total assets$1,000$1,250

10. 17-10 Key financial ratios – final forecast 20052006FInd AvgComment Basic earning power10.00% 20.00%Poor Profit margin2.52%2.62%4.00%Poor Return on equity7.20%8.77%15.60%Poor Days sales outstanding43.8 days34.0 days32.0 daysOK Inventory turnover8.33x10.00x11.00xOK Fixed assets turnover4.00x3.57x5.00xPoor Total assets turnover2.00x 2.50xPoor Debt/assets30.00%40.34%36.00%OK Times interest earned6.25x7.81x9.40xPoor Current ratio2.50x1.75x3.00xPoor Payout ratio30.00% OK

11. 17-11 What was the net investment in operating capital? OC 2006 = NOWC + Net FA = $625 - $125 + $625 = $1,125 OC 2005 = $900 Net investment in OC = $1,125 - $900 = $225

12. 17-12 How much free cash flow is expected to be generated in 2006? FCF= NOPAT– Net inv. in OC = EBIT (1 – T) – Net inv. in OC = $125 (0.6) – $225 = $75 – $225 = -$150.

13. 17-13 Suppose fixed assets had only been operating at 85% of capacity in 2005 The maximum amount of sales that can be supported by the 2005 level of assets is: Capacity sales = Actual sales / % of capacity = $2,000 / 0.85 = $2,353 2006 forecast sales exceed the capacity sales, so new fixed assets are required to support 2006 sales.

14. 17-14 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, debt ratio, and TIE would improve.

15. 17-15 How would the following items affect the AFN? Higher dividend payout ratio? Increase AFN: Less retained earnings. Higher profit margin? Decrease AFN: Higher profits, more retained earnings. Higher capital intensity ratio? Increase AFN: Need more assets for given sales. Pay suppliers in 60 days, rather than 30 days? Decrease AFN: Trade creditors supply more capital (i.e., L*/S 0 increases).