chap026 - Chapter 26: Corporate Financial Models and...

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Unformatted text preview: Chapter 26: Corporate Financial Models and Long-term Planning 26.1 Forecast sales: S = 0.00001 GNP = 0.00001 ($2,050 billion) = $20,500,000 Compute the other values: CA = $500,000 + 0.25 ($20,500,000) = $5,625,000 FA = $1,000,000 + 0.50 ($20,500,000) = $11,250,000 CL = $100,000 + 0.10 ($20,500,000) = $2,150,000 NP = 0.02 ($20,500,000) = $410,000 Compute the new amount of retained earnings: RE = NP (1 - 0.34) = $410,000 (0.66) = $270,600 RE = $3,400,000 + $270,600 = $3,670,600 Compute the new amount of bonds: Debt-to-Asset Ratio = ($1,100,000 + $2,500,000) / ($3,000,000 + $6,000,000) = 0.40 Bonds = [(CA + FA) x 0.40] - CL = ($5,625,000 + $11,250,000) (0.40) - $2,150,000 = $4,600,000 Compute the new amount of stock: Stock = [(CA + FA) - (CL + Bonds + RE)] = ($5,625,000 + $11,250,000) - ($2,150,000 + 4,600,000 + 3,670,600) = $6,454,400 Current Assets Fixed Assets Total Assets 5,625,000 11,250,000 $16,875,000 Balance Sheet Current Liabilities Bonds Common Stock Retained Earnings Total Liabs & CS $2,150,000 4,600,000 6,454,400 3,670,600 $16,875,000 26.2 S = 330 - 330 / (1 + 10%) = $30 million a. External funds needed = (25% +150%) x 30 - (40% + 45%) x 30 - (12% x 330) (1 - 40%) = $3.24 million b. Current assets = 25% x 330 / (1 + 10%) = 75 Fixed assets = 150% x 330 / (1+10%) = 450 Total assets = Current assets + Fixed assets = 75 + 450 = $525 million Short term debt = 40% x 330 / (1+10%) = 120 Long term debt = 45% x 330 / (1 + 10%) = 135 Common stock = 50 Retained earnings = 220 Total liabilities = $525 million c. Pro Forma Balance Sheet Current assets = 25% x 330 = 82.5 Fixed assets = 150% x 330 = 495 Total assets = $577.5 million Short term debt = 40% x 330 = 132 Long term debt = 45% x 330 = 148.5 Common stock = 50 Retained earnings = 243.76 Total liabilities = 574.26 External fund needed = 577.5-574.26 = $3.24 million Answers to End-of-Chapter Problems B-215 26.3 a. b. c. Compute the sustainable growth using the formula from the text. S P(1 - d)(1 + L) 0.05(.5)(2) = = = 0.0526 = 5.26% S T - P(1 - d)(1 + L) 1 - 0.05(0.5)(2) Yes, it is possible for the actual growth to differ from the sustainable growth. If any of the actual parameters (P, T, L or d) differ from those used to compute the sustainable growth rate, the actual growth rate will deviate from the sustainable growth rate. Stieben Company can increase its growth rate by doing any of the following. i. Sell new stock ii. Increase its debt-to-equity ratio by either selling more debt or repurchasing stock iii. Increase its net profit margin iv. Decrease its total assets to sales ratio v. Reduce its dividend payout Since you are making a projection for one year in the future it is reasonable to assume that fixed costs do not change. Thus, if sales grow 20%, then net income will grow 20%. Net income is $2,000,000(1.2) = $2,400,000. Determine total uses of funds. NWC = 0.20 ($16,000,000 - $10,000,000) = $1,200,000 INV = 0.20 ($16,000,000) + Dep = $3,200,000 + Dep Dividend = 0.70 ($2,400,000) = $1,680,000 Total uses = NWC + INV + Dep + Dividend = $6,080,000 + Dep Operating sources = Net income + Dep = $2,400,000 + Dep New External Funds = Total uses - Operating sources = ($6,080,000 + Dep) - (2,400,000 + Dep) = $3,680,000 To maintain its debt-to-equity ratio, Optimal Scam must issue $2,880,000 of new stock and $800,000 of new long-term debt. 26.4 a. b. Pro Forma Balance Sheet Optimal Scam Company Current assets $19,200,000 Fixed assets 19,200,000 Total assets $38,400,000 Current liabilities $12,000,000 Long-term debt 4,800,000 Total liabilities $16,800,000 Common stock $16,880,000 Accumulated retained earnings 4,720,000 Total equity $21,600,000 Total liabilities and equity $38,400,000 c. Sustainable growth = S P(1 - d)(1 + L) = S T - P(1 - d)(1 + L) = 0.0625(.3)(1.7778) = 0.0345 = 3.45% 1 - 0.0625(0.3)(1.7778) B-216 Answers to End-of-Chapter Problems d. Optimal Scam is far below its growth rate objective. Cutting the dividend to zero will not be enough. It could only attain a 12.5% growth rate by eliminating the dividend. Optimal Scam must increase its asset utilization and/or its profit margin substantially to be able to achieve its objective growth rate. Optimal could also increase its debt load; this action will increase ROE. 26.5 a. Sustainable growth = S P(1 - d)(1 + L) = S T - P(1 - d)(1 + L) 0.10(.50)(2) = 0.0714 = 7.14% 1.5 - 0.10(0.50)(2) = b. MBI Company can achieve its zero growth objective by reducing its profit margin to zero or increasing its dividend payout ratio to one. Reduction of the profit margin to zero, however, will hurt stockholders. Thus, a 100% payout ratio would probably be MBI's best choice. 26.6 Undertaking positive NPV projects is how companies increase shareholders' value. Financial planning allows the company to determine the interrelationships among the different aspects of managerial finance that will ultimately allow management to correctly utilize the NPV approach. 26.7 The new MBA is correct though perhaps naively so. The two formulas are essentially the same. Answers to End-of-Chapter Problems B-217 S Net Income = ROE(1 - d) = (1 - d) S Net Worth Net Income(1 - d) = TA - RE - B Divide by sales, S, (NI / S)(1 - d) TA / S - RE / S - B / S (NI / S)(1 - d) = TA / S - (NI / S)(1 - d) - (B / TA)(TA / S) = Since NI / S = P, TA / S = T, P(1 - d) T - P(1 - d) - LT / (1 + L) P(1 - d) = T / (1 + L) - P(1 - d) P(1 - d)(1 + L) = T - P(1 - d)(1 + L) = 26.8 a. Sustainable growth rate = = ROE(1 - d) 1 - ROE(1 - d) 16%(1 - 60%) = 6.84% 1 - 16%(1 - 60%) b. P(1 - 60%)(1 + 50%) = 6.84% 175% - P(1 - 60%)(1 + 50%) P = 18.67% 26.9 The two shortcomings of financial-planning models we should beware of are: i. financial-planning models don't indicate which financial policies are the best. ii. financial-planning models are too simple that they don't fully reflect real-world complications. B-218 Answers to End-of-Chapter Problems ...
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