Topic: Financial Planning and Forecasting Textbook Chapter 16: Integrated Case - New World Chemicals Inc (pp. 591 592) Required to develop financial forecasts of cash flows given data for 2016 Make reasonable assumptions as decided by your group to forecast FCFs for 2017, 2018, 2019-2020 (you do not have to incorporate all details stated on Page 591) Incorporate any reasonable uncertainty as decided by your group for any risky scenarios You are required to calculate investment prospects for this project Submit your group analysis as a Word document supported by work shown in Excel Worksheet Please Note: Your detailed work shown in Excel is worth 15% of the assignment grade Current asses! Fixed assets A 'C/50 S ,000 .00 $1,000 $1.000 0.333 33.3% operating at full capacity. TABLE 15.1 Additional Funds Needed (AFN) Model (Millions of Dollars) H I A B C D E F G 2 Part I. 2016 Data from Chapter Tables 3.1 and 32 A Assets at 12/31/16. All assets were needed for 2016 sales 4S, 2016 Sales 5 2016 Net Income 6 2016 Dividends 7 L 2016 payables + accruals, which increase spontaneously with sales Base C 2016 Data 10.00% 0.6667 & Partil Data Used in the AENEquation: 2016 Ratios Hein Constant AFN - Additional Funds Needed to buy assets needed to support growth Arts in addition to funds raised internally, L., AFN represents required external funds. 10 g - Target growth rate in sales. A/S, - Assets required per $1 of sales $2,000/$3,000. When multiplied by the increase in sales shows the required new assets for the coming year. Also called the capital intensity ratio. The higher this ratio, the more new assets the firm will need to 11 support a given amount of growth. 12S, 2017 Sales (1+)(S.) - (1.1$3,000) 13 As Growth in sales - S.-S, - $3,300 - $3.000. Can also be found as 18 - (S.) LYS, -Spontaneously generated funds per dollar of new sales. When multiplied by As, we find the new payables and accruals that are available to support growth. $3,300 $300 0.0667 0.0392 M-Profit margin on sales 2016 net incomals. $117.5/53,000. Multiply by S. (not 15 s.) to find the net income available in 2017 for dividends or growth. 11 - Dividend Payout Ratio - 1 - (Dividends/Net Income) - 1 - ($57.5/5117.50). The lower the payout rate, the more of the net income is retained to support growth 0.5106 Parti The AFN. Equation AFN - Required increase in assets Funds obtained as new retained earnings. Based on 2017 sales Spontaneous Increase in payables and accruals (L./S.AS 0.0667(5300) $20 - (A, 45,MAS 0.6667(5300) $200 $114 million MS,(1 - Payout) 0.0392($3,300(0.5106) $66 21 22 AFN - (continued 576 Part 6 Working Capital Management, Forecasting, and Multinational Financial Management Additional Funds Needed (AFN) Model (Millions of Dollars) (Continued) TABLE 16.1 AFN (Old = $114) Change: New New - Old 23 Part IV Sensitivity Analysis: AEN with Changed Input Values 5201 $87 $27 -$87 $64 -$50 Higher 15%, up from 10%. With faster growth, the firm needs more new Growth: assets. Lower 5% down from 10%. With slower growth, the firm needs less 26 Growth: new assets. 0.5000, down from 0.6667. This factor is called the capital intensity ratio. We lowered it in the sample; and with a lower A/S value, fewer assets are required for any i loval of sales. If Allied's management can Ironcs the total to turnover ratio, the A/S, ratio will declina and that will reduce AFN. 0.0800, up from 0.0667. Allied spontaneously gearates funds from accounts payable and accruais; and the larger the LTS, L,978, ratio, the smaller the need for external financing. Here we increase the ratio. With a higher value, more spontaneous funds are available; so the AFN declines. 0.1000, up from 0.0392. If the profit margin increases, more earnings will be available to support growth and thus the smaller the AFN. Here we increase M and the AFN declines. 0.2000, down from 0.4894. If Allied lowers the dividend payout ratio, then more of its earnings will be retained and thus the Payout: smaller the AFN. Here we lower the payout, so the AFN declines. $110 $12 -$102 M: $77 -$37 -$189 -5303 Change all variables simultaneously to g 5% and the other values as indicated above. The result is a large but negative AFN, indicating that the 31 firm is generating a substantial amount of capital. 