1. From the scenario, cite your forecasting conclusions that support TFC?s decision to expand to the West Coast market. Speculate as to whether or not the agency conflict discussed in the scenario could become a roadblock to your conclusions. Provide a rationale for your response. (Scenario: See FIN534_Week7_Scenario_Script_10-10-13_Final.docx) 2. From the mini case, recommend two (2) desired characteristics of a board of directors. Provide support for your response, citing the ways in which these characteristics usually lead to effective corporate governance. (strayer ch12 mini.xlsx) 3. From the e-Activity, contrast the differences between a stock dividend and a stock split. Imagine that you are a stockholder in a company. Determine whether you would prefer to see the company that you researched declare a 100% stock dividend or declare a 2-for-1 split. Provide support for your answer with one (1) real-world example of your preference. (e-Activity: Use the Internet to research a company that declared a 100% stock dividend or a 2-for-1 split. Be prepared to discuss) 4. From the scenario, examine the dividend rate that TFC is paying in order to determine if the company should receive a rate adjustment. Suggest whether TFC?s dividends should either (1) stay the same; (2) be increased; (3) or go down. Provide a rationale for your response. (FIN534 Week 8 Scenario Script_Final.docx) 3.

FIN534 Week 8 Scenario Script: An Overview of cash dividends; Procedures for Cash Dividends; and The pros and cons of dividends and repurchases Slide Scene/Interaction Narration # Slide 1 Intro Scene Slide 2 Scene 2 Joe in front of TFC with Don End of scene FIN534_8_2_Joe-1: Don, I am glad that I ran into you. I have some great news. Late last night I met with the board of directors and updated them on the expansion project. They really liked all the details and analyses that have gone into this project so far. However, two of the board members are concerned about our emphasis on retaining as much cash as possible. FIN534_8_2_Joe-2: While our projections are showing that in the first expansion year, our cash account will take a significant hit, our fellow board members think that we should still continue to reward our shareholders through dividends. I explained to them that we are planning on a constant ten percent growth rate. While they were pleased with that move, they still want us to revisit our cash dividend distribution policy. They also want us to look at a cash budget for TFC since building a sustainable level of cash is one of our primary financial goals. FIN534_8_2_Joe-3: So, please gather your team to work on this next assignment. I believe that if we provide the information that these board members want, then we will be on our way to expanding out west. Good luck! FIN534_8_2_Don-1: Joe, we are again up to the challenge. I am supposed to meet Linda and the Intern in the conference room now, so I'll fill them in on this assignment. You can always count on us! Slide Scene 3 FIN534_8_3_Don-1: As you know things 3 Don in conference room with Linda Go to next slide move fast around here. I met with Joe a few minutes ago and he has another assignment for us. The board of directors liked what we have done so far but they want more information on our dividend distribution policy and cash budget planning before they will make a decision on the project. FIN534_8_3_Linda-1: it. Don, we are right on Up until now we have been focusing on how TFC will generate cash flow. Now, we are going to look at ways we can use those free cash flows. FIN534_8_3_Linda-2: Our free cash flows can be thought of as the amount of cash flow available to our investors after payment of the required operating expenses and other corporate actions. FIN534_8_3_Linda-3: And in comparison with many companies, our effective ways to use this free cash flow are very similar. We use these cash flows to pay our interest expenses, reduce the principal portion of our debts, pay dividends, and purchase short term marketable securities. Another choice would be to repurchase company stock, but we have never done that. FIN534_8_3_Linda-4: When we use free cash flows to pay down debt, we always need to keep in mind our capital structure. If we would pay down our debt entirely, then we would not be able to take advantage of the interest expense deduction. FIN534_8_3_Linda-5: With purchasing marketable securities, it is a nice risk reducing move on our part in case we need cash immediately. But it still doesn't feel like we are giving something back to our shareholders. That comes from our dividend policy. We have the option of issuing a stock dividend or a cash dividend. At our company, we are about cash, so that is the dividend we issue. Slide 4 Scene 4 Dollar Sign Linda speaking Let us review one of our most recent cash dividend distributions. FIN534_8_4_Linda-1: When we went public, we were not declaring dividends. However, as we generated more free cash flow, we started distributing a dividend as a type of reward for our shareholders. FIN534_8_4_Linda-2: Here are some specifics about our most recent dividend. Typically companies pay dividends on a quarterly basis, but here, as you know, we are anything but normal. We pay dividends on an annual basis. Our most recent dividend was ten dollars a share. But we are projecting that to go up at a constant rate. THE DATES TO SHOW ON THE TABLET. FIN534_8_4_Linda-3: Before actually paying a dividend we had to set a few dates. Earlier this morning I sent you an email that contained some helpful information on the different types of dates. Turn on your tablet and follow along as I go over each of the dates. FIN534_8_4_Linda-4: Declaration Date - this is the date our board of directors met to decide if TFC should pay a dividend and how much. They also decide when the dividend payment would be made to the shareholders and would be eligible to receive it. This is also the date that TFC, for accounting purposes, takes on the liability of paying the dividend. The declaration date is also referred as the announcement date. FIN534_8_4_Linda-5: Holder-of Record Date - This is the determination date of who gets paid. If someone is a shareholder on that date, they will receive the dividend. In other words, this is the date when TFC needs to know the rightful owner of a share of stock in regard to receiving a dividend. Keep in mind that this may not be the actual owner of a share of stock. FIN534_8_4_Linda-6: Ex-dividend Date - This can be considered the actual owner date of the stock. In other words if a stock is traded on that date the new owner will receive the dividend. If it is traded the next day, the previous owner will receive the dividend. This Ex-dividend date is two business days before the Holder of Record Date FIN534_8_4_Linda-7: Payment Date - This