226144

Tab 1
Chapter 12. Tool Kit for Financial Planning and

Forecasting Financial Statements
On Tab 1 we do the calculations for the AFN formula, using MicroDrive's data as presented in Chapter 2.
Then, on Tab 2, we forecast the firm's financial statements and analyze the results. On Tab 3 we forecast
using different finanical policies from those in Tab 2. In Tab 4 we explain financing feedback. On Tab 5 we
demonstrate multi-year forecasts.
SALES FORECAST (Section 12.2)
Strategic planning is one of the core functions of an organization, and it involves the coordination of
operating plans with financial plans. While operational plans outline how the firm intends to reach its
corporate objectives, financial plans outline the manner in which the firm will obtain the necessary
productive assets to operate. Financial planning generally begins with a sales forecast, and that forecast
generally starts with a review of the firm's recent history. Here are MicroDrive Inc.'s sales over the past 5
years:
Annual
Growth
Sales Rate
2006 $2,058
2007 2,534 23.1%
2008 2,472 -2.4%
2009 2,850 15.3%
2010 3,000 5.3%
Figure 12-1. MicroDrive Inc.: Historical Sales (Millions of Dollars)
Net Sales
$3,500
$3,000
$2,500
$2,000
$1,500
$1,000
$500
$0
2006 2007 2008 2009 2010 2011
Year
$1,000
$500
$0
2006 2007 2008 2009 2010 2011
Year
There are several ways to estimate the historical growth rate, ranging from the simple to the complicated. The simples
ways are to estimate the arithmetic average annual growth rate and the compound (geometric) annual growth rate.
Arithmetic average annual growth rate = 10.3%
Compound (geometric) annual growth rate = 9.9% (Use the RATE function.)
Both approaches have flaws. For example, suppose sales start at 100, drop by 20% to 80, then increase by 25% to 100
arithmetic approach would find the average of -20% and +25%, which is +2.5%, even though sales started at 100 and en
at 100. The geometric average is too senstive to the starting and ending values (the PV and FV used in the rate functio
It would be easy to estimate the projected sales by fitting a regression to the graph and plotting the predicted sales 1
period ahead. An easy way to do this is with the TREND function. This allows you to specify the past years and sales,
then specify a projected year. It then fits the regression line and gives you the projected value. See below for details.
Projected sales for 2011 = 3,243 (Using the TREND function)

Implied growth rate = 8.1%
The compound growth rate is very sensitive to the particular starting and ending dates that are chosen. One way to
smooth this out is to regress the natural log (LN) of sales versus the years. The slope coefficient is the estimate of the
historical sales growth rate. Instead of doing a full regression with the Y variable being the log of sales, we could find t
slope of the "log" regression directly using the LOGEST function. In this function, we simply specify the original sales
the Y variable, the years as the X variable, and the function finds the "log-based" slope coefficient, which is an estimat
(1+g).
(1+g) rate using LOGEST = 1.091035801

g= 9.1%
MicroDrive's managers took these different estimates into consideration, along with their knowledge of the
economy, the industry, and MicroDrive's own situation. Their best estimate was a 10% forecast growth in
sales for the next year. But as you will see, MicroDrive's managers also performed sensitivity analysis on
this critical input when they projected their financial plans.
Additional Funds Needed (AFN) (Section 12.3)
Figure 12-2. MicroDrive's Most Recent Financial Statements (Millions of Dollars Except Per Share Data)
INCOME STATEMENTS 2009 2010 BALANCE SHEETS 2009

Assets
Sales $2,850.0 $3,000.0 Cash $15.0
Costs except depreciation 2,497.0 2,616.2 ST Investments 65.0
Depreciation 90.0 100.0 Accounts receivable 315.0
Total operating costs $2,587.0 $2,716.2 Inventories 415.0
EBIT 263.0 283.8 Total current assets $810.0
Less interest (INT) 60.0 88.0 Net plant and equip. 870.0
Earnings before taxes (EBT) $203.0 $195.8 Total assets $1,680.0
Taxes (40%) 81.2 78.3
Income before pref. dividends $121.8 $117.5 Liabilities and equity
Preferred dividends 4.0 4.0 Accounts payable $30.0
Net income for common (NI) $117.8 $113.5 Accruals 130.0
Notes payable 60.0
Dividends to common (DIVs) $53.0 $57.5 Total current liab. $220.0
Add. to retained earnings: Long-term bonds 580.0
(NI – DIVs) $64.8 $56.0 Total liabilities $800.0
Shares of common stock 50 50 Preferred stock 40.0
Earnings per share (EPS) $2.36 $2.27 Common stock 130.0
Dividends per share (DPS) $1.06 $1.15 Retained earnings 710.0
Price per share (P) $26.00 $23.00 Total common equity $840.0
Total liab. & equity $1,680.0
Figure 12-3. Additional Funds Needed (AFN), in millions

The AFN model forecasts MicroDrive's need for external funds to support its forecasted 2011 sales. Year 0 is 2010, wh
has just ended, and Year 1 is 2011, which has just begun. (Ignore rounding differences.)
Part I. Inputs and Definitions
S0: Last year's sales, i.e., 2010 sales:
g: Forecasted growth rate in sales:
S1: Coming year's sales, i.e., 2011 sales = S 0 × (1 + g):
gS0: Change in sales = S1 – S2 = ΔS:
A0*: Assets that must increase to support the increase in sales:
A0* / S0: Required assets per dollar of sales:
L0*: Last year's spontaneous assets, i.e., payables + accruals:
L0* /S0: Spontaneous liabilities per dollar of sales:
Profit margin (M): 2010 profit margin = net income/sales:
Payout ratio (POR): Last year's dividends / net income = % of income paid out:
Part II. Additional Funds Needed (AFN) to Support Growth

Spontaneous Increase
AFN = Required Increase in Assets − in Payables and −
= (A0*/S0)∆S − Accruals
(L 0
*/S0)∆S −
− −
= (A0*/S0)(gS0) − (L0*/S0)(gS0) −
− −
= (0.667)($300) − (0.067)($300) −
= $200 − $20.00 −
AFN = $118.42 million
Under the assumed conditions, the firm must raise $118.42 million externally to support its planned growth. However,
model assumes (1) that no excess capacity existed in 2010, so all assets were needed to produce the indicated sales,
(2) that the key ratios will remain constant at their 2010 levels. We explain later how to relax these assumptions, but it
better to use forecasted financial statements to deal with these issues, as we do on Tab 2 of the model.
Under the assumed conditions, the firm must raise $118.42 million externally to support its planned growth. However,
model assumes (1) that no excess capacity existed in 2010, so all assets were needed to produce the indicated sales,
(2) that the key ratios will remain constant at their 2010 levels. We explain later how to relax these assumptions, but it
better to use forecasted financial statements to deal with these issues, as we do on Tab 2 of the model.
Self-Supporting Growth Rate. This is the maximum growth rate that can be attained without raising external funds, i.e
value of g that forces AFN = 0, holding other things constant. We found this rate, g = 3.20986%, with Excel's Goal Seek
function and also algebraically, as explained below.
1. Using algebra. The sustainable growth rate can also be found by solving the equation as shown on the 3rd row abo
then finding the value of g that causes AFN to equal zero. This results in the same value as we find with Goal Seek. Th
algebriac solution is easy if we give you the equation, but if you had to solve the AFN equation for g, you would probab
find the Goal Seek solution easier.
PM(1 – POR)(S0) $55.98

Sustainable g = = = 3.20986%
A0* – L0* – PM(1 – POR)S0 $1,744.00
Therefore, if MicroDrive's ratios remain constant, the company can grow at about 3.21% without external financing.
2. Using Goal Seek. To find the sustainable growth rate with Goal Seek, first highlight cell B152. Then, with Excel 07,
the Main Menu bar click Data>What-If-Analysis>Goal Seek. With Excel 03 click Tools>Goal Seek. Then complete the di
box as shown below. When you click OK, Cell I133 will change to 3.209862%, which will cause Cell B152 to change to
$0.00, and you will see the dialog box below and to the right. Record the new growth rate now in Cell I133 and then re
to the base case by clicking Cancel. Or, you could click OK to leave the new growth rate in Cell I133 and then over-typ
with 10% in that cell to get back to the base case.
Goal Seek is one of Excel's most useful features. We use it elsewhere in this chapter to find the required amount of ne
capital. In capital budgeting, we use it to see how high the WACC can go before the NPV becomes negative, how low th
WACC must be for the NPV to be positive, how low the initial cost must be to achieve a positive NPV, how long a proje
must last to achieve a positive NPV, and so forth. We have worked on real world cases dealing with almost every chap
in the text, and we almost always have occasion to use Goal Seek. We can't overemphasize its usefulness.
EXCESS CAPACITY ADJUSTMENTS

