Initially assume that all assets including fixed vary

Initially assume that all assets, including fixed, vary directly with sales
 Accounts payable will also normally vary directly with sales
 Notes payable, long-term debt and equity generally do not vary with sales
because they depend on management decisions about capital structure
 The change in the retained earnings portion of equity will come from the
dividend decision

  Example 3 – External Financing Needed
 The firm needs to come up with an additional $200 in deby or equity to make the
Statement of Financial Position Balance
 TA – TL&OE = 10450 = 10250 = 200
 Choose plug variable
 Borrow more short-term (notes payable)
 Borrow more long term (LT debt)
 Sell more Common Shares
 Decrease dividend payout, which increases additions to retained earnings
 Example 4 – Operating at less than full capacity
 Suppose that a company is currently operating at 80% capacity
 Full capacity sales = 5000/.80 = 6250
 Estimated sales = 5500 so would still only be operating at 88%
 Therefore, no additional fixed assets would be required
 Pro Forma Total Assets = 6050 + 4000 = 10050
 Total Liabilities and Owners Equity = 10250
 Choose the Plug Variable
 Repay some short-term debt
 Repay some long-term debt
 But back shares
 Pau more in dividends (reduce additions to RE)
 Increase cash account
 Growth and External Financing
 At low growth levels, internal financing (retained earnings) may exceed the required
investment in assets
 As the growth rate increases, the internal financing will not be enough, and the firm will
have to go to the capital markets for money
 Examining the relationship between growth and external financing required is a useful
tool in long-range planning
 The internal growth rate
 The internal growth rate tells us how much the firm can grow assets using retained
earnings as the only source of financing, with raising additional external capital


 The Sustainable Growth Rate
 The sustainable growth rate tells us how much the firm can grow by using internally
generated funds and issuing debt to maintain a constant debt ratio

 Determinants of Growth
 Profit Margin – operating efficiency
 Total asset turnover – asset use efficiency
 Financial policy – choice of optimal debt/equity ratio
 Dividend policy – choice of how much to pay to shareholders versus reinvesting in the
firm
Finance Lecture 3 (Chapter 5, 6)
 Value of $100 – 10% interest, 2 years
 Year 1
 $100 x 1.10 (10%)
 Value after 1 st year is $110
 Year 2
 $110 x 1.10 (10%)
 Value after 2 nd year is $121
 General equation
 FV = PV (1 + r) ⁿ

 FV = future value
 PV = present value
 R = interest rate per
period
 N = number of periods