32 3.45% Part V. Sustainable Growth Rate Maximum achievable growth without raising external funds, i.e., 9 that forces AFN-0, holding other variables at base-case levels. Use g - 3.45% and you will see that AFN=0. Goal Seek Setelt 1822 To value: By changing cel: S$10 The sustainable growth rate is found using Excel's Goal Seek. AFN (calculated in Cell B22) is set to zero by changing the growth rate in Cell 110. Once you click OK, the growth rate in Cell 110 changes until AFN equals zero. You should see that this growth rate is 3.45%. Now suppose that the current assets were used at full capacity but that fixed assets had been used at only 96% of capacity in 2016. Therefore, if fixed assets had been used to full capacity, sales could have reached $3,125 million before any INTEGRATED CASE NEW WORLD CHEMICALS INC. 16-16 FINANCIAL FORECASTING Sue Wilson, the new financial manager of New World Chemicals (NWC), a California producer of specialized chemicals for use in fruit orchards, must prepare a formal financial forecast for 2017. NWC's 2016 sales were $2 billion, and the marketing department is forecasting a 25% increase for 2017. Wilson thinks the company was operating at full capacity in 2016, but she is not sure. The first step in her forecast was to assume that key ratios would remain unchanged and that it would be "business as usual" at NWC. The 2016 financial statements, the 2017 initial forecast, and a ratio analysis for 2016 and the 2017 initial forecast are given in Table IC 16.1. Assume that you were recently hired as Wilson's assistant and that your first major task is to help her develop the formal financial forecast. She asks you to begin by answering the following questions a. Assume (1) that NWC was operating at full capacity in 2016 with respect to all assets, (2) that all assets must grow at the same rate as sales, (3) that accounts payable and accrued liabilities also will grow at the same rate as sales, and (4) that the 2016 profit margin and dividend payout will be maintained Under those conditions, what would the AFN equation predict the company's financial requirements to be for the coming year? b. Consultations with several key managers within NWC, including production, inventory, and receivable managers, have yielded some very useful information. 1. NWC's high DSO is largely due to one significant customer who battled through some hardships the past 2 years but who appears to be financially healthy again and is generating strong cash flow. As a result, NWC's accounts receivable manager expects the firm to lower receivables enough for a calculated DSO of 34 days without adversely affecting sales. 2. NWC was operating slightly below capacity, but its forecasted growth will require a new facility, which is expected to increase NWC's net fixed assets to $700 million 3. A relatively new inventory management system (installed last year) has taken some time to catch on and to operate efficiently. NWC's inventory tumover improved slightly last year, but this year NWC expects even more improvement as inventories decrease and inventory tumover is expected to rise to 10x Incorporate that information into the 2017 initial forecast results, as these adjustments to the initial forecast represent the final forecast for 2017. (Hint: Total assets do not change from the initial forecast.) Calculate NWC's forecasted ratios based on its final forecast and compare them with the company's 2016 historical ratios, the 2017 initial forecast ratios, and the industry averages. How does NWC compare with the average firm in its industry, and is the company's financial position expected to improve during the coming year? Explain. d. Based on the final forecast, calculate NWC's free cash flow for 2017. How does this FCF differ from the FCF forecasted by NWC's initial "business as usual" forecast? e. Initially, some NWC managers questioned whether the new facility expansion was necessary, especially as it results in increasing net fixed assets from $500 million to $700 million (a 40% increase). However, after extensive discussions about NWC needing to position itself for future growth and being flexible and competitive in today's marketplace, NWC's top managers agreed that the expansion was necessary. Among the issues raised by opponents was that NWC's fixed assets were being operated at only 85% of capacity. Assuming that its fixed assets were operating at only 85% of capacity, by how much could sales have increased, both in dollar terms and in percentage terms, before NWC reached full capacity? f. How would changes in the following items affect the AFN: (1) the dividend payout ratio, (2) the profit margin, (3) the capital intensity ratio, and (4) NWC beginning to buy from its suppliers on terms that permit it to pay after 60 days rather than after 30 days? (Consider each item separately and hold all other things constant.) Topic: Financial Planning and Forecasting Textbook Chapter 16: Integrated Case - New World Chemicals Inc (pp. 591 592) Required to develop financial forecasts of cash flows given data for 2016 Make reasonable assumptions as decided by your group to forecast FCFs for 2017, 2018, 2019-2020 (you do not have to incorporate all details stated on Page 591) Incorporate any reasonable uncertainty as decided by your group for any risky scenarios You are required to calculate investment prospects for this project Submit your group analysis as a Word document supported by work shown in Excel Worksheet Please Note: Your detailed work shown in Excel is worth 15% of the assignment grade Current asses! Fixed assets A 'C/50 S ,000 .00 $1,000 $1.000 0.333 33.3% operating at full capacity. TABLE 15.1 Additional Funds Needed (AFN) Model (Millions of Dollars) H I A B C D E F G 2 Part I. 2016 Data from Chapter Tables 3.1 and 32 A Assets at 12/31/16. All assets were needed for 2016 sales 4S, 2016 Sales 5 2016 Net Income 6 2016 Dividends 7 L 2016 payables + accruals, which increase spontaneously with sales Base C 2016 Data 10.00% 0.6667 & Partil Data Used in the AENEquation: 2016 Ratios Hein Constant AFN - Additional Funds Needed to buy assets needed to support growth Arts in addition to funds raised internally, L., AFN represents required external funds. 10 g - Target growth rate in sales. A/S, - Assets required per $1 of sales $2,000/$3,000. When multiplied by the increase in sales shows the required new assets for the coming year. Also called the capital intensity ratio. The higher this ratio, the more new assets the firm will need to 11 support a given amount of growth. 12S, 2017 Sales (1+)(S.) - (1.1$3,000) 13 As Growth in sales - S.-S, - $3,300 - $3.000. Can also be found as 18 - (S.) LYS, -Spontaneously generated funds per dollar of new sales. When multiplied by As, we find the new payables and accruals that are available to support growth. $3,300 $300 0.0667 0.0392 M-Profit margin on sales 2016 net incomals. $117.5/53,000. Multiply by S. (not 15 s.) to find the net income available in 2017 for dividends or growth. 11 - Dividend Payout Ratio - 1 - (Dividends/Net Income) - 1 - ($57.5/5117.50). The lower the payout rate, the more of the net income is retained to support growth 0.5106 Parti The AFN. Equation AFN - Required increase in assets Funds obtained as new retained earnings. Based on 2017 sales Spontaneous Increase in payables and accruals (L./S.AS 0.0667(5300) $20 - (A, 45,MAS 0.6667(5300) $200 $114 million MS,(1 - Payout) 0.0392($3,300(0.5106) $66 21 22 AFN - (continued 576 Part 6 Working Capital Management, Forecasting, and Multinational Financial Management Additional Funds Needed (AFN) Model (Millions of Dollars) (Continued) TABLE 16.1 AFN (Old = $114) Change: New New - Old 23 Part IV Sensitivity Analysis: AEN with Changed Input Values 5201 $87 $27 -$87 $64 -$50 Higher 15%, up from 10%. With faster growth, the firm needs more new Growth: assets. Lower 5% down from 10%. With slower growth, the firm needs less 26 Growth: new assets. 0.5000, down from 0.6667. This factor is called the capital intensity ratio. We lowered it in the sample; and with a lower A/S value, fewer assets are required for any i loval of sales. If Allied's management can Ironcs the total to turnover ratio, the A/S, ratio will declina and that will reduce AFN. 0.0800, up from 0.0667. Allied spontaneously gearates funds from accounts payable and accruais; and the larger the LTS, L,978, ratio, the smaller the need for external financing. Here we increase the ratio. With a higher value, more spontaneous funds are available; so the AFN declines. 0.1000, up from 0.0392. If the profit margin increases, more earnings will be available to support growth and thus the smaller the AFN. Here we increase M and the AFN declines. 0.2000, down from 0.4894. If Allied lowers the dividend payout ratio, then more of its earnings will be retained and thus the Payout: smaller the AFN. Here we lower the payout, so the AFN declines. $110 $12 -$102 M: $77 -$37 -$189 -5303 Change all variables simultaneously to g 5% and the other values as indicated above. The result is a large but negative AFN, indicating that the 31 firm is generating a substantial amount of capital. 