production with its fixed assets. Also, assume that it could sell off its redundant FA at their book value. Sales for the l
year were $3,000 million, while fixed assets were $1,000 million. We can use this information to calculate the firm's fu
2010 Sales
2011 Sales
2010 Total Assets
2010 Fixed Assets
Original 2010 FA/Sales ratio = $1,000/$3,000
FA capacity was used only to this percent
FA that were actually needed during 2010 = 0.96($1,000)
Excess Fixed Assets for 2010
A0* / S0 if Fixed Assets had been operated at full capacity = (TA – Excess)/Sales
Previously calculated AFN
AFN using revised ratio in the AFN equation
Reduction in AFN due to reduced need for Fixed Assets
Obviously, the reduction in AFN would have been greater if there had been more excess capacity. Also, assuming FA c
be sold at book value, MicroDrive could (1) sell off $40 of fixed assets to bring them down to the required level, then us
the new FA/S ratio for the forecasted AFN, taking AFN down to $114.42. Since the company would receive the $40, this
would bring its total AFN for 2011 down to $114.42 – $40 = $74.42. The $40 is a one-time reduction and thus a one-time
increase in FCF.
Obviously, the reduction in AFN would have been greater if there had been more excess capacity. Also, assuming FA c
be sold at book value, MicroDrive could (1) sell off $40 of fixed assets to bring them down to the required level, then us
the new FA/S ratio for the forecasted AFN, taking AFN down to $114.42. Since the company would receive the $40, this
would bring its total AFN for 2011 down to $114.42 – $40 = $74.42. The $40 is a one-time reduction and thus a one-time
increase in FCF.
4/11/2010
sented in Chapter 2.
On Tab 3 we forecast
eedback. On Tab 5 we
e coordination of
ends to reach its
the necessary
ast, and that forecast
sales over the past 5
2011
Year
2011
Year
e to the complicated. The simplest

geometric) annual growth rate.
TE function.)
o 80, then increase by 25% to 100. The

though sales started at 100 and ended
PV and FV used in the rate function.
and plotting the predicted sales 1

specify the past years and sales, and
cted value. See below for details.
REND function)
es that are chosen. One way to

pe coefficient is the estimate of the
ng the log of sales, we could find the
we simply specify the original sales as
pe coefficient, which is an estimate of
their knowledge of the

% forecast growth in
ensitivity analysis on
ars Except Per Share Data)
2010
$10.0
0.0
375.0
615.0
$1,000.0
1,000.0
$2,000.0
$60.0
140.0
110.0
$310.0
754.0
$1,064.0
40.0
130.0
766.0
$896.0
$2,000.0
ted 2011 sales. Year 0 is 2010, which

es.)
$3,000
10.000000%
$3,300
$300
$2,000
66.67%
$200
6.67%
3.78%
50.67%
Addition to Retained
Earnings.
S1 × M × (1 – POR)
(1+g)S0 × M × (1 – POR)
$3,300(0.0378)(1 – 0.507)
$61.58
port its planned growth. However, the

ed to produce the indicated sales, and
to relax these assumptions, but it is
Tab 2 of the model.
without raising external funds, i.e., the
3.20986%, with Excel's Goal Seek
ation as shown on the 3rd row above g,

alue as we find with Goal Seek. The
N equation for g, you would probably
21% without external financing.
ht cell B152. Then, with Excel 07, on

>Goal Seek. Then complete the dialog
will cause Cell B152 to change to
h rate now in Cell I133 and then return
rate in Cell I133 and then over-type it
r to find the required amount of new

NPV becomes negative, how low the
e a positive NPV, how long a project
es dealing with almost every chapter
phasize its usefulness.
at their book value. Sales for the last

formation to calculate the firm's full
$3,000
$3,300
$2,000
$1,000
33.33%
96%
$960
$40
65.333%
$118.42
$114.42
$4.00
ess capacity. Also, assuming FA can

down to the required level, then use
mpany would receive the $40, this
ime reduction and thus a one-time
Tab 2 4/11/2010
FINANCIAL STATEMENT FORECASTING (Section 12.4)
On this tab we forecast MicroDrive's financial statements for the upcoming year and then calculate ratios and
other data to analyze the firm's projected financial condition. Initially, we base the projection on the most recent
year's data, which amounts to a "Status Quo" forecast. We then add three scenarios, one where the company
achieves industry average ratios (the Best-Case Scenario), one designed to show what would happen if the
economy goes into an even deeper recession (the Worst-Case Scenario), and a Final forecast that was
developed at the end of the firm's planning conference.
We begin by repeating MicroDrive's most recent financial statements for convenience, including additional data
concerning interest rates and investor-supplied capital.
MicroDrive's Most Recent Financial Statements (Millions of Dollars Except Per Share Data)
INCOME STATEMENTS 2009 2010 BALANCE SHEETS 2009

Assets
Sales ### $3,000.0 Cash $15.0
Costs except depreciation 2,497.0 2,616.2 ST Investments 65.0
Depreciation 90.0 100.0 Accounts receivable 315.0
Total operating costs ### $2,716.2 Inventories 415.0
EBIT 263.0 283.8 Total current assets $810.0
Less Interest (INT) 60.0 88.0 Net plant and equip 870.0
Earnings before taxes (EBT) $203.0 $195.8 Total assets $1,680.0
Taxes (40%) 81.2 78.3
Income before pref. dividends $121.8 $117.5 Liabilities and equity
Preferred dividends 4.0 4.0 Accounts payable $30.0
Net income for common (NI) $117.8 $113.5 Accruals 130.0
Notes payable 60.0
Dividends to common (DIVs) $53.0 $57.5 Total current liabs $220.0
Add. to retained earnings: Long-term bonds 580.0
(NI – DIVs) $64.8 $56.0 Total liabilities $800.0
Shares of common stock 50 50 Preferred stock 40.0
Earnings per share (EPS) $2.36 $2.27 Common stock 130.0
Dividends per share (DPS) $1.06 $1.15 Retained earnings 710.0
Price per share (P) $26.00 $23.00 Total common equity $840.0
2010 interest rate on notes payable: 9.00% Total liabs. & equity $1,680.0
2010 interest rate on long-term bonds: 11.00% Investor-supplied capital* $1,520.0
*Investor-supplied capital consists of notes payable, long-term bonds, preferred stock, and total common equity.
It is also equal to total liabilities and equity minus accounts payable and accruals. Accounts payable and
accruals are not included in investor-supplied capital because they are a part of operations and are not sources
of capital from investors.
Input Data for the Forecast
Following is an explanation of the input data and structure of the model shown below.
Forecasting financial statements requires the use of a set of equations that must be solved in a specific
sequence. However, the steps are relatively straightforward, so you should not have trouble following our model
if you proceed slowly and carefully. Financial managers typically make such models, but managers from all
departments provide inputs and are affected by the results, hence need a general understanding of financial
forecasts.
Forecasting financial statements requires the use of a set of equations that must be solved in a specific
sequence. However, the steps are relatively straightforward, so you should not have trouble following our model
if you proceed slowly and carefully. Financial managers typically make such models, but managers from all
departments provide inputs and are affected by the results, hence need a general understanding of financial
forecasts.
MicroDrive initially forecasts a 10% sales growth rate. Prior year data for the industry and MicroDrive are shown
in Columns C and D for Figure 12-4 below. The most recent data are used for the Status Quo forecast. The the
Best-Case forecast assumes the company operates at industry average levels except for capital structure. Data
used in the Final forecast were developed after a lengthly planning meeting attended by all of the firm's senior
managers. Data for these four cases are shown in Columns F, G, H, and I, which are color coded. Note that the
data in Columns F, G, H, and I are not used directly in the calculations. Rather, when we "show" scenarios using
the Scenario Manager, the values in the corresponding scenario are placed into Column E, which we designate
as the "active column" because its data are being used in the actual calculations.
The orange colored rows in the Financing Data section deal with capital structure. Those 4 items must total to
100%. The capital structure ratios are held constant in all cases except for the Final scenario.
If you change any individual number in Column E, this will lead to a new forecast, using this one new number
along with the other numbers then in Column E. Thus, you can do sensitivity analyses for each variable.
The model uses the Column E data to forecast the statements shown in Figure 12-5. The model is built with a
series of equations, and Excel inserts data from Figure 12-4 into the equations in Figure 12-5. The sequencing of
the equations as discussed in Part 3 of Figure 12-5 is important.
We use Excel's Scenario Manager to execute the different scenarios. Scenario Manager in essence takes data
from the four color coded sets of inputs in Figure 12-4, inserts this data into the calculating model in Figure 12-5,
and then gets results for the different scenarios. For those who are interested, we explain how to use the
scenario tool off to the right, starting in Column M.
Figure 12-4. Input Data and Key Results for the Forecast (Millions Except Percentages and Per Share Data)
2010 2011
Inputs Actual Values Forecasted Input Values for Scenarios
Active
Industry MicroDrive Scenario:
Operating Ratios: Final Status Quo Best
Growth rate in sales 10.00% 5.26% 10.00% 10.00% 10.00%
Op costs except depr'n / Sales 83.00% 87.21% 86.00% 87.21% 83.00%
Depr'n / Net plant & equip. 10.20% 10.00% 10.20% 10.00% 10.00%
Cash / Sales 0.25% 0.33% 0.25% 0.33% 0.33%
Accounts Rec. / Sales 9.80% 12.50% 11.00% 12.50% 9.80%
Inventory / Sales 11.11% 20.50% 16.00% 20.50% 11.11%
Net plant & equip. / Sales 33.33% 33.33% 33.33% 33.33% 33.33%
Accounts Pay. / Sales 2.00% 2.00% 2.00% 2.00% 2.00%
Accruals / Sales 4.00% 4.67% 4.00% 4.67% 2.00%
Tax rate: 40.00% 40.00% 40.00% 40.00% 40.00%
Financing Data:
Notes payable/Investor-sup cap 5.00% 6.11% 5.00% 6.11% 6.11%
LT bonds/Investor-sup capital 32.00% 41.89% 37.00% 41.89% 41.89%
Pref. stock/Investor-sup cap. 3.00% 2.22% 3.00% 2.22% 2.22%
Comm equity/Investor-sup cap 60.00% 49.78% 55.00% 49.78% 49.78%
Interest rate on notes payable 8.00% 9.00% 8.50% 9.00% 8.50%
Interest rate on L-T bonds 10.00% 11.00% 10.50% 11.00% 10.50%
Dividend rate on pfd stock 9.00% 10.00% 9.50% 10.00% 9.50%
Target dividend payout ratio 40.00% 50.67% 40.00% 50.67% 50.67%
2010 2011 2011 2011
Key Results MicroDrive Final Status Quo Best
Free cash flow (FCF) -$174.70 $208.61 $7.35 $401.57
Return on inv. capital (ROIC) 9.46% 11.65% 9.46% 16.21%
Earnings per share (EPS) $2.27 $3.11 $2.43 $5.07
Return on equity (ROE) 12.67% 15.70% 12.64% 25.97%
# Shares, end-of-year 50.00 50.06 51.22 42.54
Dividends per share (DPS) $1.15 $1.24 $1.23 $2.57
The forecasting model is in Figure 12-5. It starts with the firm's 2010 data, pulls "input factors" down from
Column E of Figure 12-4, and then uses these factors as indicated in the "Forecast Basis" column to make the
forecasted balance sheet and income statement shown in Column G. The factors change with each scenario,
causing the forecasts to change. The forecasts for operating current assets and spontaneous current liabilities
is straightforward, and the model calculates them first. The way the other items are forecasted is a bit
complicated, but we explain them in Part 3 of the figure, the Supplemental calculations section.
Figure 12-5. Forecasted Financial Statements (Millions Except Per Share Data)
Scenario Shown: Final Final