is the date the dividend is actually paid. On this date, the shareholders of record will be sent a check for the declared dividend. This is the last date of all of the dates. Slide 5 Scene 5 - CYU Set up click and drag here TFC would like you to match up one of their next dividend distribution with each term. Declaration Date - Wednesday November 20, 2013 Holder-of-Record-Date - Thursday December 19, 2013 Ex-Dividend Date - Tuesday, December 17, 2013 Payment Date - Friday, January 10, 2014 (have the students match up the dates. If they get it wrong, you can put in: Declaration Date is when the dividend is decided; Holder-of- Record Date - when a shareholder gets the dividend Ex-Dividend Date - two business days before Holder-of-Record Date Payment Date - when the dividends are actually paid Slide 6 Scene 6 Linda speaking Reinvestment of Dividends Stock Dividends FIN534_8_6_Linda-1: Great job. Our dividend policy is really important to us as our shareholders have invested in us and we want to reward them. Remember earlier when two of our board of directors wanted us to revisit our cash dividend policy? They know how much investor wealth means to us and making sure we are rewarding our owners is important. I am really glad they wanted us to look into this policy more. FIN534_8_6_Linda-2: Another point about cash dividends is reinvestment of them for more stock. While we haven't implemented it yet, we are considering a dividend reinvestment plan or DRIP as they are known to our shareholders. What happens here is instead of receiving a cash dividend, our shareholders can opt to purchase more shares of stock. The benefit of this is our shareholders will increase their stock balance in TFC. Also, shares are typically purchased at a discount. So it is a great offering for shareholders if they choose. We are however still reviewing the corporate action and may offer it in the future. FIN534_8_6_Linda-3: Another option is to issue dividends in the form of stock instead of cash. We have never done that and would rather have our shareholders choose how they would like to use their investment. However, it is a good way for companies to give back to their shareholders. Slide 7 Scene 7 Don speaking Stock repurchase FIN534_8_7_Don-1: Linda, great explanations. Also there is the stock repurchase option that we utilize. There are many reasons why we would repurchase shares in the secondary market. FIN534_8_7_Don-2: First, we may need to look at our capital structure and offer more debt and less equity. We can do that by issuing debt and using the proceeds to buy stock. FIN534_8_7_Don-3: Another reason has to do with stock options. If our employees decide to exercise them, we need to make sure we have available shares. By repurchasing stock, we can have a reserve for our employees when they exercise their options. FIN534_8_7_Don-4: And our last reason has to deal with cash. If we have excess cash, we may repurchase shares. It really depends on our cash situation. Slide 8 Don in Conference Room FIN534_8_7_Don-5: To date, TFC has not repurchased shares. It has been a corporate decision on our part, but it is something we revisit periodically as we are always looking for ways to increase shareholder wealth. FIN534_8_8_Don-1: As I mentioned, we haven't repurchased any shares; however, we revisit this option for a number of reasons. Pros and Cons of Repurchasing stock FIN534_8_8_Don-2: Let's look at some of the reasons we always look into this option. Next slide Some advantages of repurchasing stock are as follows: Scene 8 FIN534_8_8_Don-3: First, from a psychological standpoint, if we decide to repurchase stock, investors usually look at this as a good sign since the stock price is undervalued. It is believed that if TFC feels the stock is undervalued and can purchase it at a discount. So, timing is important here and in the public eye, investors would feel that the stock is an attractive investment. FIN534_8_8_Don-4: Second, shareholders can get cash for shares. Typically shareholders will decide if they want to sell their stock when a repurchase is planned. This is different from a cash dividend where all shareholders need to receive the cash dividend. So choice is mainly at the discretion of the shareholder. FIN534_8_8_Don-5: The third advantage is that it is pretty much the norm that companies only raise dividends; whereas reducing the cash dividend rate can be thought of as bad company business. Also if there is an anticipated positive cash flow that cannot be sustained, our company may decide that it is best to repurchase stock instead of paying out a cash dividend. FIN534_8_8_Don-6: Fourth is capital structure. If we decide that our current capital structure of sixty percent equity and forty percent debt needs to be changed then a repurchase can do that. For example, when repurchasing stock TFC may decide to borrow lots of money. This would modify the capital structure as debt would increase. FIN534_8_8_Don-7: Another advantage is that there are stock options. While TFC has never offered stock options, if we did we would need to have a supply of stock shares available to employees. Repurchasing stock is a way to build up a reserve for those options. Slide 9 Scene 9 - Linda in room FIN534_8_8_Don-8: The last advantage is the cash dividend component factor. If a total dividend amount is set without regard to shares outstanding, and if shares are repurchased that means there will be more to go around in the form of dividends as there will be less stock outstanding. FIN534_8_9_Linda-1: Good points Don. But there are also some disadvantages to Disadvantages of repurchasing shares repurchasing stock. Let's look at a few....... FIN534_8_9_Linda-2:When looking at the price of a share of stock, cash dividends are generally considered to be more consistent than repurchasing shares. As we saw when we were pricing a share of TFC stock, we use a growth factor that is based on dividends growth, not repurchase of stock. FIN534_8_9_Linda-3:Another disadvantage is awareness for the selling shareholders. While it may sound like a good idea that a shareholder wants to have more cash available, keep in mind that if they don't know all the planned activities for a company, they may miss out on future stock price growth. Slide 10 Scene 10 Don Next screen FIN534_8_9_Linda-4:And a big disadvantage involves the price paid to repurchase stock. If a company pays more than what the stock is worth, the remaining stockholders may see price fluctuations. For example, if a company repurchases shares at a price higher than what the market is asking, the stock will go up, but after the repurchase is done, the stock price will correct itself. So there is a chance the stock will be repurchased at an inflated price only to see it drop, which may not be beneficial to long