Transcript No Slide Title

Principles of Corporate Finance
Brealey and Myers

Sixth Edition
Financial Analysis and Planning
Slides by
Matthew Will
Irwin/McGraw Hill
Chapter 28
©The McGraw-Hill Companies, Inc., 2000
28- 2
Topics Covered
 Executive Paper Corporation
 Financial Ratios
 The DuPont System
 Financial Planning
 Growth and External Financing
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28- 3
Executive Paper
Executive Paper Balance Sheet
Dec
1998
Dec
1999
diff
Assets
Current Assets
Cash & Securities
Receivables
Inventory
Total
100.0
433.1
339.9
873.0
110.0
440.0
350.0
900.0
10.0
6.9
10.1
27.0
Fixed Assets
P, P, E
accum Depr
Net Fixed Assets
929.8
396.7
533.1
100.0
450.0
550.0
-829.8
53.3
16.9
1,406.1
1,450.0
43.9
Total Assets
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28- 4
Executive Paper
Dec
1998
Dec
1999
diff
Liabilities and Equity
Current Liabilities
Debt due in 1 year
Payable
Total current liabilities
96.6
349.9
446.5
100.0
360.0
460.0
3.4
10.1
13.5
Long term debt
400.0
400.0
0.0
Shareholders equity
559.6
590.0
30.4
1,406.1
1,450.0
43.9
Total liabilities and equity
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Executive Paper
Executive Paper - Other Data
1998
1999
Estimated repalcement cost of assets
1110
1231
598
708
Average number of shares, millions
14.16
14.16
Share price, dollars
42.25
50
Market value of equity
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Executive Paper
Executive Paper Income Statement (1999)
Revenues
Costs
Depreciation
EBIT
Interest
Tax
Net income
Dividend
Retained earnings
Earnings per share, dollars
Dividend per share, dollars
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$ millions
2,200.00
1,980.00
53.30
166.70
40.00
50.70
76.00
45.60
30.40
5.37
3.22
©The McGraw-Hill Companies, Inc., 2000
28- 7
Executive Paper
Executive Paper Sources and Uses of Funds (1999)
Sources:
Net Income
Depreciation
Operating cash flow
Borrowing
Stock issues
Total sources
Uses:
Increase in net working capital
Investment
Dividends
Total uses
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$ millions
76.00
53.30
129.30
129.30
13.50
70.20
45.60
129.30
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28- 8
Leverage Ratios
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Leverage Ratios
total liabilities
Total debt ratio =
total assets
Times interest earned
=
EBIT
interest payments
EBIT + depreciation
Cash cover age ratio =
interest payments
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Liquidity Ratios
Net working capital
to total assets ratio
Net working capital
=
Total assets
current assets
Current ratio =
current liabilities
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Liquidity Ratios
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Efficiency Ratios
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Efficiency Ratios
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Profitability Ratios
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Profitability Ratios
dividends
Payout ratio =
earnings
earnings - dividends
Plowback ratio =
earnings
= 1 - payout ratio
earnings - dividends
Growth in equity from plowback =
earnings
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Market Value Ratios
stock price
PE Ratio =
earnings per share
P0
Div 1
1
Forecasted PE ratio =
=
x
aveEPS 1
EPS1
r - g
dividend per share
Dividend yield =
stock price
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Market Value Ratios
Price per share = P0
Div 1
=
r - g
stock price
Market to book ratio =
book value per share
market value of assets
Tobins Q =
estimated replcement cost
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The DuPont System
 A breakdown of ROE and ROA into
component ratios:
EBIT - taxes
ROA =
assets
earnings available for common stock
ROE =
equity
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The DuPont System
sales
EBIT - taxes
ROA =
x
assets
sales
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The DuPont System
sales
EBIT - taxes
ROA =
x
assets
sales
asset
turnover
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profit
margin
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28- 21
The DuPont System
ROE =
assets
sales
EBIT - taxes EBIT - taxes - interest
x
x
x
equity
assets
sales
EBIT - taxes
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The DuPont System
ROE =
assets
sales
EBIT - taxes EBIT - taxes - interest
x
x
x
equity
assets
sales
EBIT - taxes
leverage asset
ratio turnover
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profit
margin
debt
burden
©The McGraw-Hill Companies, Inc., 2000
Principles of Corporate Finance
Brealey and Myers

Sixth Edition
Short Term Financial Planning
Slides by
Matthew Will
Irwin/McGraw Hill
Chapter 29
©The McGraw-Hill Companies, Inc., 2000
28- 24
Topics Covered
 Working Capital
 Links Between Long-Term and Short-Term
Financing
 Tracing Changes in Cash and Working Capital
 Cash Budgeting
 A Short-Term Financing Plan
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Working Capital
Net Working Capital - Current assets minus current
liabilities. Often called working capital.