Most Recent Forecast
Part 1. Balance Sheet 2010 Factors Basis for 2011 Forecast 2011
Assets
Cash $10.0 0.25% Factor × 2011 Sales $8.25
Accounts receivable 375.0 11.00% Factor × 2011 Sales $363.00
Inventories 615.0 16.00% Factor × 2011 Sales $528.00
Total current assets $1,000.0 $899.25
Net plant and equipment 1,000.0 33.33% Factor × 2011 Sales $1,100.00
Total assets (TA) $2,000.0 $1,999.25
Liabilities and equity
Accounts payable $60.0 2.00% Factor × 2011 Sales $66.00
Accruals 140.0 4.00% Factor × 2011 Sales $132.00
Notes payablea 110.0 5.00% % of investor-sup. cap. $90.06
Total current liabilities $310.0 $288.06
Long-term bondsa 754.0 37.00% % of investor-sup. cap. $666.46
Total liabilities $1,064.0 $954.52
Preferred stocka $40.0 3.00% % of investor-sup. cap. $54.04
Common stock 130.0 Tot. Com. Eq – Ret. Earn $131.37
Retained earnings 766.0 Old RE + Add. to RE $859.32
Total common equitya $896.0 55.00% % of investor-sup. cap. $990.69
Total liabilities and equity $2,000.0 $1,999.25
a
Investor-supplied capital $1,800.0 TA − accts. pay. − accruals $1,801.25
Scenario Shown: Final Final
Most Recent Forecast
Part 2. Income Statement 2010 Factor Basis for 2011 Forecast 2011
Sales $3,000.0 110% Factor × 2010 Sales $3,300.00
Costs except depreciation 2,616.2 86.00% Factor × 2011 Sales $2,838.00
Depreciation 100.0 10.20% Factor × 2011 Net plant $112.20
Total operating costs $2,716.2 $2,950.20
EBIT $283.8 $349.80
Less: Interest on notes 9.9 8.50% Interest rate × Avg notes $8.50
Interest on bonds 78.1 10.50% Interest rate × Avg bonds $74.57
Earnings before taxes (EBT) $195.8 $266.72
Taxes (40%) 78.3 40.00% Tax rate × 2011 EBT $106.69
NI before preferred dividends $117.5 $160.03
Preferred dividends 4.0 9.50% Pfd div rate × Avg preferred $4.47
NI available to common $113.5 $155.57
Dividends paid out $57.5 40.00% Net income × Payout rate $62.23
Addition to retained earnings $56.0 Net income – Dividends $93.34
Change in shares outstanding (Change in Com. stk.)/P2010 0.06
Ending shares outstanding 50.00 Shares2010 + D shares 50.06
Earnings per share, EPS $2.27 Net income/Total shares $3.11
Dividends per share, DPS $1.15 Total dividends/Total shares $1.24
Part 3. Procedures used to complete the financial statements

1. Forecast next year's sales based on the assumed growth rate:
S2011 = S2010 × (1 + g).
2. Forecast each of the operating assets (cash, accounts receivable, inventories, and
net plant & equipment) and the spontaneous current liabilities (accounts payable and
accruals) as a percent of forecasted sales. This completes the assets section of the
balance sheet and partially completes the liabilities section.
3. Use the forecasted operating data from Step 2 to calculate the required investor-
supplied capital, found as total assets – (accounts payable + accruals).
4. Multiply the investor-supplied capital found in Step 3 by the inputs for the target
capital structure percentages shown in Table 12-4 to forecast the amounts of notes
payable, long-term bonds, preferred stock, and total common equity. This completes
the balance sheet except for dividing the forecasted total common equity into its two
components, common stock and retained earnings.
5. Calculate operating costs as a percent of forecasted sales and depreciation as a
percent of forecasted net plant & equipment. Subtract these costs from sales to find
EBIT.
6. It is assumed that new debt will be borrowed throughout the year, so interest
expenses will be based on the average amount of debt outstanding during the year.
The average amount of debt outstanding during the year is equal to the average of
the beginning-of-year debt and the end-of-year debt forecast in Step 4. Multiply this
average by the interest rate to determine the forecasted interest expense. Notice that
the income statement shows separate lines for the interest expense due to notes
payable and long-term bonds-- we find that we make fewer errors if we have more
lines in a spreadsheet but less complicated formulas in each cell.
7. Subtract interest expense from EBIT to find taxable income (EBT). Calculate taxes
and subtract them from EBT to get net income before preferred dividends.
8. Forecast preferred dividends in a similar manner as the forecasted interest
expense in Step 6: (1) find the average amount of preferred stock outstanding during
the year and (2) multiply it by the preferred stock's dividend rate.
9. Subtract the forecasted preferred dividends from the net income before preferred
dividends to find the net income available to common stockholders.
10. Multiply the net income by the target payout ratio to forecast the total amount of
common dividends paid. If net income is negative, set common dividends to zero.
10. Multiply the net income by the target payout ratio to forecast the total amount of
common dividends paid. If net income is negative, set common dividends to zero.
11. Subtract common dividends from net income to find the addition to retained
earnings.
12. The forecasted total retained earnings shown on the balance sheet is equal to the
prior year's retained earnings plus the addition to retained earnings calculated in
Step 11.
13. The forecasted total common stock must be equal to the difference between
forecasted total common equity from Step 4 and the forecasted retained earnings
balance from Step 12: Common stock = Total common equity − retained earnings.
14. The required additional dollars of common stock issued or repurchased are
equal to the change in common stock: Additional dollars of stock issued or
repurchased = Common stock in 2011 − common stock in 2010. If the amount is
negative, it means that stock will be repurchased rather than issued.
15. The number of new shares either issued or repurchased is equal to the additional
dollars of common stock found in Step 14 divided by the price per share. Because
the stock is assumed to be sold at the beginning of 2011, the assumed stock price is
$23, the price at the end of 2010. We calculate this as: Change in shares = (Additional
dollars of common stock) / (Stock price at the beginning of the year).
16. The number of shares outstanding at the end of the year is equal the number of
outstanding shares at the beginning of the year plus the change in the number of
shares calculated in Step 15.
The numbers in Figure 12-6, Column I, change when scenarios are changed. We ran a scenario, immediately
copied as values the results from Column I to the column corresponding to the scenario. (We could have used
the Summary feature in Scenario Manager but chose not to use it because we didn't want to add an another
worksheet to the workbook.) The data in Figure 12-6 are used to appraise the company's situation and to plan for
the next year.
Figure 12-6. Summary of Key Results for Forecasted Scenarios (Millions Except Percentages and Per Share Data)
2010 Actual 2011 Forecasts
Industry MicroDrive
Key Results Final Status Quo Best
Net operating profit after taxes NA $170 $210 $187 $271
Net operating working capital NA $800 $701 $880 $569
Total operating capital NA $1,800 $1,801 $1,980 $1,669
FCF = NOPAT – Δ op. capital NA -$175 $209 $7 $402
Return on invested capital 11.0% 9.5% 11.7% 9.5% 16.2%
EPS NA $2.27 $3.11 $2.43 $5.07
DPS NA $1.15 $1.24 $1.23 $2.57
Return on equity (ROE) 15.0% 12.7% 15.7% 12.6% 26.0%
Return on assets (ROA) 9.0% 5.7% 7.8% 5.7% 12.0%
Inventory turnover 9.0 4.9 6.3 4.9 9.0
Days sales outstanding 36.0 45.6 40.2 45.6 35.8
Total liabilities / TA 46.0% 53.2% 47.7% 53.2% 51.8%
Times interest earned 6.0 3.2 4.2 3.2 5.3
Shares outstanding NA 50.00 50.06 51.22 42.54
Payout ratio 40.0% 50.7% 40.0% 50.7% 50.7%
AFNa NA $224 -$92 $119 -$237
a
Unlike the AFN equation, the approach used to forecast the statements in these scenarios determines the total
amount of financing (the sum of notes payable, bonds, preferred stock, and common equity) rather than the
additional financing needed in comparison to the financing used in the most recent year. Therefore, the
additional financing needed is calculated directly from the changes in notes payable, bonds, preferred stock,
and common stock.
a
Unlike the AFN equation, the approach used to forecast the statements in these scenarios determines the total
amount of financing (the sum of notes payable, bonds, preferred stock, and common equity) rather than the
additional financing needed in comparison to the financing used in the most recent year. Therefore, the
additional financing needed is calculated directly from the changes in notes payable, bonds, preferred stock,
and common stock.
Figure 12-7 Statement of Cash Flows (Millions of Dollars)