term stockholders. FIN534_8_10_Don-1: Linda you brought up some very good points and it is why we as a company have stayed away from repurchase actions. There are advantages to both. FIN534_8_10_Don-2: For example, if we wanted to change our capital structure to fifty percent equity and fifty percent debt, repurchasing stock may help us achieve that goal if we had to acquire debt to pay for the repurchased shares. There is also a tax benefit. Taxes have to be paid on cash dividends and repurchasing stock. The difference is when they have to be paid. In our case, dividends are paid annually so shareholders have to report the dividend on their taxes. FIN534_8_10_Don-3: Repurchases have to be reported as well but only when sold. If a shareholder decides to have shares repurchased after owning it for many years, the tax reporting transaction occurs when sold. So the shareholder has been able to defer paying taxes on any distribution if they don't receive a dividend. FIN534_8_10_Don-4: So there are many pros and cons, but at this time we at TFC have decided that it is best not to repurchase shares. But we are considering a stock split. Slide 11 Scene 11 Don - stock split Next Slide FIN534_8_10_Linda-1: A stock split? This is news hot of the press! Please tell us more FIN534_8_11_Don-1: We have seen tremendous growth here and our stock price has benefited from it. But at this point we think it may be too high. FIN534_8_11_Don-2: Joe believes that when a price becomes too high there are some investors who we cannot reach. And you know how Joe wants to reach everyone that is working out and investing in us. While reaching everyone is not possible, making our stock attractive in price is. A stock split will enable us to do that. FIN534_8_11_Don-3: With a stock split, everything works out the same mathematically. It is just how it is divided. FIN534_8_11_Don-4: For example, if TFC's stock price is trading at two hundred dollars a share and a shareholder owns one hundred shares, the shareholder's value in TFC would be twenty thousand dollars. If we declare a stock split of two for one, what happens is the number of shares the stockholder owns is now multiplied by two or two hundred shares and the share price is divided by the same two for a per share price of one hundred dollars. FIN534_8_11_Don-5: The shareholder's value is still the same, but now the shareholder owns two hundred shares at a share price of one hundred dollars a share. It is understood that with this stock split we can now reach more shareholders because our stock will be priced lower. And let's not even mention the possibility of stock growth should the shares go up. Also, there is the optimal stock price level that we would want to reach. We are still uncertain as to what that would be for TFC, but too high of a price may push some investors away. FIN534_8_11_Linda-1: Thanks Don. Do you think it is something we will implement now? FIN534_8_11_Don-6: With this expansion project going on, we don't know if the timing is right. But since we have you and the intern doing several analyses, we would like you to do some more research on the stock splits. Slide 12 Scene 12 CYU Stock splits - plug in answers as in 2 answers with the first being new share price and second new shares owns (share price, shares owned) Linda and Don would like you to calculate the stock splits as follows: Please calculate the following stock splits for a shareholder owning five hundred shares (500). Assuming TFC's stock price is $200. 1) 2 for 1 split - answer ($100 share price; 1000 shares owned 2) 3 for 1 split ($67 share price; 1,500 shares owned) 3) 4 for 1 split ($50 share price; 2,000 shares owned 4) 5 for 1 split ($40 share price; 2,500 shares owned) Correct feedback. Great job! When stock splits occur the share price will go down accordingly with the hope that additional investors will now have the funds to acquire an interest in the company. Slide 13 Incorrect feedback. Nice try. New stock price is old stock price divided by split while new shares owned is old shares owned multiplied by the split. Scene 13 Linda talking about stock splits FIN534_8_13_Linda-1: As you saw, the higher the stock split, the higher the number of shares owned and the lower the price. It is that inverse relationship, just like when we were pricing bonds. It is very interesting to see how finance is all related. FIN534_8_13_Linda-2: One thing I know for sure is we really examined a lot with dividends at the request of our board members. I am sure they will be pleased with our analysis. Slide 14 Scene 14 Don Summary slide Don's office Next Slide FIN534_8_13_Linda-3: Before we end the day, let's go to Don's office and review what we covered today. FIN534_8_14_Don-1: I just reviewed your findings and what an excellent job on it. Joe is going to be pleased as will the board members. FIN534_8_14_Don-2: Let's review what we covered today. First we looked at our dividend policy and we learned that there are many dates that go into setting dividends, which also determines who is the rightfully owner of the dividends once payment is made. FIN534_8_14_Don-3: We also looked at offering stock dividends instead of cash as a possible option to shareholders. FIN534_8_14_Don-4: We then switched gears and looked at TFC repurchasing shares back from stockholders. While it isn't something we are currently doing, we may revisit it in the future thanks to your research on it. FIN534_8_14_Don-5: Finally, we looked at stock splits as a way of setting an appropriate share price for investors to consider. FIN534_8_14_Don-6: The analysis again was well done and it will help answer a lot of questions that may arise by our board of directors and any interested party. FIN534_8_14_Don-7: But the dividend policy was only one part of our assignment. They also want us to look at our cash budget. FIN534_8_14_Don-8: Before we move onto that area of our assignment. Let's get a workout in because as they say, \"working out pays huge dividends to your health!