Build-a-model

Build-a-modelStarting with this partial model, which contains
financial statements and other information, complete sections a
thru g. All sections in yellow must be completed using
formulas. All data must be computed using formulas referencing
data from the financial statements and other data. Manual entry
of data for solutions will result in zero points for the particular
calculation.Income Statement for the Year Ending December 31
(Millions of Dollars)2019Net Sales$ 800.0Costs (except
depreciation)$ 576.0Depreciation$ 60.0 Total operating
costs$ 636.0Earning before int. & tax$ 164.0 Less interest$
32.0Earning before taxes$ 132.0 Taxes (25%)$ 33.0Net
income before pref. div.$ 99.0 Preferred div.$ 9.00Net
income avail. for com. div.$ 90.0Common dividends$
30.0Addition to retained earnings$ 60.0Number of shares (in
millions)10Dividends per share$ 3.00Tax Rate25%Balance
Sheets for December 31 (Millions of
Dollars)Assets2019Liabilities and Equity2019Cash$
28.0Accounts Payable$ 16.0Short-term investments40.0Notes
payable30.0Accounts
receivable80.0Accruals24.0Inventories180.0 Total current
liabilities$ 70.0 Total current assets$ 328.0Long-term
bonds$ 300.0Net plant and equipment600.0Preferred stock$
90.0Total Assets$ 928.0Common Stock
(Par plus PIC)$ 257.0Retained earnings211.0 Common
equity$ 468.0Total liabilities and equity$ 928.0Key
Assumptions: Operating ratios remain unchanged from values
in most recent year. Sales are expected to increase, 15%, 10%,
6%, and 6% during the next four years. The tax rate will remain
at 25% and WACC is assumed to be 15% for all years. This data
should be in a separate input table and referenced for the
calculations when needed. This means you create an input table
for the key assumptions data.a. Calculate the actual operating
and projected ratios. Also fill in the tax rate and WACC for
each year.

(6.75pts)InputsActualProjectedProjectedProjectedProjected12/3
1/1912/31/2012/31/2112/31/2212/31/23Sales Growth
RateCosts/SalesDepreciation/(Net PPE)Cash/Sales(Acct.
Rec.)/SalesInventories/Sales(Net PPE)/Sales(Acct.
Pay.)/SalesAccruals/SalesTax rateWeighted average cost of
capital (WACC)b. Forecast the parts of the income statement
and balance sheets necessary to calculate free cash flow.
(13.75pts)Partial Income Statement for the Year Ending
December 31 (Millions of
Dollars)ActualProjectedProjectedProjectedProjectedIncome
Statement Items12/31/1912/31/2012/31/2112/31/2212/31/23Net
SalesCosts (except depreciation)Depreciation Total operating
costsEarning before int. & taxPartial Balance Sheets for
December 31 (Millions of
Dollars)ActualProjectedProjectedProjectedProjectedOperating
Assets12/31/1912/31/2012/31/2112/31/2212/31/23CashAccounts
receivableInventoriesNet plant and equipmentOperating
LiabilitiesAccounts PayableAccrualsc. Calculate free cash
flow for each projected year. Also calculate the growth rates of
free cash flow each year to ensure that there is constant growth
(i.e., the same as the constant growth rate in sales) by the end of
the forecast period.
(11.25pts)ActualProjectedProjectedProjectedProjectedCalculati
on of FCF12/31/1912/31/2012/31/2112/31/2212/31/23Operating
current assetsOperating current liabilitiesNet operating working
capitalNet PPETotal net operating capitalNOPATInvestment in
total net operating capitalnaFree cash flownaGrowth in FCF
(gL)naGrowth in salesd. Calculate the return on invested
capital (ROIC=NOPAT/Total net operating capital) and the
growth rate in free cash flow. Compare to the WACC. (2.5pts)
ActualProjectedProjectedProjectedProjected12/31/1912/31/2012
/31/2112/31/2212/31/23Return on invested capital
(ROIC=NOPAT/[Total net operating capital])Weighted average
cost of capital (WACC)e. Calculate the current value of
operations. (Hint: First calculate the horizon value at the end of
the forecast period, which is equal to the value of operations at