Scenario Shown: Final Actual Forecast
2010 2011
Operating Activities
Net Income before preferred dividends $117.5 $160.0
Noncash adjustments
Depreciation and amortization 100.0 112.2
Due to changes in working capital
Increase(-)/Decrease (+) in accounts receivable -60.0 12.0
Increase(-)/Decrease (+) in inventories -200.0 87.0
Increase(-)/Decrease (+) in payables 30.0 6.0
Increase(-)/Decrease (+) in accruals 10.0 -8.0
Net cash provided by operating activities -$2.5 $369.2
Long-term investing activities

Cash used to acquire fixed assets -$230.0 -$212.2
Sale of short-term investments 65.0 0.0
Net cash provided by financing activities -$165.0 -$212.2
Financing Activities
Increase(+)/Decrease(-) in notes payable $50.0 -$19.9
Increase(+)/Decrease(-) in bonds 174.0 -87.5
Preferred stock issue (+) / repurchase(-) 0.0 14.0
Payment of common and preferred dividends -61.5 -66.7
Common stock issue (+) / repurchase (-) 0.0 1.4
Net cash provided by financing activities $162.5 -$158.8
Net cash flow -$5.0 -$1.7

Cash at beginning of the year 15.0 10.0
Cash at end of the year $10.0 $8.3
calculate ratios and
ion on the most recent
where the company
ould happen if the
cast that was
luding additional data
are Data)
2010
$10.0
0.0
375.0
615.0
$1,000.0
1,000.0
$2,000.0
$60.0
140.0
110.0
$310.0
754.0
$1,064.0
40.0
130.0
766.0
$896.0
$2,000.0
$1,800.0
d total common equity.

nts payable and
ns and are not sources
d in a specific
ble following our model
managers from all
anding of financial
d MicroDrive are shown
uo forecast. The the
capital structure. Data
ll of the firm's senior
coded. Note that the
show" scenarios using
E, which we designate
e 4 items must total to

rio.
his one new number

r each variable.
model is built with a

2-5. The sequencing of
n essence takes data

g model in Figure 12-5,
n how to use the Using Scenarios. See to right for making scena
If no scenarios had been created for the works
2007 click Data>What-If Analysis>Scenario Man
d Per Share Data) then click "Add" to create the first scenario. W
scenario, etc. We ended up with four scenarios
2011 box below.
Values for Scenarios Using Excel 03:
Worst Final
-10.00% 10.00%
92.21% 86.00%
10.00% 10.20%
0.33% 0.25%
15.00% 11.00%
25.50% 16.00%
40.00% 33.33%
2.00% 2.00%
4.67% 4.00%
40.00% 40.00%
6.11% 5.00%
41.89% 37.00%
2.22% 3.00%
49.78% 55.00%
11.00% 8.50%
This box shows the names of our 4 scenarios,
11.50% 10.50%
specified for the highlighted scenario, Close ta
10.00% 9.50% Delete gets rid of the scenario, Edit permits us
50.67% 40.00% effects, and Summary gives us a summary of a
2011 2011 Merge.
Worst Final Using Excel 03:
-$141.03 $208.61
3.07% 11.65%
-$0.10 $3.11
-0.55% 15.70%
54.62 50.06
$0.00 $1.24
tors" down from

column to make the
e with each scenario,
ous current liabilities
asted is a bit
ction.
Now click Tools>Scenarios to open Scenario M

click "Show." The model will immediately recal
change anything. Then do the same thing with
Manager.
enario, immediately
(We could have used
to add an another
situation and to plan for
ges and Per Share Data)

sts Scenario now
in model
Worst Final
$61 $210
$922 $701
$2,002 $1,801
-$141 $209
3.1% 11.7%
-$0.10 $3.11
$0.00 $1.24
-0.5% 15.7%
-0.2% 7.8%
3.9 6.3
54.8 40.2
52.3% 47.7%
1.0 4.2
54.62 50.06
0.0% 40.0%
$208 -$92
s determines the total

ty) rather than the
Therefore, the
ds, preferred stock,
rios. See to right for making scenarios
os had been created for the worksheet (tab), then if you click Tools > Scenarios, the following dialog box would open. (For Excel
ata>What-If Analysis>Scenario Manager.) This is Excel's Scenario Manager, the "main menu" for work with scenarios. You would
dd" to create the first scenario. When we started, we clicked Add, put in a scenario, clicked add again and put in a second
. We ended up with four scenarios. Therefore, when you actually click on Tools>Scenarios on this tab, you will get the second
Using Excel 07:

ws the names of our 4 scenarios, and it also shows all the things we can now do. Show changes all the inputs to those
the highlighted scenario, Close takes us out of Scenario Manager, Add opens a new dialog box for use in adding a scenario,
rid of the scenario, Edit permits us to change the inputs used in the scenario, Merge merges two scenarios to see their joint
Summary gives us a summary of all the scenarios' results. In this worksheet we used all of these features except Delete and
Using Excel 07:
ols>Scenarios to open Scenario Manager. You should see a "live" version of the box shown above. Highlight "Best" and then
" The model will immediately recalculate everything, using the Best case inputs. Scroll around to check this out, but don't
hing. Then do the same thing with Status Quo and Worst, and end up back on Final. Then click "Close" to exit Scenario
Making Scenarios
alog box would open. (For Excel
To make a scenario, open Scenario Manager and click "Add," which will bring up an "Edit
r work with scenarios. You would
scenario, then go to the "Changing cells" box. If you are starting with no previous scenar
d again and put in a second
opened Scenario manager. If the worksheet already has scenarios, it will show the chang
this tab, you will get the second
usually the new scenario simply inserts new values for the variables.
ges all the inputs to those
for use in adding a scenario,
o scenarios to see their joint
se features except Delete and
When you click OK, you will then get the "Scenario Values" box, where you tell Excel wha
starts you with the values used for the scenario that was in Column E when you began. N
changes that are appropriate for your new scenario. When you have completed the chang
Scenario Manager, also shown below and a little to the right.
Now you can click "Show" to see the results of your new scenario or
do any of the other things listed in Scenario Manager. We recommend
ove. Highlight "Best" and then that you end this exercise by clicking on Final, Show, and Close. We
to check this out, but don't deleted the Example scenario to let you start with a clean slate.
"Close" to exit Scenario
" which will bring up an "Edit" box like the following. First name the new
ting with no previous scenarios, it will show the cell you were in when you
narios, it will show the changing cells (cells with the input variables), because
ariables.
box, where you tell Excel what your input values are for the new scenario. Excel
Column E when you began. Now you can scroll down the list and make the
ou have completed the changes, click OK, which will take you back to the revised
Tab 3
FINANCIAL STATEMENT FORECASTING-- Continued (Section 12.4)
Alternative Financial Policies and Multi-Year Forecasts
On this tab we forecast MicroDrive's financial statements for the upcoming year assuming a
different financial policy than the one in Tab 2. In this particular example, the financial policy plan
is to (1) let the DPS grow at a specified rate, (2) not change the level of existing notes payable, and
(3) not issue or repurchase bonds, preferred stock, or common stock.
On Tab 4 we explain and incorporate financing feedback effects. On Tab 5 we extend the 1-year
projections under the alternative financial policy to multi-year projections.
We begin by repeating MicroDrive's most recent financial statements for convenience, including
additional data concerning interest rates and investor-supplied capital.
INCOME STATEMENTS 2009 2010 BALANCE SHEETS 2009 2010

