Corporate Finance Ch. 19

The Planning Documents Strategic Plan, Investment Plan, Financing Plan, Divisional Business Plan, Cash Budget
Strategic Plan Where is the company headed?
Investment Plan What capital resources does the management need to get there?
Financing Plan How is the firm going to pay for the resources needed?
Divisional Business Plans What the division will do to achieve the firm’s strategic goals.
Cash Budget How is the firm going to pay its day to day bills?
Free Cash Flow (Cash Flow from Assets) Operating Cash Flow – Net Investments
Operating Cash Flow NI +noncash charges+interest
Internal Growth Rate Addition to retained earnings / initial total assets; maximum growth rate that a firm can achieve without external financing
IGR Plowback ratio return on equity measure of leverage
Firms that achieve higher growth rates without seeking external financing have the following characteristics – they have a high plowback ratio- they employ less equity and/or are able to generate high net income leading to a high ROE- they are not highly leveraged
Sustainable Growth Rate the rate of growth that a firm can sustain without selling additional shares of equity.= plowback ratio * ROE
Why wouldn’t shareholders want their companies to issue more common stock? – Automatic drop 2-4% in the stock price- potential sign that the stock is overvalued- ownership dilution
Why don’t US corporate managers like issuing more equity? -equity is expensive-automatically reduces EPS which may affect management compensation-most managers feel their stock is undervalued so they feel they are leaving money on the table-equity markets are a fickle source of funding
Investment Policy Decision identify the investment decisions to be evaluated as part of the financial planning process
Financial policy decision – capital structure decisions- financing decisions- pay out decisions
dividend payout ratio cash dividends / net income
retention ratio addition to retained earnings / net income
capital intensity ratio the ratio of total assets needed by the firm to generate $1 sales; firms that are highly capital intensive are more risky than those that are not because a downturn can reduce sales sharply but fixed costs do not change rapidly
EFN External Funding Needed; defined as the additional debt or equity a firm needs to issue so it can purchase additional assets to support an increase in sales. EFN is tied to new investments the management has deemed necessary to support the sales growth
EFN Formula New Investments – Addition to retained earnings
EFN = (Growth Rate * Initial Total Assets) – Addition to retained earnings

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