the end of the forecast period. Assume that the annual growth
rate beyond the horizon is equal to the growth rate at the
horizon.) (6.5pts)Weighted average cost of capital
(WACC)ActualProjectedProjectedProjectedProjected12/31/1912
/31/2012/31/2112/31/2212/31/23Free cash flowLong-term
constant growth in FCFHorizon valuePresent value of horizon
valuePresent value of forecasted FCFValue of operations (]PV
of HV] + [PV of FCF])Total net operating capitalf. Calculate
the price per share of common equity as of 12/31/2018.
(3.25pts)Millions except price per shareActual12/31/19Value of
operations+ Value of short-term investmentsTotal value of
company− Total value of all debt− Value of preferred
stockValue of common equityDivided by number of sharesPrice
per shareg. If the actual price of the stock is $69.75, what is
your assessment of the proposed operating plan? What are some
actions the company can take to improvement the operating
plan? Explain how such actions would improve the plan. (6 pts)
ChapterTool KitChapter 1211/21/18Corporate Valuation and
Financial Planning12-2 Financial Planning at MicroDrive,
Inc.The process used by MicroDrive to forecast the free cash
flows from its operating plan is described in the sections
below.We begin with MicroDrive's most recent financial
statements and selected additional data.Figure 12-1
MicroDrive’s Most Recent Financial Statements (Millions,
Except for Per Share Data)INCOME STATEMENTSBALANCE
SHEETS20182019Assets20182019Net
sales$4,800$5,000Cash$102$100COGS (excl.
depr.)3,7103,900ST
Investments4010Depreciation180200Accounts
receivable384500Other operating
expenses470500Inventories7741,000EBIT$440$400Total
CA$1,300$1,610Interest expense4060Net PP&E1,7802,000Pre-
tax earnings$400$340Total assets$3,080$3,610Taxes
(25%)10085NI before pref. div.$300$255Liabilities and
equityPreferred div.77Accounts payable$180$200Net

income$293$248Notes payable28150Accruals370400Other
DataTotal CL$578$750Common dividends$59.4$60.0Long-term
bonds350520Addition to RE$233.6$188.0Total
liabilities$928$1,270Tax rate25%25%Preferred
stock100100Shares of common stock6060Common
stock500500Earnings per share$4.88$4.13Retained
earnings1,5521,740Dividends per share$0.99$1.00Total
common equity$2,052$2,240Price per share$45.00$31.00Total
liabs. & equity$3,080$3,610The figure below shows all the
inputs required to project the financial statements for the
scenario that has been selected with the Scenario Manager:
Data, What-If Analysis, Scenario Manager. There are four
scenarios. The first is named Status Quo because all operating
ratios except the sales growth rate are assumed to remain
unchanged. The initial sales growth rate was chosen by
MicroDrive's managers based on the existing product lines. The
growth rate declines over time until it eventually levels off at a
sustainable rate. The second scenario is one with higher sales
growth but no improvements in operations. The third scenario
improves operations but does not increase sales growth rates
higher than those in the Status Quo scenario. The fourth
scenario improves operations and sales growth rates. Section 1
shows the inputs required to estimate the items in an operating
plan. For each of these inputs, Section 1 shows the industry
averages, the actual values for the past two years for
MicroDrive, and the forecasted values for the next five years.
The managers assumed the inputs for future years (except the
sales growth rate) would be equal to the inputs in the first
projected year.MicroDrive's managers assume that sales will
eventually level off at a sustaniable constant rate.Sections 2 and
3 show the data required to estimate the weighted average cost
of capital. Section 4 shows the forecasted growth rate in
dividends.Note: These inputs are linked throughout the model.
If you want to change an input, do it here and not other places
in the model.Figure 12-2MicroDrive's Forecast: Inputs for the
Selected Scenario (Millions of Dollars)Status

QuoIndustryMicroDriveMicroDriveInputsActualActualForecast1
. Operations20192018201920202021202220232024Sales growth
rate5%10.0%4.2%10.000%8.000%7.000%5.000%5.000%(COGS
excl.
depr.)/Sales76%77.3%78.0%78.000%78.000%78.000%78.000%
78.000%Depreciation/(Net
PP&E)9%10.1%10.0%10.000%10.000%10.000%10.000%10.000
%(Other op.
exp.)/Sales10%9.8%10.0%10.000%10.000%10.000%10.000%10
.000%Cash/Sales1%2.1%2.0%2.000%2.000%2.000%2.000%2.00
0%(Acc.
rec.)/Sales8%8.0%10.0%10.000%10.000%10.000%10.000%10.0
00%Actual Historical
FinancingInventory/Sales15%16.1%20.0%20.000%20.000%20.0
00%20.000%20.000%20182019(Net
PP&E)/Sales33%37.1%40.0%40.000%40.000%40.000%40.000%
40.000%Short-term debt$28$150(Acc.
pay.)/Sales4%3.8%4.0%4.000%4.000%4.000%4.000%4.000%Lo
ng-term
debt$350$520Accruals/Sales7%7.7%8.0%8.000%8.000%8.000%
8.000%8.000%Preferred stock$100$100Tax
rate25%25.0%25.0%25.000%25.000%25.000%25.000%25.000%
Market value of equity = (Price x # shares)$2,700$1,860Cost of
strategic
initiativesNANANA0.000%0.000%0.000%0.000%0.000%Total$
3,178$2,6302. Capital StructureActual Market WeightsTarget
Market Weights% Short-term
debt4%0.9%5.7%4%4%4%4%4%Percent short-term
debt0.9%5.7%% Long-term
debt20%11.0%19.8%20%20%20%20%20%% Preferred
stock2%3.1%3.8%2%2%2%2%2%% Common
stock74%85.0%70.7%74%74%74%74%74%See the box to the
right for calculations of the actual capital structures, based on
market values, for the past two years.Percent long-term
debt11.0%19.8%% Line of
credit0%0.0%0.0%0%0%0%0%0%Percent preferred

