Fundamentals of Corporate Finance

Chapter 3

Financial Analysis and Planning

Overview of Lecture

Corporate Finance in the News

Insert a current news story here to frame the material you will cover in the lecture.

The Annual Report

The Statement of Financial Position

Figure 3.1The Statement of Financial Position

The Balance Sheet Equation

Example 3.1Building the Statement of Financial Position

Example 3.1Building the Statement of Financial Position

Net Working Capital

Market vs Book Value

Example 3.2Market Value versus Book Value

Example 3.2Market Value versus Book Value

The Income Statement

The Income Statement

The Income Statement

Taxes

Which Tax Rate Should You Use in Financial Decisions?

Cash Flow

Work the Web

Now is a good time to download a set of company accounts and look through them in detail.

Financial Statement Analysis

Ratio Analysis

Liquidity or Short-Term Solvency Ratios

Short-Term Solvency Ratios

Current assets Current ratio =

Current liabilities

Current assets – Inventory Quick ratio =

Current liabilities

Cash and Cash EquivalentsCash ratio =

Current liabilities

Financial Leverage or Long-Term Solvency Ratios

Long-Term Solvency Ratios

Total assets – Total equity Total debt ratio =

Total assets

Debt–equity ratio = Total debt /Total equity

Equity multiplier = Total assets/Total equity

EBITTimes interest earned ratio =

Interest

EBIT Depreciation Cash coverage ratio

Interest

Asset Management or Turnover Ratios

Asset Management Ratios

Cost of goods sold Inventory turnover =

Inventory

365 days Days’ sales in inventory =

Inventory turnover

Sales Receivables turnover =

Trade receivables

365 days Days’ sales in receivables =

Receivables turnover

Sales Total asset turnover =

Total assets

Profitability Ratios

Profitability Ratios

Net income Profit margin =

Sales

Net income Return on assets =

Total assets

Net income Return on equity =

Total equity

Market Value Ratios

Market Value Ratios

Net income EPS =

Shares outstanding

Price per share PE ratio =

Earnings per share

Market value per share Market-to-book-ratio =

Book value per share

The Du Pont Identity

The Du Pont Identity: Proof

Net income Net income AssetsReturn on equity = = ×

Total equity Total equity Assets

Net income Assets= ×

Assets Total equity

Sales Net income AssetsROE = × ×

Sales Assets Total equity

Net income Sales AssetsROE = × ×

Sales Assets Total equityReturn on assets

= Profit margin × Total asset turnover × Equity multiplier

Using Financial Statement Information: Choose a Benchmark

Financial Statement Analysis: Some Issues

Financial Planning

Example: Chute SA

Income Statement Statement of Financial Position

Sales €1,000

Assets €500 Debt €250

Costs 800

Equity 250

Net income € 200

Total €500

Total €500

What happens if sales grow by 20 percent?

Assume that all variables are a constant percentage of sales

Example: Chute SA

Income StatementSales €1,200Costs 960Net income € 240

Statement of Financial Position

Assets €600 (+100) Debt €300 (+50)Equity 300 (+50)

Total €600 (+100) Total €600

(+100)

How can net income be €240 but equity only increases by €50?

The Percentage of Sales Approach

Example: Bogle plc

Bogle plcIncome Statement

Sales £1,000Costs 800Taxable income £ 200Taxes(28%) 56Net income £ 144Dividends £48Addition to retained earnings 96

Costs are a constant percentage of sales (i.e. Constant profit margin)Dividend payout ratio is constantWhat happens with a 25 percent increase in sales?

Example: Bogle plc (25% increase in Sales)

Bogle plcPro Forma Income Statement

Sales (projected) £1,250Costs (80% of sales) 1,000Taxable income £ 250Taxes (28%) 70Net income £ 180

Dividend payout ratio = Cash dividends / Net income = £48/£144 = 1/3

Projected dividends paid to shareholders = £180 1/3 = £ 60Projected addition to retained earnings = €180 2/3 = 120

£180

Example: Bogle plcStatement of Financial Position

Example: Bogle plcNew Statement of Financial Position

External Financing Needed

Assets Spontaneous liabilities = × Δ Sales × Δ Sales

Sales Sales× Projected sales × (1 )

EFN PM

d

For Bogle plc:

Bogle plcPossible Scenario

External Financing and Growth: Hoffman AG

Income StatementSales €500Costs 400Taxable income €100Taxes (34%) 34Net income €66Dividends €22Addition to retained earnings 44

External Financing and Growth: Hoffman AG

Financing and Growth: Hoffman AG

You forecast sales of €600 next year. What will be the new debt-equity ratio?

Sales (projected) €600.0

Costs (80% of sales) 480.0

Taxable income €120.0

Taxes (34%) 40.8

Net income € 79.2

Dividends €26.4

Addition to retained earnings

52.8

Financing and Growth: Hoffman AG

Assume Hoffman borrows €47.2, New DE Ratio is £297.2/£302.8 = .98

Growth and Projected EFN for Hoffman AG

Growth and Financing Requirements for Hoffman AG

Financial Policy and Growth

The Internal Growth Rate

For Paradise plc:

ROA ×Internal growth rate =

1 ROA ×

b

b

ROA ×Internal growth rate =

1 ROA ×

.144 × 2/3=

1 .144 × 2/3

= 10.62%

b

b

The Sustainable Growth Rate

For Paradise plc:

ROE × Sustainable growth rate =

1 ROE ×

b

b

ROE ×Sustainable growth rate =

1 ROE ×

.288 2 / 3

1 .288 2 / 3

= 23.76%

b

b

Determinants of Growth

ROE × Sustainable growth rate =

1 ROE ×

b

b

Financial Policy and Growth

Financial Planning Models: Some Caveats

Overview of Lecture

Activities for this Lecture

Thank You