\" Slide 15 Scene 15 Closing slide Closing slide FIN534 Week 7 Scenario Script: Forecasting Operations and Agency Conflicts Slide Scene/Interaction Narration # Slide 1 Intro Scene Slide 2 Scene 2 Joe meeting the intern Conference room End of scene FIN534_7_2_Joe-1: Hello everyone. I wanted to stop by and tell you how great of a job you are doing with this analysis. Your expertise in many financial areas has helped us in making our decision to expand. Before we can move forward with this project, we want to be extremely confident that this move is the best choice for TFC. FIN534_7_2_Linda-1: Joe, we have reviewed: TFC's financial statements; and Calculated ratios and compared them to the industry averages; Calculated TFC's stock price using the constant growth model; Calculated a required rate of return for TFC and used it for capital budgeting; And we ran many calculations using the net present value, internal rate of return, the payback period, and evaluated our cash flows, to help in the decision making for this project. So I have to ask, what can possibly be next? FIN534_7_2_Joe-2: Linda, that is quite a list and I can see that a lot of work went into it this by you and your intern. The Strayer MBA program must be providing its students with the necessary concepts to translate to real-world applications. Let's use some more theory to analyze some more data BEFORE we make a decision. Remember, we are a conservative company, so we want to be confident before we make the ultimate decision which will change our present day TFC. FIN534_7_2_Joe-3: What we want you to do with your intern is look at the financial planning side of TFC. There are two main pieces of the financial planning and they consist of the Operating Plan and the Financial Plan. FIN534_7_2_Linda-2: Joe, you are right. We need to look at those areas before making a decision. So, our analyses need a little more work! FIN534_7_2_Joe-4: Right! . But, we are getting close to a decision. Plus you and your intern are doing such a great job we don't want you to impede your progress. Maybe in a hundred years? FIN534_7_2_Linda-3: Joe, you have that special touch of wanting to do more for the company. That is one of the reasons why it is such a great company to work for; and to workout. (laugh) FIN534_7_2_Joe-5: That is simply the TFC way! Don will be joining you in a bit to discuss the financial planning piece of the project. As always, good luck! Slide 3 Scene 3 Don in conference room Go to next slide FIN534_7_3_Don-1: So Joe filled you in on your next part of the project of looking at both the Operating Plan and the Financial Plan. The Operating Plan will look at TFC for future operations in our market segments and will focus on our sales and marketing strategies, growth opportunities and offerings. Typically an operating plan will focus on the immediate five years. Since we are doing a lot in the first year, we will focus on that time horizon. A lot of what-if analyses will be done with the operating plan. FIN534_7_3_Don-2: The Financial Plan will focus on projecting pro forma financial statements. These statements will help in deciding how much free cash flow there will be available in future years to finance parts of the operating plan. We will again just look at the first year. Typically, we would look at five years but since we are doing so much in the coming year, our focus will be on that period. FIN534_7_3_Linda-1: There are also other reasons why we should be forecasting free cash flows. Let's take a close look at these rationales. Slide 4 Scene 4 CYU Narrator: In addition to forecasting free cash flow, what are some ways in which managers should want to use pro forma, that is projected financial statements? Select all that apply 1) The statements can help in seeing if the company is in line with its future financial goals (correct) 2) They can help create \"What if\" analyses (correct) 3) They will help in implementing policies (nice try - but managers need to look at the future with pro formas for decision making 4) They will help in planning for future financing of projects (correct) 5) They help in setting the capital structure (incorrect - Nice try. Capital budget is usually an internal policy that pro formas can use in their creation but they typically don't get involved in setting the policy. Slide 5 Scene 5 Linda In conference room Put Up Operating Plan Linda switches poses Go to next slide FIN534_7_5_Linda-1: There are many reasons to have pro forma financial statements. Here at our company, these pro forma financial statements assist with the financial planning.. As Joe mentioned, the financial planning is composed of two parts, the Operating Plan and the Financial Plan. Let us look at some of the components of the Operating Plan FIN534_7_5_Linda-2: Don previously mentioned the prime areas that we look at when building our Operating and Financial Plans. One area in particular is forecasting revenue. We are expecting assets to double in size with this expansion project in the first year; therefore, we have to think of sustained growth. This, however, may be difficult to predict. FIN534_7_5_Linda-3: Keep in mind that our Accounting Department has been analyzing many trends to get a forecasted revenue growth rate of ten percent. Also, in anticipation for the cost cutting measures that is being planned, the Accounting Department also projects that Operating Expenses will drop from eighty two percent of sales to seventy five percent. With these changes the pro forma statement in the following year will show a profit margin more than ten percent, which will make our shareholders happy if it is met. Slide 6 Scene 6 Projecting Financial Statements Forecasting any operating accounts; Keeping in line with a company's policy on taking on debt, equity and paying dividends and; Making sure the operating plan can be funded. FIN534_7_6_Linda-1: We were able to create some pro forma statements for TFC's Financial Planning process. This may seem like a pretty straightforward process but there is a lot of work that goes into the decisions. There are three basic points to projecting financial statements and they consist of Forecasting any operating accounts; Keeping in line with a company's policy on taking on debt, equity and paying dividends and; Making sure the operating plan can be funded. But there is more. During the process a company can go through many iterations of scenario analysis to determine what is best for the company. It is much like going to a show on Broadway, as you only get to see the finished production and not all the leg work behind the scenes. The same can be thought of when it comes to projecting financial statements. Much analysis goes into the decision making as the company plans around it. Slide 7 Scene 7 Financial Planning Agency Conflicts Here at TFC, we have many departments look over the projections before we sign off on them. FIN534_7_7_Don-1: Linda is right about the final projected financial statements process. Since we are a conservative company who is always thinking about how to maximize shareholder wealth, our process takes time to go through the proper channels. For this expansion project, we don't have the same luxury as other projects, but we still have to look at each area before making an informed decision. FIN534_7_7_Don-2: As a publicly traded company, we have an obligation to do the right thing for many stakeholders including shareholders, creditors, employees, and others who have a vested interest in TFC. With that comes Agency Conflicts. FIN534_7_7_Linda-1: Oh, yes. Agency Conflicts. Do you think this will hurt our