32 3.45% Part V. Sustainable Growth Rate Maximum achievable growth without raising external funds, i.e., 9 that forces AFN-0, holding other variables at base-case levels. Use g - 3.45% and you will see that AFN=0. Goal Seek Setelt 1822 To value: By changing cel: S$10 The sustainable growth rate is found using Excel's Goal Seek. AFN (calculated in Cell B22) is set to zero by changing the growth rate in Cell 110. Once you click OK, the growth rate in Cell 110 changes until AFN equals zero. You should see that this growth rate is 3.45%. Now suppose that the current assets were used at full capacity but that fixed assets had been used at only 96% of capacity in 2016. Therefore, if fixed assets had been used to full capacity, sales could have reached $3,125 million before any INTEGRATED CASE NEW WORLD CHEMICALS INC. 16-16 FINANCIAL FORECASTING Sue Wilson, the new financial manager of New World Chemicals (NWC), a California producer of specialized chemicals for use in fruit orchards, must prepare a formal financial forecast for 2017. NWC's 2016 sales were $2 billion, and the marketing department is forecasting a 25% increase for 2017. Wilson thinks the company was operating at full capacity in 2016, but she is not sure. The first step in her forecast was to assume that key ratios would remain unchanged and that it would be "business as usual" at NWC. The 2016 financial statements, the 2017 initial forecast, and a ratio analysis for 2016 and the 2017 initial forecast are given in Table IC 16.1. Assume that you were recently hired as Wilson's assistant and that your first major task is to help her develop the formal financial forecast. She asks you to begin by answering the following questions a. Assume (1) that NWC was operating at full capacity in 2016 with respect to all assets, (2) that all assets must grow at the same rate as sales, (3) that accounts payable and accrued liabilities also will grow at the same rate as sales, and (4) that the 2016 profit margin and dividend payout will be maintained Under those conditions, what would the AFN equation predict the company's financial requirements to be for the coming year? b. Consultations with several key managers within NWC, including production, inventory, and receivable managers, have yielded some very useful information. 1. NWC's high DSO is largely due to one significant customer who battled through some hardships the past 2 years but who appears to be financially healthy again and is generating strong cash flow. As a result, NWC's accounts receivable manager expects the firm to lower receivables enough for a calculated DSO of 34 days without adversely affecting sales. 2. NWC was operating slightly below capacity, but its forecasted growth will require a new facility, which is expected to increase NWC's net fixed assets to $700 million 3. A relatively new inventory management system (installed last year) has taken some time to catch on and to operate efficiently. NWC's inventory tumover improved slightly last year, but this year NWC expects even more improvement as inventories decrease and inventory tumover is expected to rise to 10x Incorporate that information into the 2017 initial forecast results, as these adjustments to the initial forecast represent the final forecast for 2017. (Hint: Total assets do not change from the initial forecast.) Calculate NWC's forecasted ratios based on its final forecast and compare them with the company's 2016 historical ratios, the 2017 initial forecast ratios, and the industry averages. How does NWC compare with the average firm in its industry, and is the company's financial position expected to improve during the coming year? Explain. d. Based on the final forecast, calculate NWC's free cash flow for 2017. How does this FCF differ from the FCF forecasted by NWC's initial "business as usual" forecast? e. Initially, some NWC managers questioned whether the new facility expansion was necessary, especially as it results in increasing net fixed assets from $500 million to $700 million (a 40% increase). However, after extensive discussions about NWC needing to position itself for future growth and being flexible and competitive in today's marketplace, NWC's top managers agreed that the expansion was necessary. Among the issues raised by opponents was that NWC's fixed assets were being operated at only 85% of capacity. Assuming that its fixed assets were operating at only 85% of capacity, by how much could sales have increased, both in dollar terms and in percentage terms, before NWC reached full capacity? f. How would changes in the following items affect the AFN: (1) the dividend payout ratio, (2) the profit margin, (3) the capital intensity ratio, and (4) NWC beginning to buy from its suppliers on terms that permit it to pay after 60 days rather than after 30 days? (Consider each item separately and hold all other things constant.)