## Transcribed Text

Mini Case_1
Figure MC-1. Financial Statements and Other Data (Millions except per share data)
Balance Sheet, Hatfield, 12/31/10
Cash and securities
Accounts receivable
Inventories 390
Income Statement, Hatfield, 2010
Sales $3,000 Total operating costs 2,800 EBIT $200 Interest 54 EBT $146 Taxes (40%) 58 Net income $88 Dividends $28 Add. to retain. earnings $60 Shares outstanding 10 EPS $8.76 DPS $2.80
Total current assets Net fixed assets Total assets
Accounts pay. + accruals Notes payable
Total current liabilities Long-term debt
$720 500 $1,220
$120 80
Total common equity $500 Total liab. & equity $1,220
Selected Ratios and Other Data, 2010
Sales, 2010 (S0):
Expected growth in sales: Profit margin (M): Assets/Sales (A0*/S0): Payout ratio (POR): Equity multiplier (Assets/Equity): Total liability/Total assets Times interest earned (EBIT/Interest): Increase in sales (ΔS = gS0): (Payables + Accruals)/Sales (L0*/S0): Operating costs/Sales: Cash/Sales: Receivables/Sales: Inventories/Sales: Fixed assets/Sales: Tax rate: Interest rate on all debt: Price/Earning (P/E): ROE (Net income/Common equity):
$200 520 $720 300 Retained earnings 200
Total liabilities Common stock
Year-end stock price
Industry $3,000 20.0% 3.67% 37.0% 35.0% 2 50.0% 5.20 $600 3.0% 90.0% 1.0% 8.2% 11.5% 14.8% 40.0% 9.0% 12.0 19.84%
Assets/Equity =
2.44
2.00
$87.60
$40 290
DuPont ROE
Hatfield
Industry
PM
2.92%
3.67%
x
Sales/Assets
2.46
2.70
Hatfield $3,000 18.0% 2.9% 40.7% 32.0% 2.44 59.0% 3.70 $540 4.0% 93.3% 1.3% 9.7% 13.0% 16.7% 40.0% 9.00% 10.0 17.52%
x
ROE
17.52%
19.84%
AFNHatfield = =
=
Add'l Req'd Assets (A0*/S0)∆S
(A0*/S0)(gS0)
- Spontaneous liabi. - (L0*/S0)∆S
- (L0*/S0)(gS0)
- Add'n to RE
- S1 × M × (1–POR)
- S1 × M × (1–POR)
=--
AFNHatfield =
million
Self-Supporting Growth Rate. This is the maximum growth rate that can be attained without raising external funds, i.e., the value of g that forces AFN = 0, holding other things constant.
1. Using algebra. The self-supporting growth rate can also be found by solving the equation below that causes AFN to equal zero. This results in the same value as we find with Goal Seek. The algebriac solution is easy if we give you the equation, but if you had to solve the AFN equation for g, you would probably find the Goal Seek solution easier.
PM(1 – POR)(S0)
Self-Supporting g = = =
A0* – L0* – PM(1 – POR)S0
2. Using Goal Seek. To find the self-supporting growth rate with Goal Seek, first highlight cell B56. Then, on the Main Menu bar click Data>What-If-Analysis>Goal Seek. When you click OK, Cell D25 will change to the answer, which will cause Cell B56 to change to $0.00. Record the new growth rate and then return to the base case by clicking Cancel. Or, you could click OK to leave the new growth rate in Cell D25 and then over-type it with 18% in that cell to get back to the base case. In this assignement, please Leave the new value for D25 to receive credits for goal seek.
Goal Seek is one of Excel's most useful features. We use it elsewhere in this chapter to find the required amount of new capital. In capital budgeting, we use it to see how high the WACC can go before the NPV becomes negative, how low the WACC must be for the NPV to be positive, how low the initial cost must be to achieve a positive NPV, how long a project must last to achieve a positive NPV, and so forth. We have worked on real world cases dealing with almost every chapter in the text, and we almost always have occasion to use Goal Seek. We can't overemphasize its usefulness.
Forecasted Financial Statements
Forecast the financial statements using the following assumptions. (1) Operating ratios remain unchanged. (2) No additional notes payable, LT bonds, or common stock will be issued. (3) The interest rate on all debt is 9%. (4) If additional financing is needed, then it will be raised through a line of credit. The line of credit will be tapped on the last day of the year, so there will be no additional interest charges due to the line of credit. (On Tab 2 we relax this assumption and assume that the line of credit is accessed smoothly throughout the year.) (5) Interest expenses for notes payable and LT bonds are based on the average balances during the year. (6) If surplus funds are available, the surplus will be paid out as a special dividend payment. (7) Regular dividends will grow by 11.91%. (8) Sales will grow by 18%. This is called the "Steady" scenario because operations remain unchanged. The same assumptions apply to the Target scenario, except there are improvements in several areas of operations.
Use the Scenaro Manager to change scenarios.