chances to expand? FIN534_7_7_Don-3: Before we think that way, let's have Joe talk to us about Agency Conflicts. He has first-hand experience in the area. Slide 8 Scene 8 Joe in Conference Room Next slide FIN534_7_8_Joe-1: Agency Conflicts is an area that I am involved with on a daily basis. To better understand it, TFC sets up agency relationships by hiring Agents to act on behalf of the company. The typical agency relationships include stockholders versus creditors; controlling interest owners versus non-controlling interest owners; and stockholders versus managers. We try to keep agency conflicts down as we have a set of rules that managers need to follow; however, there are always exceptions. Our belief is if we can keep agency conflicts down, the costs around those conflicts, called agency costs, will be lower. And, we all know that lower costs means more profit for TFC! Let's look at each of the agency relationships and see if we are doing an adequate job of keeping agency costs down. Slide 9 Scene 9 - Joe in room Conflicts between Stockholders and Creditors on slide FIN534_7_9_Joe-1: When looking at stockholder versus creditors there is a difference in points of views. Creditors are lending to TFC so they have a vested interest in seeing the investment pay off. Our creditors want to make sure we don't default on our loans. But the decision making is not coming from the creditors but instead our mangers, acting for our shareholders. In other words, the Creditors lend to TFC and our managers are responsible for keeping the company growing. The potential agency conflicts arise because Creditors want to get paid, but managers are making decisions with company assets that can potentially affect the Creditors payment schedule. FIN534_7_9_Joe-2: Our expansion project is a great example of this. Based on our capital structure for this project, we are going to have to take on a lot of new debt. So, TFC will be taking on more risk in doing the project, which is what we saw with our cash account, but creditors would rather have risk minimized. Hence, an agency conflict. SHOW OON THE SCREEN for EMPHASIS...... One choice would be to have our creditors raise the interest rate they are charging us to do the project. Second choice: to spell out in detail what the increased debt will be used for as well as put in place company performance measures. Slide 10 Scene 10 Joe in room controlling interest owners versus non-controlling interest owners So what can be done? One choice would be to have our creditors raise the interest rate they are charging us to do the project. That is not TFC's first choice as it can raise our debt expense considerably; thereby, increasing risk for us. The second approach and the one that has been adopted by TFC is to spell out in detail what the increased debt will be used for as well as put in place company performance measures. These debt covenants act as a watch guard for TFC. We understand that our Creditors want to see risk kept low, but we also want to grow. FIN534_7_10_Joe-1: With the second agency conflict of inside owners versus outside owners, it results to who is bearing the cost. Take for example, when TFC was a private company, My family bore all the costs but also reaped the benefits. This included some welldeserved vacations at the company's expense. Next screen When we decided to go public, we now took on outside owners. We still had the company pay for well-deserved company vacations, but the expense was now also being consumed by our external owners. As a result, our external owners demanded a higher rate of return. Financially, we were doing fine, but the external owners felt that the money should have gone back into the business. FIN534_7_10_Joe-2: What did we do? Well, my family met and decided that it was in the best interest of TFC to stop having the company pay for our vacations. We felt that when we decided to go public we gave up that luxury. We communicated our new policy and added additional language regarding equality across all the owners. That is why we don't have any preferred stock or special interest stock. We want everyone to be on the same \"workout\" field. Slide 11 Scene 11 Joe speaking about Managers and Shareholders conflicts Next Slide Use tablet to put the six main ways in which the actions of our managers may affect the value that our shareholders desire. This new policy has worked out great for the company and for establishing relationships. FIN534_7_11_Joe-1: The third agency conflict is the one that we encounter the most which is conflicts between the decision making managers and the shareholders of TFC. Shareholders want to see TFC's value go up. Remember, stock price maximization? But our managers also have personal and company goals that they want to meet as well. And if the actions by the managers to meet their goals are not in line with stock price maximization, conflicts can arise. FIN534_7_11_Joe-2: There are six main ways in which the actions of our managers may affect the value that our shareholders desire. I've created an activity for you to use on this tablet as we discuss each of the main ways in which actions of our managers may affect the value that our shareholders desire. FIN534_7_11_Joe-3: First, Efforts by TFC's managers regarding profit maximization. If our managers are spending more time at \"extracurricular\" activities for the company instead of seeking ways to build the company. We like it where our managers, including myself, are out there marketing TFC, but we also need to be in house. To try to alleviate this conflict, TFC has encouraged managers to be selective in those additional activities. So far this initiative has really been paying off. FIN534_7_11_Joe-4: Second, Managers overspending on non-essential items. At TFC we are cash conscious so managers have to go through an approval process to ensure they are spending within company guidelines. We are cash focused therefore extravagant purchases are not permissible. FIN534_7_11_Joe-5: Third, Inability to act prudently when it involves closer relationships. At times our managers are put in a bind and they need to act accordingly even though it may affect someone who is close to them. All of our managers know that they need to separate business from their personal feelings. This is easier said than done. However, prudent decisions need to be made if we want to grow our business. Our business model takes into consideration the personal side of the business and that is why we do so several analyses before making a decision. I am pleased to say that our model has been quite successful as we have never laid off an employee in the history of our company. FIN534_7_11_Joe-6: The fourth involves Risk Taking. With this conflict, managers may be reluctant to take on a project with risk even if it is