Assets
Sales $2,850 $3,000 Cash $15 $10
Costs (excl. depr.) $2,497 $2,616 ST Investments $65 $0
Depreciation $90 $100 Accounts receivabl $315 $375
Total op. $2,587 $2,716 Inventories $415 $615
EBIT $263 $284 Total current asset $810 $1,000
Interest exp. $60 $88 Net plant and equi $870 $1,000
EBT $203 $196 Total assets $1,680 $2,000
Taxes (40%) $81 $78
Inc. before pref. div. $122 $117 Liabilities and equity
Preferred div. $4 $4 Accounts payable $30 $60
Net income (NI) $118 $113 Accruals $130 $140
Notes payable $60 $110
Dividends to common (DIVs) $53.0 $57.5 Total current liabs $220 $310
Add. to retained earnings: Long-term bonds $580 $754
(NI – DIVs) $64.8 $56.0 Total liabilities $800 $1,064
Shares of common stock 50 50 Preferred stock $40 $40
Earnings per share (EPS) $2.36 $2.27 Common stock $130 $130
Dividends per share (DPS) $1.06 $1.15 Retained earnings $710 $766
Price per share (P) $26.00 $23.00 Total common equi $840 $896
2010 interest rate on notes payable: 9% Total liabs. & equit $1,680 $2,000
2010 interest rate on long-term bonds: 11%
We examine 2 scenarios. The first is similar to the Status Quo scenario from Tab 2. The difference
is that here we apply the financial policy described above instead of the one used in Tab 2.
Because there is no change in operating performance, we call this the "Maintain" scenario.
The second scenario is similar to the Final scenario from Tab 2. The difference is that here we
apply the financial policy described above instead of the one used in Tab 2. Because there are
significant improvements in operating performance, we call this the "Improve" scenario.
Input Data for the Forecast (Millions Except Percentages and Per Share Data)
2010 2011
Inputs Actual Values Forecasted Inputs for Scenarios
Active
Operating Ratios: Maintain Maintain Improve
Sales growth rate 10.00% 5.26% 10.00% 10.00% 10.00%
Op costs / Sales 83.00% 87.21% 87.21% 87.21% 86.00%
Depr. / Net plant 10.20% 10.00% 10.00% 10.00% 10.20%
Cash / Sales 0.25% 0.33% 0.33% 0.33% 0.25%
Acc. rec. / Sales 9.80% 12.50% 12.50% 12.50% 11.00%
Inventory / Sales 11.11% 20.50% 20.50% 20.50% 16.00%
Net plant / Sales 33.33% 33.33% 33.33% 33.33% 33.33%
Acc. pay. / Sales 2.00% 2.00% 2.00% 2.00% 2.00%
Accruals / Sales 4.00% 4.67% 4.67% 4.67% 4.00%
Tax rate: 40.00% 40.00% 40.00% 40.00% 40.00%
Financing Data:
NP int. rate 8.00% 9.00% 9.00% 9.00% 8.50%
Bond int. rate 10.00% 11.00% 11.00% 11.00% 10.50%
Line of credit int. rate 11.50% 11.50% 11.50% 11.00%
Pref. stk. div. rate 9.00% 10.00% 10.00% 10.00% 9.50%
Regular DPS growth rate 8.00% 8.49% 0.00% 0.00% 8.00%
2010 2011 2011 2011
Key Results MicroDrive Maintain Maintain Improve
Free cash flow (FCF) -$174.7 $7.4 $7.4 $208.6
Return on inv. capital (ROIC) 9.46% 9.46% 9.46% 11.65%
Earnings per share (EPS) $2.27 $2.55 $2.55 $3.06
Return on equity (ROE) 12.67% 13.20% 13.20% 17.05%
# Shares, end-of-year 50.00 50.00 50.00 50.00
Dividends per share (DPS) $1.15 $1.15 $1.15 $1.24
The forecasting model under the alternative financial policies is shown below.
Figure 12-8 (for Maintain Scenario) or Figure 12-9 (for Improve Scenario).
One-Year Forecasted Financial Statements Under an Alternative Financial Policy (Millions Except
Per Share Data)
Scenario Shown: Maintain Planned With

Actual Factor Basis for (w/o AFN) AFN AFN
Balance Sheet 2010 or Rate 2011 Forecast 2011 Adjust. 2011
Assets
Cash $10.0 0.33% × 2011 Sales $11.0 $11.0
Acc. rec. 375.0 12.50% × 2011 Sales 412.5 412.5
Inventories 615.0 20.50% × 2011 Sales 676.5 676.5
Total CA $1,000.0 $1,100.0 $1,100.0
Net plant & equip. 1,000.0 33.33% × 2011 Sales 1,100.0 1,100.0
Total assets (TA) $2,000.0 $2,200.0 $2,200.0
Liab. & equity
Accounts payable $60.0 2.00% × 2011 Sales $66.0 $66.0
Accruals 140.0 4.67% × 2011 Sales 154.1 154.1
Notes pay. (NP) 110.0 Carry over 110.0 110.0
Line of credit (LOC)a Blank $109.8 109.8
Total CL $310.0 $330.1 $440.0
LT bonds 754.0 Carry over 754.0 754.0
Tot. liab. $1,064.0 $1,084.1 $1,194.0
Pref. stock 40.0 Carry over 40.0 40.0
Com. stock 130.0 Carry over 130.0 130.0
Ret. earnings 766.0 2010 RE + DRE 836.0 836.0
Total CE $896.0 $966.0 $966.0
Total L&E $2,000.0 $2,090.1 $2,200.0
AFNb = TA − Planned total liabilities & equity $109.8

Line of creditc = AFN if AFN > 0 (additional financing needed) $109.8
Special dividendd = −AFN if AFN ≤ 0 (surplus funds available) $0.0
Scenario Shown: Maintain Planned With

Income Statement 2010 or Rate 2011 Forecast 2011 Adjust. 2011
Sales $3,000.0 1.10 × 2010 Sales $3,300.0 $3,300.0
Costs (excl. depr.) 2,616.2 87.21% × 2011 Sales 2,877.9 2,877.9
Depreciation 100.0 10.00% × 2011 Net plant 110.0 110.0
Total op. costs $2,716.2 $2,987.9 $2,987.9
EBIT $283.8 $312.1 $312.1
Int. on planned NP 9.9 9.00% × Avg notes 9.9 9.9
Int. on planned bonds 78.1 11.00% × Avg bonds 82.9 82.9
Int. on LOCe 9.00% Blank $0.0 0.0
EBT $195.8 $219.2 $219.2
Taxes (T = 40%) 78.3 40.00% × 2011 EBT 87.7 87.7
NI before pref. div. $117.5 $131.5 $131.5
Pref. div. 4.0 10.00% × Avg preferred 4.0 4.0
NI to common $113.5 $127.5 $127.5
# of shares (n) 50.0 Carry over 50.0 50.0

Regular DPS $1.15 1.00 × 2010 DPS $1.15 $1.15
Regular dividends $57.5 n × 2011 DPS $57.5 $57.5
Special dividendf 0.0 0.0 $0.0 0.0
Add. To RE (DRE) $56.0 NI – Dividends $70.0 $70.0
Notes:
a
If additional financing is needed, a line of credit will be used on a temporary basis until the board
of directors meets and decides upon a permanent financing plan.
b
The AFN in forecasted financial statements is equal to the required assets minus the planned
liabilities and equity: AFN = TA − Accts. pay. − Accruals − Planned NP − Planned LT bonds −
Planned preferred stock − Planned common stock − Previous retained earnings − Planned
additions to RE. Thus, AFN is not exactly equal to the net change in external financing, but instead
is equal to the amount of additional financing needed in excess of any planned financing resulting
from the company's choice of financial policies regarding capital structure and dividend payouts.
In this particular example, the financial policy plan is to (1) let the DPS grow at a specified rate, (2)
b
additions to RE. Thus, AFN is not exactly equal to the net change in external financing, but instead
is equal to the amount of additional financing needed in excess of any planned financing resulting
from the company's choice of financial policies regarding capital structure and dividend payouts.
In this particular example, the financial policy plan is to (1) let the DPS grow at a specified rate, (2)
not change the level of existing notes payable, and (3) not issue or repurchase bonds, preferred
stock, or common stock.
c
If AFN > 0, then additional financing is needed. This additional financing will be raised by
borrowing from a line of credit on a temporary basis.
d
If AFN ≤ 0, then no additional financing is needed. Instead, surplus funds are available and will be
used to pay a special dividend.
e
This forecast assumes that any borrowing from the line of credit will be done at the end of the
year. Thus, there will be no additional interest expense due to the line of credit.
f
Any surplus funds will be paid out as a special dividend.
The numbers below in Column G change when scenarios are changed. We ran a scenario,
immediately copied as values the results from Column G to the column corresponding to the
scenario. (We could have used the Summary feature in Scenario Manager but chose not to use it
because we didn't want to add an another worksheet to the workbook.)
Summary of Key Results for Forecasted Scenarios (Millions Except Percentages and Per Share Data)
Scenario
2010 Actual 2011 Forecasts now in
Industry MicroDrive model
Key Results Maintain Improve Maintain
Net operating profit after taxes NA $170 $187 $210 $187
Net operating working capital NA $800 $880 $701 $880
Total operating capital NA $1,800 $1,980 $1,801 $1,980
FCF = NOPAT – Δ op. capital NA -$175 $7 $209 $7
Return on invested capital 11.0% 9.5% 9.5% 11.7% 9.5%
EPS NA $2.27 $2.55 $3.06 $2.55
DPS NA $1.15 $1.15 $1.24 $1.15
Return on equity (ROE) 15.0% 12.7% 13.2% 17.0% 13.2%
Return on assets (ROA) 9.0% 5.7% 5.8% 7.7% 5.8%
Inventory turnover 9.0 4.9 4.9 6.3 4.9
Days sales outstanding 36.0 45.6 45.6 40.2 45.6
Total liabilities / TA 46.0% 53.2% 54.3% 53.1% 54.3%
Times interest earned 6.0 3.2 3.4 4.0 3.4
Shares outstanding NA 50.00 50.00 50.00 50.00
Payout ratio 40.0% 50.7% 45.1% 40.6% 45.1%
AFN NA $224 $110 -$90 $110
Figure 12-7 Statement of Cash Flows (Millions of Dollars)

