# In the previous section we took a growth rate as

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Unformatted text preview: the higher the rate of growth in sales or assets, the greater will be the need for external financing. In the previous section, we took a growth rate as given, and then we determined the amount of external financing needed to support that growth. In this section, we turn things around a bit. We will take the firm’s financial policy as given and then examine the relationship between that financial policy and the firm’s ability to finance new investments and thereby grow. We emphasize that we are focusing on growth not because growth is an appropriate goal; instead, for our purposes, growth is simply a convenient means of examining the interactions between investment and financing decisions. In effect, we assume that the use of growth as a basis for planning is just a reflection of the very high level of aggregation used in the planning process. EFN and Growth The first thing we need to do is establish the relationship between EFN and growth. To do this, we introduce the simplified income statement and balance sheet for the Hoffman Company in Table 3.15. Notice we have simplified the balance sheet by combining shortterm and long-term debt into a single total debt figure. Effectively, we are assuming that none of the current liabilities vary spontaneously with sales. This assumption isn’t as restrictive as it sounds. If any current liabilities (such as accounts payable) vary with sales, we can assume that any such accounts have been netted out in current assets. Also, we continue to combine depreciation, interest, and costs on the income statement. Suppose the Hoffman Company is forecasting next year’s sales level at \$600, a \$100 increase. Notice that the percentage increase in sales is \$100/500 20 percent. Using the percentage of sales approach and the figures in Table 3.15, we can prepare a pro forma income statement and balance sheet as in Table 3.16. As Table 3.16 illustrates, at a 20 percent growth rate, Hoffman needs \$100 in new assets (assuming full capacity). The projected addition to retained earnings is \$52.8, so the external financing needed, EFN, is \$100 52.8 \$47.2. 72 PART 1 Overview ros82361_ch03.indd 72 5/27/08 10:15:09 AM Confirming Pages TABLE 3 .1 5 H O FFM A N C O M PA N Y Income Statement and Balance Sheet Income Statement Sales Costs Taxable income Taxes (34%) Net income Dividends Addition to retained earnings Balance Sheet Assets \$ Current assets Net fixed assets Total assets \$200 300 \$500 PERCENTAGE OF SALES 40% 60 100% Total debt Owners’ equity Total liabilities and owners’ equity Liabilities and Owners’ Equity \$ \$250 250 \$500 PERCENTAGE OF SALES n/a n/a n/a \$500 400 \$100 34 \$ 66 \$22 44 TABLE 3 .1 6 H O FFM A N C O M PA N Y Pr o Fo r m a I n c o m e S t a t e m e n t a n d B a l a n c e S h e e t Income Statement Sales (projected) Costs (80% of sales) Taxable income Taxes (34%) Net income Dividends Addition to retained earnings Balance Sheet Assets \$ Current assets Net fixed assets Total assets \$240.0 360.0 \$600.0 PERCENTAGE OF SALES 40% 60 100% Total de...
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