Initially assume that all assets including fixed vary

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Initially assume that all assets, including fixed, vary directly with salesAccounts payable will also normally vary directly with salesNotes payable, long-term debt and equity generally do not vary with salesbecause they depend on management decisions about capital structureThe change in the retained earnings portion of equity will come from thedividend decision
Example 3 – External Financing NeededThe firm needs to come up with an additional $200 in deby or equity to make theStatement of Financial Position BalanceTA – TL&OE = 10450 = 10250 = 200Choose plug variableBorrow more short-term (notes payable)Borrow more long term (LT debt)Sell more Common SharesDecrease dividend payout, which increases additions to retained earningsExample 4 – Operating at less than full capacitySuppose that a company is currently operating at 80% capacityFull capacity sales = 5000/.80 = 6250Estimated sales = 5500 so would still only be operating at 88%Therefore, no additional fixed assets would be requiredPro Forma Total Assets = 6050 + 4000 = 10050Total Liabilities and Owners Equity = 10250Choose the Plug VariableRepay some short-term debtRepay some long-term debtBut back sharesPau more in dividends (reduce additions to RE)Increase cash accountGrowth and External FinancingAt low growth levels, internal financing (retained earnings) may exceed the requiredinvestment in assetsAs the growth rate increases, the internal financing will not be enough, and the firm willhave to go to the capital markets for moneyExamining the relationship between growth and external financing required is a usefultool in long-range planningThe internal growth rateThe internal growth rate tells us how much the firm can grow assets using retainedearnings as the only source of financing, with raising additional external capital
The Sustainable Growth RateThe sustainable growth rate tells us how much the firm can grow by using internallygenerated funds and issuing debt to maintain a constant debt ratioDeterminants of GrowthProfit Margin – operating efficiencyTotal asset turnover – asset use efficiencyFinancial policy – choice of optimal debt/equity ratioDividend policy – choice of how much to pay to shareholders versus reinvesting in thefirmFinance Lecture 3 (Chapter 5, 6)Value of $100 – 10% interest, 2 yearsYear 1$100 x 1.10 (10%)Value after 1styear is $110Year 2$110 x 1.10 (10%)Value after 2ndyear is $121General equationFV = PV (1 + r) ⁿ
FV = future valuePV = present valueR = interest rate perperiodN = number of periods

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Term
Winter
Professor
GeorgeKlar

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