Scenario Shown: Maintain Actual Forecast
2010 2011
Net Income before preferred dividends $117.5 $131.5
Noncash adjustments
Depreciation and amortization 100.0 110.0
Increase(-)/Decrease (+) in accounts receivable -60.0 -37.5
Increase(-)/Decrease (+) in inventories -200.0 -61.5
Increase(-)/Decrease (+) in payables 30.0 6.0
Increase(-)/Decrease (+) in accruals 10.0 14.1
Net cash provided by operating activities -$2.5 $162.6

Cash used to acquire fixed assets -$230.0 -$210.0
Sale of short-term investments 65.0 0.0
Net cash provided by financing activities -$165.0 -$210.0
Increase(+)/Decrease(-) in notes payable $50.0 $109.8
Increase(+)/Decrease(-) in bonds 174.0 0.0
Preferred stock issue (+) / repurchase(-) 0.0 0.0
Payment of common and preferred dividends -61.5 -61.5
Common stock issue (+) / repurchase (-) 0.0 0.0
Net cash provided by financing activities $162.5 $48.3
Net cash flow -$5.0 $1.0

Cash at beginning of the year 15.0 10.0
Cash at end of the year $10.0 $11.0
4/11/2010
er Share Data)
Tab 4
On this tab we forecast MicroDrive's financial statements for the upcoming year assuming the
same financial policies used in Tab 3. In this particular example, the financial policy plan is to (1)
let the DPS grow at a specified rate, (2) not change the level of existing notes payable, and (3) not
issue or repurchase bonds, preferred stock, or common stock. We also explain and incorporate
financing feedback effects.
On Tab 5 we extend these 1-year projections under the alternative financial policy to multi-year
projections.
INCOME STATEMENTS 2009 2010 BALANCE SHEET 2009 2010

Assets
Sales $2,850 $3,000 Cash $15 $10
Depreciation $90 $100 Accounts receivab $315 $375
EBT $203 $196 Total assets $1,680 $2,000
Taxes (40%) $81 $78
We examine the two scenarios from Tab 3.
2010 2011
Active
Operating Ratios: Improve Maintain Improve
Op costs / Sales 83.00% 87.21% 86.00% 87.21% 86.00%
Depr. / Net plant 10.20% 10.00% 10.20% 10.00% 10.20%
Cash / Sales 0.25% 0.33% 0.25% 0.33% 0.25%
Acc. rec. / Sales 9.80% 12.50% 11.00% 12.50% 11.00%
Inventory / Sales 11.11% 20.50% 16.00% 20.50% 16.00%
Net plant / Sales 33.33% 33.33% 33.33% 33.33% 33.33%
Acc. pay. / Sales 2.00% 2.00% 2.00% 2.00% 2.00%
Accruals / Sales 4.00% 4.67% 4.00% 4.67% 4.00%
Tax rate: 40.00% 40.00% 40.00% 40.00% 40.00%
Financing Data:
NP int. rate 8.00% 9.00% 8.50% 9.00% 8.50%
Bond int. rate 10.00% 11.00% 10.50% 11.00% 10.50%
Pref. stk. div. rate 9.00% 10.00% 9.50% 10.00% 9.50%
Financing Feedback:
LOC added at portion of yr. 0.5
2010 2011
Key Results MicroDrive Improve
Free cash flow (FCF) -$174.7 $208.6
Return on inv. capital (ROIC) 9.46% 11.65%
Earnings per share (EPS) $2.27 $3.06
Return on equity (ROE) 12.67% 17.05%
# Shares, end-of-year 50.00 50.00
Dividends per share (DPS) $1.15 $1.24
The forecasting model under the alternative financial policies is shown below. To incorporate
financing feedback due to interest on the line of credit, follow these steps.
Step 1: Forecast column F, the column without any AFN.
Step 2: Use the forecast in column F to determine the undadjusted AFN.
Step 3: If the AFN is positive and the line of credit is required, the line of credit is equal to the AFN
divided by the following adjustment factor:
Adjustment factor = 1 − [ (1−f) x r x (1−T) ]
where r is the interest rate on the line of credit and T is the tax rate. The value for f is the fraction
of the year that has elapsed the point in the year when the line of credit is tapped. If the line of
credit is tapped on the first day of the year, then f = 0. If the line is tapped at the end of the year, f
= 1. If the line is tapped smoothly throughout the year, f =0.5.
Step 4: If the AFN is negative, no adjustment is needed in the special dividend.
Step 5: Calculate the interest expense at Year t as:

LOC Interestt = [ f x r x LOCt−1 ] + [(1−f) x r LOCt ]
where LOCt is the line of credit for Year t and LOCt−1 is the line of credit for the previous year.
One-Year Forecasted Financial Statements Under an Alternative Financial Policy and Including
Financing Feedback (Millions Except Per Share Data)
Scenario Shown: Improve Planned With

Balance Sheet 2010 or Rate 2011 Forecast 2011 Adjust. 2011
Assets
Cash $10.0 0.25% × 2011 Sales $8.3 $8.3
Acc. rec. 375.0 11.00% × 2011 Sales 363.0 363.0
Inventories 615.0 16.00% × 2011 Sales 528.0 528.0
Total CA $1,000.0 $899.3 $899.3
Net plant & equip. 1,000.0 33.33% × 2011 Sales 1,100.0 1,100.0
Total assets (TA) $2,000.0 $1,999.2 $1,999.2
Liab. & equity
Accounts payable $60.0 2.00% × 2011 Sales $66.0 $66.0
Accruals 140.0 4.00% × 2011 Sales 132.0 132.0
Notes pay. (NP) 110.0 Carry over 110.0 110.0
Line of credit (LOC)a Blank $0.0 0.0
Total CL $310.0 $308.0 $308.0
LT bonds 754.0 Carry over 754.0 754.0
Tot. liab. $1,064.0 $1,062.0 $1,062.0
Pref. stock 40.0 Carry over 40.0 40.0
Com. stock 130.0 Carry over 130.0 130.0
Ret. earnings 766.0 2010 RE + DRE 856.8 New DRE 767.2
Total CE $896.0 $986.8 $897.2
Total L&E $2,000.0 $2,088.8 $1,999.2
AFN before adj.b = TA − Planned total liabilities & equity -$89.6

LOC added at portion of yr.c 0.5
LOC adj. factord 0.97
Line of credite = AFN if AFN > 0 (additional financing needed) $0.0
Special dividendf = −AFN if AFN ≤ 0 (surplus funds available) $89.6
Scenario Shown: Improve Planned With

Income Statement 2010 or Rate 2011 Forecast 2011 Adjust. 2011
Sales $3,000.0 1.10 × 2010 Sales $3,300.0 $3,300.0
Costs (excl. depr.) 2,616.2 86.00% × 2011 Sales 2,838.0 2,838.0
Depreciation 100.0 10.20% × 2011 Net plant 112.2 112.2
Total op. costs $2,716.2 $2,950.2 $2,950.2
EBIT $283.8 $349.8 $349.8
Int. on planned NP 9.9 8.50% × Avg notes 9.4 9.4
Int. on planned bonds 78.1 10.50% × Avg bonds 79.2 79.2
Int. on LOCg 11.00% Blank $0.0 0.0
EBT $195.8 $261.3 $261.3
Taxes (T = 40%) 78.3 40.00% × 2011 EBT 104.5 104.5
NI before pref. div. $117.5 $156.8 $156.8
Pref. div. 4.0 9.50% × Avg preferred 3.8 3.8
NI to common $113.5 $153.0 $153.0
# of shares (n) 50.0 Carry over 50.0 50.0

Regular DPS $1.15 1.08 × 2010 DPS $1.24 $1.24
Regular dividends $57.5 n × 2011 DPS $62.1 $62.1
Special dividendh 0.0 0.0 $89.6 89.6
Add. To RE (DRE) $56.0 NI – Dividends $90.9 $1.3
Notes:
a
b
The unadjusted AFN in forecasted financial statements is equal to the required assets minus the
planned liabilities and equity: AFN = TA − Accts. pay. − Accruals − Planned NP − Planned LT
bonds − Planned preferred stock − Planned common stock − Previous retained earnings −
Planned additions to RE. Thus, AFN is not exactly equal to the net change in external financing,
but instead is equal to the amount of additional financing needed in excess of any planned
financing resulting from the company's choice of financial policies regarding capital structure
and dividend payouts. In this particular example, the financial policy plan is to (1) let the DPS
grow at a specified rate, (2) not change the level of existing notes payable, and (3) not issue or
repurchase bonds, preferred stock, or common stock.
c
The factor "f" denotes the portion of the year that has elapsed has elapsed since the line of
credit was tapped. If the line of credit is tapped on the first day of the year, then f = 0. If the line is
tapped at the end of the year, f = 1. If the line is tapped smoothly throughout the year, f =0.5.
d
If AFN > 0, then the unadjusted AFN must be divided by the following adjustment factor to
determine the amount of LOC needed when feedback effects are incorporated:
Adjustment factor = 1 − [ (1−f) x r x (1−T) ].
e
If AFN > 0, then additional financing is needed. This additional financing will be raised by
borrowing from a line of credit on a temporary basis. The required LOC is equal to the unadjusted
AFN divided by the adjustment factor to incorporate financing feedback effects.
If AFN ≤ 0, then no additional financing is needed. Instead, surplus funds are available and will be
f
used to pay a special dividend.
g
portion of the year defined by the factor f. Thus, the annual interest expense will be a weighted
average of the LOC balance at the beginning of the year and the balance at the end of the year:
h
The numbers below in Column E change when scenarios are changed.