stock3.1%3.8%3. Costs of
CapitalForecastTotal15.0%29.3%Rate on ST
debt8.0%8.0%8.0%8.0%8.0%Rate on LT
debt10.0%10.0%10.0%10.0%10.0%Rate on preferred stock
(ignoring flotation costs)7.0%7.0%7.0%7.0%7.0%Flotation cost
of new preferred stock2.1%2.1%2.1%2.1%2.1%Cost of
equity13.0%13.0%13.0%13.0%13.0%Additional rate on line of
credit vs. ST debt1.5%1.5%1.5%1.5%1.5%4. Target Dividend
PolicyActualForecastGrowth rate of
dividends11%1.0%5%5%5%5%5%12-3 Forecasting
OperationsThe figure below shows the forecasted items for the
operating plan. For convenience, we repeat the inputs of
operating ratios.Section B1 shows the sales forecast. Each
year's sales is equal to the previous year's sales multiplied by
the forecasted sales growth rate.Section B2 shows the
projections of operating assets and operating liabilities. The
operating asset for a particular year is equal to the product of
that asset's ratio in Section A1 and that particular year's
projected sales. The operating liabilities are projected in a
similar manner.Section B3 shows the projections of operating
income. The COGS and other operating expenses are equal to
the product of the ratio in Section A1 and that particular year's
projected sales. Depreciation is equal to the product of the ratio
in Section A1 and that particular year's projected net PP&E.
EBIT is net sales minus COGS, depreciation, and other
operating expenses (including the cost to implement the
strategic initiatives in the other scenarios). NOPAT is EBIT(1-
T), where T is the tax rate. Section B4 shows the projections of
free cash flows. NOWC is equal to operating CA (i.e., cash,
accounts receivable, and inventories from Section B2) minus
operating CL (i.e., accounts payable and accruals from Section
4). Total capital is equal to the sum of NOWC and net PP&E
(from Section B2). Section B5 shows the results of the
operating plan. The first rows in Section B5 report the target
WACC (calculated as shown in Chapter 9), the return on
invested capital, and the growth rate in FCF. The horizon value,

value of operations, and estimated intrinsic stock price are
calculated using the FCF valuation model as present in Chapter
7.The forecast of operations for the current scenario is shown
below. To look at a different scenario, look in the menu bar and
choose Data, What-If Analysis, Scenario Manager, select a
scenario and click Show. The information for each scenario is
shown to the right, but the values are fixed.Note: Do not change
inputs here! The "input" cells here are linked to the ones in
Figure 12-2. If you want to change inputs, do so in 12-2 or use
Scenario Manager.Figure 12-3Fixed Values for the Scenario
Shown BelowFixed Values for the Scenario Shown BelowFixed
Values for the Scenario Shown BelowFixed Values for the
Scenario Shown BelowMicroDrive's Forecast of Operations for
the Selected Scenario (Millions of Dollars, Except for per Share
Data)Status QuoIndustryMicroDriveMicroDriveFixed values for
each scenario are shown to the right.Status
QuoIndustryMicroDriveMicroDriveHigher Sales Growth
(Only)IndustryMicroDriveMicroDriveImprove Operations
(Only)IndustryMicroDriveMicroDriveImprove Operations and
GrowthIndustryMicroDriveMicroDrivePanel A:
InputsActualActualForecastPanel A:
InputsActualActualForecastA1.
Operations20192018201920202021202220232024A1.
Operations20192018201920202021202220232024A1.
Operations20192018201920202021202220232024A1.
Operations20192018201920202021202220232024A1.
Operations20192018201920202021202220232024Sales growth
rate5%10%4%10.0%8.0%7.0%5.0%5.0%Sales growth
rate5%10%4%11.0%9.0%8.0%6.0%6.0%(COGS excl.
depr.)/Sales76%77%78%78.0%78.0%78.0%78.0%78.0%(COGS