projected to be a winner. Take for example our expansion project. It is very risky and if not successful the result can be bleak for TFC. The blame would then go to me and the management staff involved in the project. As a result of this managers may be reluctant to take on the risk even though shareholders stand to benefit from it. To alleviate this conflict, we treat it much in the same way as the other conflicts and complete a detailed review of any high exposure project to ensure we are comfortable. FIN534_7_11_Joe-7: The fifth is Cash Management Decision Making. It is no secret that TFC is a cash conscious business. Cash is good but too much cash may not be. Remember the saying, "Cash is king". Cash flow is important to the general health of the business. It might sound odd but think of it from the point of view of the shareholder. They like to see some immediate returns on their investment. If a company is continuing to hold on to their cash, shareholders are not reaping the benefits. Also, extra cash may entice managers to make poor investment decisions down the road. Cash is also important but it also needs to be regulated here. In order to regulate this cash we have a policy in place to keep cash at an adequate level that will help us be financially strong while also giving back to our investors in stock growth and dividends. FIN534_7_11_Joe-8: The sixth and last area involves Information Sharing. With this conflict, managers may not share all available information in a timely manner as they don't want their competitors to gain an advantage. Also, if the company is not doing well, they may delay the release of bad information or change it to not look as bad. At TFC, we are an open book company. Our policy is to share all available information as soon as possible. We are more focused on our company image and believe that being up front is the best way to go. Slide 12 Scene 12 Joe and Linda finishing up Agency Conflicts FIN534_7_12_Linda-1: Joe, thank you so much for explaining the potential agency conflicts. I never realized how much there is to this concept. FIN534_7_12_Joe-1: You are welcome Linda and I am always learning something new every day. That is why we are putting so much effort into analyzing this expansion project. We still have not made a final decision, but the numbers may speak for themselves. However, we have to consider the effects on the interested parties. FIN534_7_12_Linda-2: I guess you can say it is a continuous learning process. Slide 13 Scene 13 CYU As part of your understanding about Agency Conflicts, please select all those that can be considered potential Agency Conflicts between managers and shareholders (1) Manager finds out that company will not meet expected earnings and put a different spin on the earnings so it doesn't look as bad (2) Manager's best friend is part of a division that is scheduled to be closed but the manager lobbies to keep it open even though it is hurting company profits. (3) Manager decides to invest extra cash in stocks or bonds instead of giving some of the cash back to the shareholders (4) Manager decides to take the entire staff on an all-inclusive trip to Hawaii with everyone in first class staying at the most expensive hotel Answer - They all can be considered potential agency costs. Shareholders want managers to maximize their wealth but managers also have their own goals which can cause conflicts. Slide 14 Next Slide Scene 14 Conference room Summary Slide - FIN534_7_14_Don-1: Wow - great information by everyone. We first learned that pro forma statements are an important part of Financial Planning which includes the Operating and Financial Plans. A lot of research is needed in developing these statements as company projections which then help in establishing projected cash flows which in turn assist in valuation projections. We also learned about Agency conflicts. The three typical Agency Conflicts are stockholders versus creditors; controlling interest owners versus non-controlling interest owners; and stockholders versus managers. The conflicts can arise as profit maximization measures may not be implemented to the fullest due to a number of factors. Interested parties are then faced with some decisions. If the core values of the company are kept in mind, this may help in the decision making process. FIN534_7_14_Linda-1: While we did not do a lot of calculations this time around, we did do a lot of examination of policies and procedures. These are also very important whenever we evaluate a project not to mention one as big as this expansion project. All of this hard work has really made me ready to join one of those TFC Intense Exercise classes. One of them is starting in a few minutes. Let's go exercise! Slide 15 Scene 15 Closing slide Closing slide 5/6/13 Chapter 12 Mini Case Hatfield Medical Supplies's stock price had been lagging its industry averages, so its board of directors brought in a new CEO, Jaiden Lee. Lee had brought in Ashley Novak, a finance MBA who had been working for a consulting company, to replace the old CFO, and Lee asked Ashley to develop the financial planning section of the strategic plan. In her previous job, Novak's primary task had been to help clients develop financial forecasts, and that was one reason Lee hired her. Novak began as she always did, by comparing Hatfield's financial ratios to the industry averages. If any ratio was substandard, she discussed it with the responsible manager to see what could be done to improve the situation. The following data shows Hatfield's latest financial statements plus some ratios and other data that Novak plans to use in her analysis. Hatfield Medical Supplies: Balance Sheet (Millions of Dollars), 12/31/2013 Cash Accts. rec. Inventories Total CA Hatfield Medical Supplies: Income Statement (Millions of Dollars Except per Share) 2013 $2,000.0 $1,800.0 $50.0 $150.0 $20 $280 $400 $700 Net fixed assets Total assets $500 $1,200 Accts. pay. & accruals Line of credit Total CL Longterm debt Total liabilities Common stock Retained earnings Total common equ. Total liab. & equity Sales Op. costs (excl. depr.) Depreciation EBIT $80 $0 $80 $500 $580 $420 $200 $620 $1,200 Interest Pretax earnings Taxes (40%) Net income $40.0 $110.0 $44.0 $66.0 Dividends Add. to RE Common shares EPS DPS Ending stock price $20.0 $46.0 10.0 $6.6 $2.0 $52.80 Selected Ratios and Other Data, 2013 Op. costs/Sales Depr./FA Cash/Sales Receivables/Sales Inventories/Sales Fixed assets/Sales Acc. pay. & accr. / Sales Tax rate ROIC NOPAT/Sales Total op. capital/Sales Hatfield 90% 10% 1% 14% 20% 25% 4% 40% 8.0% 4.5% 56.0% Additional Data Exp. Saled growth rate Interest rate on LT debt Target WACC Industry 88% 12% 1% 11% 15% 22% 4% 40% 12.5% 5.6% 45.0% Hatfield 48.3% 3.8 5.5% 3.30% 1.67 1.94 10.6% 8.0 2014 10% 8% 9% Total liability/Total