Summary of Key Results for Forecasted Scenarios (Millions Except Percentages and Per Share Data)
Actual Forecast
2010 2011
Industry MicroDrive Improve
Key Results
Net operating profit after taxes NA $170 $210
Net operating working capital NA $800 $701
Total operating capital NA $1,800 $1,801
FCF = NOPAT – Δ op. capital NA -$175 $209
Return on invested capital 11.0% 9.5% 11.7%
EPS NA $2.27 $3.06
DPS NA $1.15 $1.24
Return on equity (ROE) 15.0% 12.7% 17.0%
Return on assets (ROA) 9.0% 5.7% 7.7%
Inventory turnover 9.0 4.9 6.3
Days sales outstanding 36.0 45.6 40.2
Total liabilities / TA 46.0% 53.2% 53.1%
Times interest earned 6.0 3.2 4.0
Shares outstanding NA 50.00 50.00
Payout ratio 40.0% 50.7% 40.6%
AFN NA $224 -$90
4/11/2010
er Share Data)
Tab 5
On this tab we forecast MicroDrive's financial statements for the upcoming years assuming
financial feedback and the same financial policies used in Tab 3. In this particular example, the
financial policy plan is to (1) let the DPS grow at a specified rate, (2) not change the level of
existing notes payable, and (3) not issue or repurchase bonds, preferred stock, or common stock.
INCOME STATEMENTS 2009 2010 BALANCE SHEET 2009 2010

Assets
Sales $2,850 $3,000 Cash $15 $10
Depreciation $90 $100 Accounts receivab $315 $375
EBT $203 $196 Total assets $1,680 $2,000
Taxes (40%) $81 $78
We examine 2 scenarios. The first is similar to the Status Quo scenario from Tab 2. The difference
is that here we apply the financial policy described above instead of the one used in Tab 2.
Because there is no change in operating performance, we call this the "Maintain" scenario.
significan improvements in operating performance, we call this the "Improve" scenario.
significan improvements in operating performance, we call this the "Improve" scenario.
2010 2011
Active
Operating Ratios: Improve Maintain Improve
Op costs / Sales 83.00% 87.21% 86.00% 87.21% 86.00%
Depr. / Net plant 10.20% 10.00% 10.20% 10.00% 10.20%
Cash / Sales 0.25% 0.33% 0.25% 0.33% 0.25%
Acc. rec. / Sales 9.80% 12.50% 11.00% 12.50% 11.00%
Inventory / Sales 11.11% 20.50% 16.00% 20.50% 16.00%
Net plant / Sales 33.33% 33.33% 33.33% 33.33% 33.33%
Acc. pay. / Sales 2.00% 2.00% 2.00% 2.00% 2.00%
Accruals / Sales 4.00% 4.67% 4.00% 4.67% 4.00%
Tax rate: 40.00% 40.00% 40.00% 40.00% 40.00%
Financing Data:
NP int. rate 8.00% 9.00% 8.50% 9.00% 8.50%
Bond int. rate 10.00% 11.00% 10.50% 11.00% 10.50%
Pref. stk. div. rate 9.00% 10.00% 9.50% 10.00% 9.50%
Financing Feedback:
LOC added at portion of yr. 0.5
2010 2011
Key Results MicroDrive Improve
Free cash flow (FCF) -$174.7 $208.6
Return on inv. capital (ROIC) 9.46% 11.65%
Earnings per share (EPS) $2.27 $3.06
Return on equity (ROE) 12.67% 17.05%
# Shares, end-of-year 50.00 50.00
Dividends per share (DPS) $1.15 $1.24
Inputs
Operating Ratios: 2010 2011 2012 2013 2014 2015

Sales growth rate 5.26% 10.00% 10.00% 10.00% 10.00% 10.00%
Op costs / Sales 87.21% 86.00% 86.00% 86.00% 86.00% 86.00%
Depr. / Net plant 10.00% 10.20% 10.20% 10.20% 10.20% 10.20%
Cash / Sales 0.33% 0.25% 0.25% 0.25% 0.25% 0.25%
Acc. rec. / Sales 12.50% 11.00% 11.00% 11.00% 11.00% 11.00%
Inventory / Sales 20.50% 16.00% 16.00% 16.00% 16.00% 16.00%
Net plant / Sales 33.33% 33.33% 33.33% 33.33% 33.33% 33.33%
Acc. pay. / Sales 2.00% 2.00% 2.00% 2.00% 2.00% 2.00%
Accruals / Sales 4.67% 4.00% 4.00% 4.00% 4.00% 4.00%
Tax rate: 40.00% 40.00% 40.00% 40.00% 40.00% 40.00%
Financing Data: 0.000% 0.000% 0.00% 0.00% 0.00% 0.00%
NP int. rate 9.00% 8.50% 8.50% 8.50% 8.50% 8.50%
Bond int. rate 11.00% 10.50% 10.50% 10.50% 10.50% 10.50%
Line of credit rate 11.00% 11.00% 11.00% 11.00% 11.00%
Pref. stk. div. rate 10.00% 9.50% 9.50% 9.50% 9.50% 9.50%
Regular DPS growth rat 8.49% 8.00% 8.00% 8.00% 8.00% 8.00%
Financing Feedback:
LOC added at portion of yr. 0.5 0.5 0.5 0.5 0.5
Scenario Shown: Improve

Actual Forecast Forecast Forecast Forecast Forecast
Balance Sheet 2010 2011 2012 2013 2014 2015
Assets
Cash $10.0 $8.3 $9.1 $10.0 $11.0 $12.1
Acc. rec. 375.0 363.0 399.3 439.2 483.2 531.5
Inventories 615.0 528.0 580.8 638.9 702.8 773.0
Total CA $1,000.0 $899.3 $989.2 $1,088.1 $1,196.9 $1,316.6
Net plant & equip. 1,000.0 1,100.0 1,210.0 1,331.0 1,464.1 1,610.5
Total assets (TA) $2,000.0 $1,999.2 $2,199.2 $2,419.1 $2,661.0 $2,927.1
Liab. & equity
Accounts payable $60.0 $66.0 $72.6 $79.9 $87.8 $96.6
Accruals 140.0 132.0 145.2 159.7 175.7 193.3
Notes pay. (NP) 110.0 110.0 110.0 110.0 110.0 110.0
LOCa 0.0 75.7 156.9 243.9 336.9
Total CL $310.0 $308.0 $403.5 $506.5 $617.4 $736.8
LT bonds 754.0 754.0 754.0 754.0 754.0 754.0
Tot. liab. $1,064.0 $1,062.0 $1,157.5 $1,260.5 $1,371.4 $1,490.8
Pref. stock 40.0 40.0 40.0 40.0 40.0 40.0
Com. stock 130.0 130.0 130.0 130.0 130.0 130.0
Ret. earnings 766.0 767.2 871.6 988.6 1,119.6 1,266.3
Total CE $896.0 $897.2 $1,001.6 $1,118.6 $1,249.6 $1,396.3
Total L&E $2,000.0 $1,999.2 $2,199.2 $2,419.1 $2,661.0 $2,927.1
Balance check: TA-TL&Eq $0.0 $0.0 $0.0 $0.0 $0.0
Scenario Shown: Improve

Actual Forecast Forecast Forecast Forecast Forecast
Income Statement 2010 2011 2012 2013 2014 2015
Sales $3,000.0 $3,300.0 $3,630.0 $3,993.0 $4,392.3 $4,831.5
Costs (excl. depr.) 2,616.2 2,838.0 3,121.8 3,434.0 3,777.4 4,155.1
Depreciation 100.0 112.2 123.4 135.8 149.3 164.3
Total op. costs $2,716.2 $2,950.2 $3,245.2 $3,569.7 $3,926.7 $4,319.4
EBIT $283.8 $349.8 $384.8 $423.3 $465.6 $512.1
Int. on planned NP 9.9 9.4 9.4 9.4 9.4 9.4
Int. on planned bonds 78.1 79.2 79.2 79.2 79.2 79.2
Int. on LOCb 0.0 4.2 12.8 22.0 31.9
EBT $195.8 $261.3 $292.1 $321.9 $355.0 $391.7
Taxes (T = 40%) 78.3 104.5 116.8 128.8 142.0 156.7
NI before pref. div. $117.5 $156.8 $175.3 $193.2 $213.0 $235.0
Pref. div. 4.0 3.8 3.8 3.8 3.8 3.8
NI to common $113.5 $153.0 $171.5 $189.4 $209.2 $231.2
# of shares (n) 50.0 50.0 50.0 50.0 50.0 50.0

Regular DPS $1.15 $1.24 $1.34 $1.45 $1.56 $1.69
Regular dividends $57.5 $62.1 $67.1 $72.4 $78.2 $84.5
Special dividendsc 0.0 89.6 0.0 0.0 0.0 0.0
Add. To RE (DRE) $56.0 $1.3 $104.4 $116.9 $131.0 $146.7
The steps below in blue are to calculate the unadjusted AFN. The basic idea is to
calculate what assets, liabilities, and equity (including the addition to retained
earnings) would be if there were no line of credit or special dividends in the year being
forecasted.
TA $1,999.2 $2,199.2 $2,419.1 $2,661.0 $2,927.1