excl.
depr.)/Sales76%77%78%78.0%78.0%78.0%78.0%78.0%(COGS
excl.
depr.)/Sales76%77%78%78.0%78.0%78.0%78.0%78.0%(COGS
excl.
depr.)/Sales76%77%78%78.0%77.1%77.1%77.1%77.1%(COGS
excl.
depr.)/Sales76%77%78%78.0%77.1%77.1%77.1%77.1%Depreci
ation/(Net
PP&E)9%10%10%10.0%10.0%10.0%10.0%10.0%Depreciation/(
Net
Net
Net
Net PP&E)9%10%10%10.0%10.0%10.0%10.0%10.0%(Other op.
exp.)/Sales10%10%10%10.0%10.0%10.0%10.0%10.0%(Other
op.
exp.)/Sales10%10%10%10.0%10.0%10.0%10.0%10.0%(Other
op.
exp.)/Sales10%10%10%10.0%10.0%10.0%10.0%10.0%(Other
op.
exp.)/Sales10%10%10%10.0%10.0%10.0%10.0%10.0%(Other
op.
exp.)/Sales10%10%10%10.0%10.0%10.0%10.0%10.0%Cash/Sal
es1%2%2%2.0%2.0%2.0%2.0%2.0%Cash/Sales1%2%2%2.0%2.
0%2.0%2.0%2.0%Cash/Sales1%2%2%2.0%2.0%2.0%2.0%2.0%
Cash/Sales1%2%2%2.0%2.0%2.0%2.0%2.0%Cash/Sales1%2%2
%2.0%2.0%2.0%2.0%2.0%(Acc.
rec.)/Sales8%8%10%10.0%10.0%10.0%10.0%10.0%(Acc.
rec.)/Sales8%8%10%10.0%10.0%10.0%10.0%10.0%(Acc.
rec.)/Sales8%8%10%10.0%10.0%10.0%10.0%10.0%(Acc.
rec.)/Sales8%8%10%10.0%10.0%10.0%10.0%10.0%(Acc.
rec.)/Sales8%8%10%10.0%10.0%10.0%10.0%10.0%Inventory/S
ales15%16%20%20.0%20.0%20.0%20.0%20.0%Inventory/Sales

15%16%20%20.0%20.0%20.0%20.0%20.0%Inventory/Sales15%
16%20%20.0%20.0%20.0%20.0%20.0%Inventory/Sales15%16%
20%18.0%15.0%15.0%15.0%15.0%Inventory/Sales15%16%20%
18.0%15.0%15.0%15.0%15.0%(Net
PP&E)/Sales33%37%40%40.0%40.0%40.0%40.0%40.0%(Net
PP&E)/Sales33%37%40%40.0%40.0%40.0%40.0%40.0%(Net
PP&E)/Sales33%37%40%40.0%40.0%40.0%40.0%40.0%(Net
PP&E)/Sales33%37%40%38.0%36.0%36.0%36.0%36.0%(Net
PP&E)/Sales33%37%40%38.0%36.0%36.0%36.0%36.0%(Acc.
pay.)/Sales4%4%4%4.0%4.0%4.0%4.0%4.0%(Acc.
pay.)/Sales4%4%4%4.0%4.0%4.0%4.0%4.0%(Acc.
pay.)/Sales4%4%4%4.0%4.0%4.0%4.0%4.0%(Acc.
pay.)/Sales4%4%4%4.0%4.0%4.0%4.0%4.0%(Acc.
pay.)/Sales4%4%4%4.0%4.0%4.0%4.0%4.0%Accruals/Sales7%
8%8%8.0%8.0%8.0%8.0%8.0%Accruals/Sales7%8%8%8.0%8.0
%8.0%8.0%8.0%Accruals/Sales7%8%8%8.0%8.0%8.0%8.0%8.0
%Accruals/Sales7%8%8%8.0%8.0%8.0%8.0%8.0%Accruals/Sal
es7%8%8%8.0%8.0%8.0%8.0%8.0%Tax
rate25%25%25%25.0%25.0%25.0%25.0%25.0%Tax
rate25%25%25%25.0%25.0%25.0%25.0%25.0%Tax
rate25%25%25%25.0%25.0%25.0%25.0%25.0%Tax
rate25%25%25%25.0%25.0%25.0%25.0%25.0%Tax
rate25%25%25%25.0%25.0%25.0%25.0%25.0%Cost of
strategic initiativesNANANA$0$0$0$0$0Cost of strategic
initiativesNANANA$0$0$0$0$0Cost of strategic
initiativesNANANA$150$0$0$0$0Panel B:
ResultsActualForecastPanel B: ResultsActualForecastPanel B:
ResultsActualForecastPanel B: ResultsActualForecastPanel B:
ResultsActualForecastB1. Sales
Revenues201920202021202220232024B1. Sales
Revenues201920202021202220232024B1. Sales
Revenues201920202021202220232024B1. Sales
Revenues201920202021202220232024B1. Sales
Revenues201920202021202220232024Net