Inputs for Forecasts
Sales growth rate
Operating costs/Sales Cash/Sales
Receivables/Sales Inventories/Sales
Fixed assets/Sales
Payables and accruals/ Sales Growth rate in regular dividends Interest rate on all debt
Tax rate
Cash
Accounts receivable Inventories
Total assets
Liabilities & equity
$40 290 390
18.00% 93.30% 1.30% 9.70% 13.00% 16.70% 4.00% 11.91% 9.00% 40.00%
Steady
18.00% 93.30% 1.30% 9.70% 13.00% 16.70% 4.00% 11.91% 9.00% 40.00%
Forecast Scenarios
Target
20.00% 90.00% 1.00% 8.20% 11.50% 14.80% 3.00% 12.90% 9.00% 40.00%
Active is
Hatfield 2010
Scenario:
Hatfield
Balance Sheet
Assets
2010
Forecast
Factor Basis for 2011 Forecast
w/o AFN
2011
With AFN
2011
Factor × Forecasted Sales Factor × Forecasted Sales Factor × Forecasted Sales
$720 500
Factor × Forecasted Sales
$1,220
$120 80 0
Factor × Forecasted Sales Carry over 2010 amount New LOC if AFN > 0
Carry over 2010 amount Carry over 2010 amount
$200 520
$720 300
Retained earnings 2010 + Add'n to RE from Income St. Total common equity
Total liab. & equity
AFN = TA – (Planned Liab & Equity)
200
$500
$1,220
Income Statement
Scenario:
Hatfield
2010
Forecast
Special dividend (if AFN ≤ 0) =
w/o AFN
With AFN
Sales
Total operating costs
$3,000.0 2,800.0
Factor Basis for 2011 Forecast
2011
2011
(1 + Factor) × 2010 Sales Factor × Forecasted Sales
$200.0
Interest: NP planned Interest: LT debt planned Interest: Line of credit
7.2 46.8 0.0
Rate x NP
Rate x L-T Debt
Rate x Beginning Balance
$146.0 58.4
Tax rate × EBT
Net inc. for common (NI)
$87.6
Dividends- regular (DIVs)
Special dividends Add. to ret. earnings
$28.0
$0.0
(1 + g) × 2010 Dividends
Special dividend if AFN ≤ 0 NI − all dividends
$59.6
Steady
Forecast Scenarios
Target
Active is
Performance
Net operating profits after taxes Net operating working capital
Hatfield 2010 $120 $600
Total current assets Net fixed assets
Accts pay. and accruals Notes payable: Planned Line of credit (LOC) Total current liabs
LT debt: Planned Total liabilities Common stock
EBIT
Earnings before taxes (EBT) Taxes
New line of credit (if AFN > 0) =
Total operating capital Free cash flow
Return on invested capital AFN
EPS
DPS (regular dividends) Payout ratio (all dividends) Profit margin
Sales/Assets (Assets turnover) Assets/Equity
ROE
Operating costs/Sales
Total liability/Total assets
TIE ratio
Growth rate
Operating costs/sales Cash/Sales Receivables/Sales Inventories/Sales
Fixed assets/Sales
Payables and Accruals/ Sales Interest rate on notes payable Payout ratio
Tax rate
P/E ratio
Shares outstanding (millions)
Hatfield
2010
18.0% 93.3% 1.3% 9.7% 13.0% 16.7% 4.0% 9.0% 32.0% 40% 10.0 10.000
$1,100 NA 10.9% NA $8.76 $2.80 32.0% 2.9% 2.46 2.44 17.5% 93.3% 59.0% 3.70
ADJUSTED FOR INTEREST ON ADDED NOTES PAYABLE
Steady State
Steady
18.0% 93.3% 1.3% 9.7% 13.0% 16.7% 4.0% 9.0% 32.0% 40% 10.0 10.000
Adjusted for New Interest
Data Used in the Scenarios
Inputs for Forecasts
Target
Target
20.0% 90.0% 1.0% 8.2% 11.5% 14.8% 3.0% 9.0% 35.0% 40% 12.0 10.000
Active
Adjusted for New Interest Hatfield Forecast
This data is for:
2011
Balance Sheet 2010 Factor Procedure for 2011 Forecast Forecast Assets
Cash
Accounts receivable Inventories
Total current assets Net fixed assets
Accts payable and accruals
Total assets
$40 290 390
Factor × Forecasted Sales Factor × Forecasted Sales Factor × Forecasted Sales
$720 500
Factor × Forecasted Sales
$1,220
Claims on Assets
Notes payable
Add' notes to balance Total current liabs
Long Term Debt Total liabilities Common stock Retained earnings Total common equity Total liabs and equity Shares outstanding
$120
80 0
Factor × Forecasted Sales
Carry over 2010 amount New notes (+/-) to balance
Carry over 2010 amount
Carry over 2010 amount
2010 + Add'n to RE from Income Statement
$200 520
$720 300 200
$500
Year-end stock price
$1,220
10.000
$87.60
Difference between Assets and Liab+Equity:
Adjusted for New Interest
Adjusted for New Interest Hatfield Forecast
2010 Income Statement 2010 Factors Forecast 2011
Scenario:
Sales $3,000.0 Total operating costs 2,800.0
(1 + Factor) × 2010 Sales Factor × Forecasted Sales
EBIT
Interest on initial debt
Total interest
Earnings before taxes (EBT) Taxes
$200.0
54.0 Interest rate × (NP+L-T Debt)
$54.0 $146.0
58.4 Tax rate × 2011 EBT
Interest on 1/2 of new debt 0.0
Net income for common (NI) $87.6
Interest rate × (0.5 × Δ notes)
Dividends (DIVs) $28.0
Payout Ratio × NI
Add. to ret. earns (NI – DIVs) $59.6
Shares outstanding EPS
DPS
Stock Price
10.000 $8.76 $2.80
$87.60
Adjusted for New Interest
Adjusted for New Interest Hatfield
Steady State
Final
Performance
EPS
Year-end stock price
