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# Review Ch. 4 and Ch. 12

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1. Review Ch. 4 and Ch. 12

2. Chapter 4 Outline • What is financial planning • Financial planning models • The percentage of sales approach • External financing and growth • Caveats in financial planning

3. Percentage of sales approach:

4. EFN and Capacity Usage • Suppose COMPUTERFIELD is operating at 80% capacity: 1. What would be sales at full capacity? (1p) 2. What is the capital intensity ratio at full capacity? (1p) 3. What is EFN at full capacity and Dividend payout ratio is 15%? (1p) What is EFN to increase sales to 12000 and Dividend payout ratio is 35%?

5. Q 1:8,000/.8=10,000; Full capacity as increase10,000/8,000 = 1.25 (25%) • Income statement • Sales \$8,000 • Costs \$5,800 • N I \$2,200 • Ret earnings 2,200*.85=1,870 • New Ret earnings 1,870*1.25=2,337.5 • There is no indication that any changes took place in % cost for the proforma income statement, we can get the same result by increasing RE or by creating proforma IS

6. New assets needed • CA • 5000*1.25=6,250 • TA =6,250+7000 • 13,250 • capital intensity ratio at full capacity • =13,250/10,000 =1.325 • EFN =0 change in TA = 1250 which is less than the retained earnings, we can fully finance internally full capacity operation.

7. What is EFN to increase sales to 12,000 (50%) and Dividend payout ratio is 35%? • Income statement • Sales \$8,000 • Costs \$5,800 • N I \$2,200 • Ret earnings 2,200*.65=1,430 • New Ret earnings 1,430*1.5=2,145 • There is no indication that any changes took place in % cost for the proforma income statement, we can get the same result by increasing RE or by creating proforma IS

8. Recent Sales 8,000; Proj. Sales 12,000Increase 50% • CA 5,000*1. 5=7,500 • FA=7,000+1,400 • TA =15,900 • FA=7000/10000 per unit of sales=.7 • Inv . Need for 2000 more units of sales =.7*2000=1,400 • EFN=1,755 change in TA = 3,900 from RE=2,145

9. EFN=1,755 • D/E ratio =3/2 • EFN=1,755 • How much debt should be issued? • How much equity? • If they issue only debt (all 1,755 in bonds) what will be the D/E ratio on the proforma BS? • D=8,250+1,755=10,005 • E=3,750+2,145=5,895 D/E=1.69

10. Please, Review also • Internal Growth Rate • Sustainable Growth Rate

11. Chapter 12 Overview • Return of an investment: arithmetic and geometric • The variability of returns • Efficiency of capital markets

12. Arithmetic vs. Geometric Averages (1) • Geometric return = the average compound return earned per year over multiyear period • Arithmetic average return = the return earned in an average (typical) year over a multiyear period Geometric average return =

13. The Variability of Returns • Variance = the average squared deviation between the actual return and the average return • Standard deviation = the positive square root of the variance

14. The Normal Distribution (2)

15. Z-score • For any normal random variable: • Z – z-score • X – normal random variable • - mean