assets Times interest earned Return on assets (ROA) Profit margin (M) Sales/Assets Assets/Equity Return on equity (ROE) P/E ratio Industry 36.7% 8.9 10.2% 4.99% 2.04 1.58 16.1% 16.0 a. Using Hatfield's data and its industry averages, how well run would you say Hatfield appears to be in comparison with 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 Du Pont equation (see Chapter 3) as one part of your analysis. Hatfield is less profitable, uses its assets less efficiently, and has too much leverage. Du Pont ROE Hatfield Industry M x 3.30% 4.99% Sales/Assets 1.67 2.04 x Assets/Equity 1.94 1.58 = = = ROE 10.6% 16.1% b. Use the AFN equation to estimate Hatfield's required new external capital for 2014 if the sale growth rate is 10%. Assume that the firm's 2013 ratios will remain the same in 2014. (Hint: Hatfield was operating at full capacity in 2013.) Data for AFN Method Growth rate in sales (g) Sales (S0) 10% $2,000 Forecasted sales (S1) $2,200 Increase in sales (S = gS0) Profit margin (M) Assets/Sales (A0*/S0) Payout ratio (POR) Spont. Liab./Sales (L0*/S0) AFNHatfield = $200 3.30% 60.0% 30.3% 4.0% Add'l Req'd Assets Spontaneous liabilities (L0*/S 0)S (A0*/S 0)S = = $120.0 AFNHatfield = $8.0 Add'n to RE M S 1 (1-POR) $50.6 $61.40 million c. 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. Answer: See PowerPoint Show d. Define the term selfsupporting growth rate. What is Hatfield's selfsupporting growth rate? Would the self supporting growth rate be affected by a change in the capital intensity ratio or the other factors mentioned in the previous question? Other things held constant, would the calculated capital intensity ratio change over time if the company were growing and were also subject to economies of scale and/or lumpy assets SelfSupporting 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. We found this rate, ith Excel's Goal Seek function and also algebraically, as explained below. 1. Using algebra. The selfsupporting growth rate can also be found by setting the AFN equation to zero and then solving for g. M(1 - POR)(S 0) = SelfSupporting g = A0* - L0* - M(1 - POR)S0 M = POR = 1POR = S0 = A* = L* = 3.30% 30.3% 69.7% $2,000 $1,200 $80 M(1 - POR)(S 0) SelfSupporting g = A0* - L0* - M(1 - POR)S0 = $46.00 $1,074.00 = 4.283% 2. Using Goal Seek. To find the selfsupporting growth rate with Goal Seek, select Data, WhatIf Analysis, and Goal Seek; then choose cell B91 as the value for the "Set Cell" area of the Goal Seek dialog box, choose 0 as the value for the "To Value" area of the dialog box, and choose cell C54 as the value for the "By Changing Cell" area of the dialog box. Then hit OK. e. Use the following assumptions to answer the questions below: (1) Operating ratios remain unchanged. (2) Sales will grow by 10%, 8%, 5%, and 5% for the next four years. (3) The target weighted average cost of capital (WACC) is 9%. This is the No Change scenario because operations remain unchanged. Inputs for the forecast are shown below. You can change inputs in blue. You can show the original scenario by going to Data, WhatIf Analysis, Scenario Manager, and select the scenario named No Change. Scenario: Improve Actual Forecast 2013 2014 10% 90% 89.5% 10% 10% 1% 1% 14% 14% 20% 16% 25% 25% 4% 4% 40% 40% 8.0% 5% 10% 9% Inputs Sales growth rate: Op. costs/Sales: Depr./FA Cash/Sales: Acct. rec. /Sales Inv./Sales: FA/Sales: AP & accr. / Sales: Tax rate: Rate on all debt Div. growth rate: Target WACC 2015 8% 90% 10% 1% 14% 16% 25% 4% 40% 8% 10% 2016 5% 90% 10% 1% 14% 16% 25% 4% 40% 8% 10% For inputs: The last 2 years of growth must 2017Error Check have same value to get constant 5% Ok growth in FCF. The last 3 years of 90% Ok the operating ratios must have same 10% Ok value to get constant growth in FCF. 1% Ok An error message will appear if this condition is violated. 14% Ok 16% Ok 25% Ok 4% Ok 40% Ok 8% 10% e. (1) For each of the next four years, forecast the following items: sales, cash, accounts receivable, inventories, net fixed assets, accounts payable & accruals, operating costs (excluding depreciation), depreciation, and earnings before interest and taxes (EBIT). Scenario: Improve Actual Forecast 2013 2014 $2,000 $2,200 $20 $22 $280 $308 $400 $352 $500 $550 $80 $88 $1,800 $1,969 $50 $55 $150 $176 Net sales Cash Accounts receivable Inventories Net fixed assets Accts. pay. & accruals Op. costs (excl. depr.) Depreciation EBIT 2015 $2,376 $24 $333 $380 $594 $95 $2,127 $59 $190 2016 $2,495 $25 $349 $399 $624 $100 $2,233 $62 $200 2017 $2,620 $26 $367 $419 $655 $105 $2,344 $65 $210 e. (2) Using the previously forecasted items, calculate for each of the next four years the net operating profit after taxes (NOPAT), net operating working capital, total operating capital, free cash flow, (FCF), annual growth rate in FCF, and return on invested capital. What does the forecasted free cash flow in the first year imply about the need for external financing? Compare the forecasted ROIC compare with the WACC. What does this imply about how well the company is performing? Scenario: Improve NOPAT NOWC Total op. capital FCF Growth in FCF ROIC Actual Forecast 2013 2014 $90 $106 $620 $594 $1,120 $1,144 $82 8.0% 2015 $114 $642 $1,236 $23 72% 9.2% 9.2% 2016 $120 $674 $1,297 $58 157.3% 9.2% 2017 $126 $707 $1,362 $61 5.0% 9.2% Definitions: NOPAT = EBIT(1T) NOWC = (Cash + accounts receivable + inventories) (Accounts payable & accruals) Total operating capital = NOWC + Net fixed assets FCF = NOPAT Change in total operating capital ROIC = NOPAT/Total operating capital e. (3) Assume that FCF will continue to grow at the growth rate for the last year in the forecast horizon (Hint: 5%). What is the horizon value at 2017? What is the present value of the horizon value? What is the present value of the forecasted FCF? (Hint: use the free cash flows for 2014 through 2017). What is the current value of operations? Using information from the 2013 financial statements, what is the current estimated intrinsic stock price? Scenario: Improve Horizon Value: = $1,598 Value of Operations: Present value of HV $1,132 Value of operations + ST investments Estimated total intrinsic value All debt Preferred stock Estimated intrinsic value of equity $1,314 $0 $1,314 $500 $0 $814 + Present value of FCF Value of operations = $182 $1,314 Number of shares Estimated intrinsic stock price = 10 $81.37 f. Continue with the same assumptions for the No Change scenario from the previous question, but now forecast the balance sheet and income statements for 2014 (but not for the following three years) using the following preliminary financial policy. (1) Regular dividends will grow by 10%. (2) No additional longterm debt or common stock will be issued. (3) The interest rate on all debt is 8%. (4) Interest expense for longterm debt is based on the average balance during the year. (5) If