Question
Managers use projected financial statements in four principal ways. (1) They use the projected statements to assess whether the firm's anticipated performance is in line
Managers use projected financial statements in four principal ways. (1) They use the projected statements to assess whether the firm's anticipated performance is in line with its own internal targets and with investors' expectations. (2) They use them to estimate the impact of proposed operating changes. (3) They use them to anticipate the firm's future financing needs and to arrange necessary financing. (4) Finally, they use them to estimate free cash flows, which determine the firm's overall value. Managers forecast free cash flows under different operating plans, forecast their capital requirements, and then choose the plan that maximizes shareholder value. Security analysts make the same types of projections as managers, and influence investors, who determine the future of firms' managers.
Increasing sales require additional assets, these assets must be financed, and it may or may not be possible to obtain all the funds needed for the firm's business plan. A key element in the financial forecasting process is to determine the -(Select-internal or external) financing requirements through the AFN equation. Additional funds needed are the amount of -(Select-internal or external) capital (interest-bearing debt and preferred and common stock) that will be necessary to acquire the required assets. The AFN equation approximates the funds needed assuming that ratios -(Select-remain constant/fluctuate widely/only decline). The AFN equation is written as follows:
AFN = (A0 */S0)S - (L0 */S0)S - MS1(1 - Payout)
The AFN equation shows the relationship of -(Select-internal or external) funds needed by a firm to its projected increase in assets, the spontaneous increase in liabilities, and the increase in retained earnings. Rapidly growing companies require larger increases in assets; other things held constant, so -(Select-expense/sales/stock) growth is an important factor to the firm's AFN. The -(Select-assets turnoverprice/earnings/capital intensity) ratio is the ratio of assets required per dollar of sales. Companies with higher assets-to-sales ratios require more assets for a given increase in sales, hence a -(Select-greater or smaller) need for external financing. -Select-(Externally financed/ Spontaneously generated/ Bank obtained) funds arise out of normal business operations from its suppliers, employees, and the government that reduce the firm's need for external financing. The -(Select-lower or higher) the profit margin, the larger the net income available to support increases in assets, hence the -(Select-smaller or greater) the need for external financing. The (Select-payout/retention/quick) ratio is the proportion of net income that is reinvested in the firm, and it is calculated as 1 minus the -(Select-P/E ratiodividend/ payout ratio/ quick ratio). The higher the -(Select-payout/retention/quick) ratio, the lower the firm's AFN. The -(Select-long-term/sustainable/expected/Gordon growth rate is the maximum achievable growth rate without the firm having to raise external funds. In other words, it is the growth rate at which the firm's AFN equals zero.
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