Cash Conversion Cycle - Period between firm’s
payment for materials and collection on its sales.
Carrying Costs - Costs of maintaining current assets,
including opportunity cost of capital.
Shortage Costs - Costs incurred from shortages in
current assets.
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Firm’s Cumulative Capital Requirement
Dollars
A
B
C
Cumulative
capital requirement
Year 1
Year 2
Time
Lines A, B, and C show alternative amounts of long-term finance.
Strategy A: A permanent cash surplus
Strategy B: Short-term lender for part of year and borrower for
remainder
Strategy C: A permanent short-term borrower
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Working Capital
Simple Cycle of operations
Cash
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Working Capital
Simple Cycle of operations
Cash
Raw materials
inventory
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Working Capital
Simple Cycle of operations
Cash
Raw materials
inventory
Finished goods
inventory
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Working Capital
Simple Cycle of operations
Cash
Raw materials
inventory
Receivables
Finished goods
inventory
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Working Capital
Simple Cycle of operations
Cash
Raw materials
inventory
Receivables
Finished goods
inventory
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28- 32
Changes in Cash & W.C.
Example - Dynamic Mattress Company
Assets
1998
1999
4
5
Current Liabilities
4
5
Bank Loans
5
0
MarkSecurities
Inventory
0
26
5
25
Accts P ayable
T otalCurr Liab
20
25
27
27
Accts Recv
25
30
LongT erm Debt
5
12
T otalCurr Assets
55
65
Net Worth
65
76
Gross investment
less Depr
56
16
70
20
Net FixedAssets
40
50
T otalLiab and
95
115
owner's equity
95
115
Current Assets
Cash
Liabilit ies & Equity 1998
1999
Fixed Assets
T otalAssets
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Changes in Cash & W.C.
Example - Dynamic Mattress Company
Income Statement
Sales
$350
Operating Costs 321
Assume
Depreciation
R.E.=$11 mil
EBIT
Interest
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4
dividend = $1 mil
25
1
Pretax income
24
. Tax at 50%
12
Net Income
$12
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28- 34
Changes in Cash & W.C.
Example Dynamic
Mattress
Company
Sources
Issued long term debt
Reduced inventorie s
Increased accounts payable
Cash from operations
Net income
Depreciati on
Total Sources
Uses
Repaid short term bank loan
Invested in fixed assets
Purchased marketable securities
Increased accounts receivable
12
4
$31
Dividend
Total Uses
1
$30
Increase in cash balance
Irwin/McGraw Hill
7
1
7
5
14
5
5
$1
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28- 35
Changes in Cash & W.C.
Example - Dynamic Mattress Company
Dynamic used cash as follows:
 Paid $1 mil dividend.
 Repaid $5 mil short term bank loan.
 Invested $14 mil.
 Purchased $5 mil of marketable securities.
 Accounts receivable expanded by $5 mil.
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Cash Budgeting
Steps to preparing a cash budget
Step 1 - Forecast the sources of cash.
Step 2 - Forecast uses of cash.