the operating results and the preliminary financing plan cause a financing deficit, eliminate the deficit by drawing on a line of credit. The line of credit would be tapped on the last day of the year, so it would create no additional interest expenses for that year. (6) If there is a financing surplus, eliminate it by paying a special dividend. After forecasting the 2014 financial statements, answer the following questions. Improve 1. Balance Sheets Assets Cash Accts. rec. Inventories Total CA Net fixed assets Total assets Liabilities and equity Accts. pay. & accruals Line of credit Total CL Longterm debt Total liabilities Common stock Retained earnings Total common equity Total liabs. & equity 2. Income Statement Sales Op. costs (excl. depr.) Depreciation EBIT Less: Interest on LTD Interest on LOC Pretax earnings Taxes (40%) Net income Regular common dividends Special dividends Addition to RE Most Recent 2013 $20.0 280.0 400.0 $700.0 500.0 $1,200.0 $80.0 0.0 $80.0 500.0 $580.0 420.0 200.0 $620.0 $1,200.0 Most Recent 2013 $2,000.0 1,800.0 50.0 $150.0 40.0 0.0 $110.0 44.0 $66.0 $20.0 $0.0 $46.0 Input Basis for 2014 Forecast 1.00% 2014 Sales 14.00% 2014 Sales 16.00% 2014 Sales $22.00 $308.00 $352.00 $682.00 $550.00 $1,232.00 25.00% 2014 Sales 4.00% 2014 Sales Draw on LOC if financing deficit Carry over from previous year Carry over from previous year Old RE + Add. to RE Check: TA Total Liab. & Eq. = Input Basis for 2014 Forecast 110% 2013 Sales 89.50% 2014 Sales 10.00% 2014 Net PP&E 8.00% Avg bonds 8.00% Beginning LOC 40.00% Pretax earnings 110% 2013 Dividend Pay if financing surplus Net income - Dividends 3. Elimination of the Financial Deficit or Surplus Increase in spontaneous liabilities (accounts payable and accruals) + Increase in longterm debt and common stock Previous line of credit + Net income minus regular common dividends Increase in financing Increase in total assets Amount of deficit or surplus financing: If deficit in financing (negative), draw on line of credit If surplus in financing (positive), pay special dividend Forecast 2014 Line of credit Special dividend $88.00 $0.00 $88.00 $500.00 $588.00 $420.00 $224 $644 $1,232 $0.00 Forecast 2014 $2,200.00 $1,969.00 $55.00 $176.00 $40.00 $0.00 $136.00 $54.40 $81.60 $22.00 $35.60 $24.00 $8.00 $0.00 $0.00 $59.60 $67.60 $32.00 $35.60 $0.00 $35.60 g. Repeat the analysis performed the previous question but now assume that Hatfield is able to improve the following inputs: operating costs (excluding depreciation)/sales = 89.5% and inventories/sales = 16%. This is the Improve scenario. Go to Scenario Manager and choose the Improve Scenario. Note: If there is an initial balance on the on the LOC, the assumption is that the balance will not change until the last day of the year. Therefore, the interest for the year is the based only on the beginning balance. Note: If there is a LOC in the previous year, then it is necessary to subtract the previous year's line of credit. In other words, this is like paying off the old line of credit on the last day of the year and then drawing on a new line of credit. 5/6/13 Financing Feeback This worksheet shows how to incorporate the impact of financing feedback, which is caused if the LOC is added during the year and not just at the end of the year. The extra notes below show the changes from this model and the one in the first worksheet, "1. Mini Case". Note: All inputs are linked to the first worksheet, "1. Mini Case", so don't make changes here! If you want to see a different scenario, go the the first worksheet, "1. Mini Case", and use the Scenario Manager there to make changes. Improve 1. Balance Sheets Assets Cash Accts. rec. Inventories Total CA Net fixed assets Total assets Liabilities and equity Accts. pay. & accruals Line of credit Total CL Longterm debt Total liabilities Common stock Retained earnings Total common equity Total liabs. & equity 2. Income Statement Sales Op. costs (excl. depr.) Depreciation EBIT Less: Interest on LTD Interest on LOC Pretax earnings Taxes (40%) Net income Regular common dividends Special dividends Addition to RE Most Recent 2013 $20.0 280.0 400.0 $700.0 500.0 $1,200.0 $0.0 $80.0 0.0 $80.0 500.0 $580.0 420.0 200.0 $620.0 $1,200.0 Most Recent 2013 $2,000.0 1,800.0 50.0 $150.0 40.0 0.0 $110.0 44.0 $66.0 $20.0 $0.0 $46.0 Input Basis for 2014 Forecast 1.00% 2014 Sales 14.00% 2014 Sales 16.00% 2014 Sales 25.00% 2014 Sales 4.00% 2014 Sales 0.00% Draw on LOC if financing deficit 0.00 Carry over from previous year Carry over from previous year Old RE + Add. to RE Check: TA Total Liab. & Eq. = Input Basis for 2014 Forecast 110% 2013 Sales 89.50% 2014 Sales 10.00% 2014 Net PP&E 8.00% Avg bonds 8.00% Avg LOC 40.00% Pretax earnings 110% 2013 Dividend Pay if financing surplus $0.00 Net income - Dividends 3. Elimination of the Financial Deficit or Surplus Increase in spontaneous liabilities (accounts payable and accruals) + Increase in longterm debt and common stock Previous line of credit + Planned increase in retained earnings + Aftertax operating income: EBIT (1T) Aftertax interest on LT debt: (INTLTD x (1T) Aftertax interest on previous LOC: (rLOC x 0.5 x LOCt1 x (1T) Regular common dividends Total planned increase in the retained earnings account Increase in financing Increase in total assets Amount of unadjusted deficit or surplus financing: Forecast #NAME? $22.00 $308.00 $352.00 $682.00 $550.00 $1,232.00 $88.00 $0.00 $88.00 $500.00 $588.00 $420.00 $224 $644 $1,232 $0.00 Forecast #NAME? $2,200.00 $1,969.00 $55.00 $176.00 $40.00 $0.00 $136.00 $54.40 $81.60 $22.00 $35.60 $24.00 $8.0 $0.0 $0.0 Note: The interest on the LOC is based on the LOC's average value during the year. Note: We subtract the previous LOC because the plan does not call for any projected LOC unless necessary. $105.6 $24.0 $0.0 $22.0 $59.6 Note: Note: interest expense is incurred on the planned LOC. Because the plan does not call for any LOC, the average balance is equal to (LOCt1 + 0)/2 = 0.5*LOCt1. $67.6 $32.0 $35.6 Note: spontaneious liabilities, planned external financing, and the planned addition to the retained earnings account. If there is a surplus (the financing need is positive), pay a special dividend: $35.6 If there is a deficit (the financing need is positive), draw on the LOC: Unadjusted line of credit = Adjustment factor (see note below) = Adjusted line of credit = Unadjusted LOC / Adjustment factor = $0.0 0.98 $0.0 The adjustment factor takes into account the financing feedback. The formula for the factor is: Adjustment factor =1[0.5 x rLOC x (1T)] The 0.5 in the formula is based on the assumption that the LOC will be added smoothly throughout the year, so the new interest will be incurred on only half the new LOC. Interest is deductible for tax pursposes, so it is only the aftertax impact that determines the adjusted LOC