− Planned liab. & equity $1,232.0 $1,251.8 $1,273.6 $1,297.5 $1,323.9
− Previous RE $766.0 $767.2 $871.6 $988.6 $1,119.6
+ Preferred and reg common div $65.9 $70.9 $76.2 $82.0 $88.3
− (EBIT-IntNP-IntBonds)(1-T) $156.8 $177.8 $200.8 $226.2 $254.2
-$89.6 $73.2 $149.3 $230.7 $317.8
+ f x r x (1-T) x LOCt−1 $0.0 $0.0 $2.5 $5.2 $8.0
AFN before adj.d -$89.6 $73.2 $151.8 $235.9 $325.8
LOC adj. factore 0.97 0.97 0.97 0.97 0.97
LOCf $0.0 $75.7 $156.9 $243.9 $336.9
Special dividendg $89.6 $0.0 $0.0 $0.0 $0.0
Notes:
a
b
portion of the year defined by the factor f. Thus, the annual interest expense will be a weighted
average of the LOC balance at the beginning of the year and the balance at the end of the year:

c
d
additions to RE. Thus, AFN is not exactly equal to the net change in external financing, but
instead is equal to the amount of additional financing needed in excess of any planned financing
resulting from the company's choice of financial policies regarding capital structure and dividend
payouts. In this particular example, the financial policy plan is to (1) let the DPS grow at a
specified rate, (2) not change the level of existing notes payable, and (3) not issue or repurchase
bonds, preferred stock, or common stock.
e
If AFN > 0, then the unadjusted AFN must be divided by this adjustment factorAdjustment factor:
1 − [ (1−f) x r x (1−T) ].
If AFN > 0, then the unadjusted AFN must be divided by the following adjustment factor to
f
determine the amount of LOC needed when feedback effects are incorporated:
Adjustment factor = 1 − [ (1−f) x r x (1−T) ].
g
The numbers below in Column G change when scenarios are changed. We ran a scenario,
immediately copied as values the results from Column G to the column corresponding to the
scenario. (We could have used the Summary feature in Scenario Manager but chose not to use it
because we didn't want to add an another worksheet to the workbook.)
Figure 12-10: Summary of Forecasted Key Results for the “Improve” Scenario (Millions Except Per Share Data)
Actual Forecast Forecast Forecast Forecast
2010 2011 2012 2013 2014
Industry MicroDrive Improve Improve Improve Improve
Key Results
Net operating profit after taxes NA $170 $210 $231 $254 $279
Net operating working capital NA $800 $701 $771 $849 $933
Total operating capital NA $1,800 $1,801 $1,981 $2,180 $2,397
FCF = NOPAT – Δ op capital NA -$175 $209 $51 $56 $61
Return on invested capital 11.0% 9.5% 11.7% 11.7% 11.7% 11.7%
EPS NA $2.27 $3.06 $3.43 $3.79 $4.18
DPS NA $1.15 $1.24 $1.34 $1.45 $1.56
Return on equity (ROE) 15.0% 12.7% 17.0% 17.1% 16.9% 16.7%
Return on assets (ROA) 9.0% 5.7% 7.7% 7.8% 7.8% 7.9%
Inventory turnover 9.0 4.9 6.3 6.3 6.3 6.3
Days sales outstanding 36.0 45.6 40.2 40.2 40.2 40.2
Total liabilities / TA 46.0% 53.2% 53.1% 52.6% 52.1% 51.5%
Times interest earned 6.0 3.2 4.0 4.3 4.8 5.3
Shares outstanding NA 50.00 50.00 50.00 50.00 50.00
Payout ratio 40.0% 50.7% 40.6% 39.1% 38.3% 37.4%
AFN NA $224 -$90 $76 $157 $244
Statement of Cash Flows (Millions of Dollars)

Scenario Shown: Improve Actual Forecast Forecast Forecast Forecast
2010 2011 2012 2013 2014
Net Income before preferred dividends $117.5 $156.8 $175.3 $193.2 $213.0
Noncash adjustments
Depreciation and amortization 100.0 112.2 123.4 135.8 149.3
Increase(-)/Decrease (+) in accounts receiv -60.0 12.0 -36.3 -39.9 -43.9
Increase(-)/Decrease (+) in inventories -200.0 87.0 -52.8 -58.1 -63.9
Increase(-)/Decrease (+) in payables 30.0 6.0 6.6 7.3 8.0
Increase(-)/Decrease (+) in accruals 10.0 -8.0 13.2 14.5 16.0
Net cash provided by operating activities -$2.5 $366.0 $229.4 $252.7 $278.5

Cash used to acquire fixed assets -$230.0 -$212.2 -$233.4 -$256.8 -$282.4
Sale of short-term investments 65.0 0.0 1.0 2.0 3.0
Net cash provided by financing activities -$165.0 -$212.2 -$232.4 -$254.8 -$279.4
Increase(+)/Decrease(-) in notes payable $50.0 $0.0 $75.7 $81.2 $87.0
Increase(+)/Decrease(-) in bonds 174.0 0.0 0.0 0.0 0.0
Preferred stock issue (+) / repurchase(-) 0.0 0.0 0.0 0.0 0.0
Payment of common and preferred dividen -61.5 -155.5 -70.9 -76.2 -82.0
Common stock issue (+) / repurchase (-) 0.0 0.0 0.0 0.0 0.0
Net cash provided by financing activities $162.5 -$155.5 $4.9 $5.0 $4.9
Net cash flow -$5.0 -$1.7 $1.8 $2.9 $4.0

Cash at beginning of the year 15.0 10.0 8.3 9.1 10.0
Cash at end of the year $10.0 $8.3 $10.1 $12.0 $14.0
4/11/2010
Except Per Share Data)
Forecast
2015
Improve
$307
$1,027
$2,637
$68
11.7%
$4.62
$1.69
16.6%
7.9%
6.3
40.2
50.9%
5.8
50.00
36.5%
$337
Forecast
2015
$235.0
164.3
-48.3
-70.3
8.8
17.6
$307.0
-$310.7
4.0
-$306.7
$93.0
0.0
0.0
-88.3
0.0
$4.7
$5.1
11.0
$16.1
SECTION 12.3
SOLUTIONS TO SELF-TEST
Suppose MicroDrive's growth rate in sales is forecast as 15% rather than 10%. If all ratios stay the same, what is
the AFN?
Sales growth rate 15%

S0 $3,000 million
A0*/ S0 66.666%
L0*/ S0 6.667%
Profit margin (M) 3.783%
Payout ratio 50.670%
Δ Sales $450.00 million

S1 $3,450.00 million
AFN $205.62 million

the same, what is

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Tab 1

Chapter 12. Tool Kit for Financial Planning and

SALES FORECAST (Section 12.2)

Figure 12-1. MicroDrive Inc.: Historical Sales (Millions of Dollars)

Arithmetic average annual growth rate = 10.3%

Projected sales for 2011 = 3,243 (Using the TREND function)

(1+g) rate using LOGEST = 1.091035801

Additional Funds Needed (AFN) (Section 12.3)

INCOME STATEMENTS 2009 2010 BALANCE SHEETS 2009

Figure 12-3. Additional Funds Needed (AFN), in millions

Part II. Additional Funds Needed (AFN) to Support Growth

PM(1 – POR)(S0) $55.98

EXCESS CAPACITY ADJUSTMENTS

e to the complicated. The simplest

o 80, then increase by 25% to 100. The

and plotting the predicted sales 1

es that are chosen. One way to

their knowledge of the

ars Except Per Share Data)

ted 2011 sales. Year 0 is 2010, which

port its planned growth. However, the

ation as shown on the 3rd row above g,

21% without external financing.

ht cell B152. Then, with Excel 07, on

r to find the required amount of new

at their book value. Sales for the last

ess capacity. Also, assuming FA can

FINANCIAL STATEMENT FORECASTING (Section 12.4)

INCOME STATEMENTS 2009 2010 BALANCE SHEETS 2009

Input Data for the Forecast

Scenario Shown: Final Final

Part 3. Procedures used to complete the financial statements

Figure 12-7 Statement of Cash Flows (Millions of Dollars)

Long-term investing activities

Net cash flow -$5.0 -$1.7

luding additional data

d total common equity.

e 4 items must total to

his one new number

model is built with a

n essence takes data

tors" down from

Now click Tools>Scenarios to open Scenario M

ges and Per Share Data)

s determines the total

Using Excel 07:

Using Excel 07:

FINANCIAL STATEMENT FORECASTING-- Continued (Section 12.4)

Alternative Financial Policies and Multi-Year Forecasts

INCOME STATEMENTS 2009 2010 BALANCE SHEETS 2009 2010

Input Data for the Forecast

Scenario Shown: Maintain Planned With

AFNb = TA − Planned total liabilities & equity $109.8

Scenario Shown: Maintain Planned With

# of shares (n) 50.0 Carry over 50.0 50.0

Figure 12-7 Statement of Cash Flows (Millions of Dollars)

Long-term investing activities

Net cash flow -$5.0 $1.0

FINANCIAL STATEMENT FORECASTING-- Continued (Section 12.4)

Alternative Financial Policies and Multi-Year Forecasts

INCOME STATEMENTS 2009 2010 BALANCE SHEET 2009 2010

Input Data for the Forecast

We examine the two scenarios from Tab 3.