Step 3 - Calculate whether the firm is facing a cash
shortage or surplus.
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Cash Budgeting
Example - Dynamic Mattress Company
Dynamic forecasted sources of cash
Quarter
Sales, $mil
1st
2nd
3rd
4th
87.50 78.50 116.00 131.00
AR ending balance = AR beginning balance + sales collections
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Cash Budgeting
Example - Dynamic Mattress Company
Dynamic collections on AR
Qtr
1st
2nd
3rd
4th
1. Beginning receivables
30.0
32.5
30.7
38.2
2. Sales
87.5
78.5
116.0
131.0
3. Collections
. Sales in current Qtr (80%)
70
62.8
92.8
104.8
. Sales in previous Qtr (20%)
15.0
17.5
15.7
23.2
Total collections
85.0
80.3
108.5
128.0
$32.5
$30.7
$38.2
$41.2
4. Receivables at end of period
. (4 = 1 + 2 - 3)
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Cash Budgeting
Example - Dynamic Mattress Company
Dynamic forecasted uses of cash
 Payment of accounts payable
 Labor, administration, and other expenses
 Capital expenditures
 Taxes, interest, and dividend payments
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Cash Budgeting
Example - Dynamic Mattress Company
Dynamic
cash budget
Qtr
1st
2nd
3rd
4th
85.0
80.3
0.0
0.0
85.0
80.3
paymentof AP
65.0
60.0
55.0
50.0
labor and admin expenses
30.0
30.0
30.0
30.0
capitalexpendit ures
32.5
1.3
5.5
8.0
4.0
4.0
4.5
5.0
T otaluses of cash
131.5
95.3
95.0
93.0
Net cash inflow
(sources minus uses)
$46.5
Sources of cash
collections on AR
other
T otalSources
108.5 128.0
12.5
0.0
121.0 128.0
Uses of cash
t axes, interest,& dividends
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$15.0 $26.0 $35.0
©The McGraw-Hill Companies, Inc., 2000
28- 41
Cash Budgeting
Example - Dynamic Mattress Company
Dynamic short term financing requirements
Cash at start of period
5
- 41.5
- 56.5 - 30.5
+ Net cash flow
- 46.5 - 15
= Cash at end of period
- 41.5 - 56.5 - 30.5
Min operatingcash balance
5
5
+ 26
5
Cumulativeshort termfinancing $46.5 $61.5 $35.5
required (minimumcash balance
minuscaash at end of period)
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+ 35
+ 4.5
5
- $.5
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28- 42
A Short Term Financing Plan
Example - Dynamic Mattress Company
Dynamic forecasted deferrable expenses
Quarter 1st 2nd 3rd 4th
Amount Deferrable,$mil
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48
44
40
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28- 43
A Short Term Financing Plan
Example Dynamic
Mattress
CompanyFinancing Plan
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1st
New borrowing
1. Line of credit
2. Stretching payables
3. Total
Repayments
4. Line of credit
5. Stetched payables
6. Total
7. Net new borrowing
8. Plus securities sold
9. Less securities bought
10. Total cash raised
Interest payments:
11. Line of credit
12. Stretching payables
13. Less interest on securities
14. Net interest paid
15. Funds for Compensating balances
16. Cash required for operations
17. Total cash required
2nd
3rd
4th
41.0
3.6
44.6
0.0
20.0
20.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
0.0
44.6
5.0
0.0
49.6
0.0
3.6
3.6
16.4
0.0
0.0
16.4
4.8
20.0
24.8
-24.8
0.0
0.0
-24.8
36.2
0.0
36.2
-36.2
0.0
0.0
-36.2
0.0
0.0
-0.1
-0.1
3.2
46.5
49.6
1.2
0.2
0.0
1.4
0.0
15.0
16.4
1.2
1.0
0.0
2.2
-1.0
0.3
-24.8
1.0
0.0
0.0
1.0
-2.2
-35.0
-36.2
©The McGraw-Hill Companies, Inc., 2000