Profit margin (PM) Sales/Assets (Assets turnover) ROE
Debt/Assets
Assets/Equity
TIE ratio
Payout ratio
2010
Steady State
Target
Active
Steady
Target
$8.76 $87.60 2.9% 2.46 17.5% 59.0% 2.44 3.70 32.0%
Final comment: Different problems require somewhat different models--one size does not fit all. For example, a firm's growth rate might be low, and if that resulted in a negative AFN, then a model would have to be programmed to do something with the excess funds. The model on Tab 2 is an example.
a. Do you think Adam Lee should develop a strategic plan for the company? Why? What are the central elements of such a plan? What is the role of finance in a strategic plan?
b. Based on the data in Figure MC-1, how well run does Hatfield appear to be in comparison to other firms in its industry? What are its primary strengths and weaknesses? Be specific in your answer, and point to various ratios that support your position. Also, use the DuPont equation as one part of your analysis.
c. Use the AFN equation to estimate Hatfield’s required new external capital for 2011 if the 18% expected growth takes place. Assume its 2010 ratios will remain the same in 2011.
d. Define the term “capital intensity.” Explain how a decline in capital intensity would affect the AFN, other things held constant. Would economies of scale combined with rapid growth affect capital intensity, other things held constant? Also, explain how changes in each of the following would affect AFN, holding other things constant: The growth rate, the amount of accounts payable, the profit margin, and the payout ratio.
e. Define the term “self-supporting growth rate.” Based on the Figure MC-1 data, what is Hatfield’s self-supporting growth rate? Would the self-supporting growth rate be changed by a change in the capital intensity ratio or the other factors mentioned in question d? Would the calculated capital intensity ratio change over time if the company were growing and was also subject to economies of scale and/or lumpy assets, other things held constant?
f. Forecast the financial statements for 2011 using the following assumptions. (1) Operating ratios remain unchanged. (2) No additional notes payable, LT bonds, or common stock will be issued. (3) The interest rate on all debt is 9%. (4) If additional financing is needed, then it will be raised through a line of credit. The line of credit will be tapped on the last day of the year, so there will be no additional interest expenses due to the line of credit. (5) Interest expenses for notes payable and LT bonds are based on the average balances during the year. (6) If surplus funds are available, the surplus will be paid out as a special dividend payment. (7) Regular dividends will grow by 11.91%. (8) Sales will grow by 18%. This is called the "Steady" scenario because operations remain unchanged.
1. How much new capital will the firm need (i.e., what is the forecasted AFN), how does it compare with the amount you calculated using the AFN equation, and why does any difference exist?
2. Calculate the firm’s free cash flow, return on invested capital, EPS, DPS, ROE, and any other ratios you think would be useful in considering the situation. (Just finish the excel file from row 144-160) for Steady case
3. Assuming all of the inputs turn out to be exactly correct, would these answers also be exactly correct? If not, why not?
g. Now repeat the analysis done for question f but assume that Hatfield is able to achieve industry averages for the following input variables: Operating costs/Sales, Receivables/Sales, Inventories/Sales, and Fixed assets/Sales. Answer questions (1) and (2) below, under the new assumptions.This is called the "Target" scenario.
1. How much new capital will the firm need for Target Scenario?
2. Calculate the firm’s free cash flow, return on invested capital, EPS, DPS, ROE, and any other ratios you think would be useful in considering the situation. (Just finish the excel file from row 144 to 160 for target case. )
h. Might a strategic plan that included an incentive compensation program affect the firm’s ability to move to or at least toward industry average operating performance?
I. Work the excel sheet when we consider the financing feedback effect (just finish the rest of the excel).

This material may consist of step-by-step explanations on how to solve a problem or examples of proper writing, including the use of citations, references, bibliographies, and formatting. This material is made available for the sole purpose of studying and learning - misuse is strictly forbidden.