sales$5,000$5,500$5,940$6,356$6,674$7,007Net
sales$5,000$5,500$5,940$6,356$6,674$7,007Net
sales$5,000$5,550$6,050$6,533$6,925$7,341Net
sales$5,000$5,500$5,940$6,356$6,674$7,007Net
sales$5,000$5,550$6,050$6,533$6,925$7,341B2. Operating
Assets and Operating LiabilitiesB2. Operating Assets and
Operating LiabilitiesB2. Operating Assets and Operating
LiabilitiesB2. Operating Assets and Operating LiabilitiesB2.
Operating Assets and Operating
LiabilitiesCash$100$110$119$127$133$140Cash$100$110$119
$127$133$140Cash$100$111$121$131$139$147Cash$100$110$
119$127$133$140Cash$100$111$121$131$139$147Accounts
receivable$500$550$594$636$667$701Accounts
receivable$500$555$605$653$693$734Inventories$1,000$1,100
$1,188$1,271$1,335$1,401Inventories$1,000$1,100$1,188$1,27
1$1,335$1,401Inventories$1,000$1,110$1,210$1,307$1,385$1,4
68Inventories$1,000$990$891$953$1,001$1,051Inventories$1,0
00$999$907$980$1,039$1,101Net
PP&E$2,000$2,200$2,376$2,542$2,669$2,803Net
PP&E$2,000$2,200$2,376$2,542$2,669$2,803Net
PP&E$2,000$2,220$2,420$2,613$2,770$2,936Net
PP&E$2,000$2,090$2,138$2,288$2,402$2,523Net
PP&E$2,000$2,109$2,178$2,352$2,493$2,643Accounts
payable$200$220$238$254$267$280Accounts
payable$200$222$242$261$277$294Accruals$400$440$475$50
8$534$561Accruals$400$440$475$508$534$561Accruals$400$
444$484$523$554$587Accruals$400$440$475$508$534$561Ac
cruals$400$444$484$523$554$587B3. Operating IncomeB3.
Operating IncomeB3. Operating IncomeB3. Operating
IncomeB3. Operating IncomeCOGS (excl.

depr.)$3,900$4,290$4,633$4,958$5,205$5,466COGS (excl.
depr.)$3,900$4,290$4,633$4,958$5,205$5,466COGS (excl.
depr.)$3,900$4,329$4,719$5,096$5,402$5,726COGS (excl.
depr.)$3,900$4,290$4,578$4,898$5,143$5,401COGS (excl.
depr.)$3,900$4,329$4,662$5,035$5,337$5,658Depreciation$200
$220$238$254$267$280Depreciation$200$220$238$254$267$2
80Depreciation$200$222$242$261$277$294Depreciation$200$2
09$214$229$240$252Depreciation$200$211$218$235$249$264
Other operating expenses$500$550$594$636$667$701Other
operating expenses$500$550$594$636$667$701Other operating
expenses$500$555$605$653$693$734Other operating
expenses$500$550$594$636$667$701Other operating
expenses$500$555$605$653$693$734Cost of strategic
initiativesNA$0$0$0$0$0Cost of strategic
initiativesNA$150$0$0$0$0EBIT$400$440$475$508$534$561E
BIT$400$440$475$508$534$561EBIT$400$394$484$523$554$
587EBIT$400$351$554$593$623$654EBIT$400$305$564$610$
646$685Net operating profit after
taxes$300$330$356$381$400$420Net operating profit after
taxes$300$229$423$457$485$514B4. Free Cash FlowsB4. Free
Cash FlowsB4. Free Cash FlowsB4. Free Cash FlowsB4. Free
Cash FlowsNet operating working
capital$1,000$1,100$1,188$1,271$1,335$1,401Net operating
working capital$1,000$1,100$1,188$1,271$1,335$1,401Net
operating working
capital$1,000$1,110$1,210$1,307$1,385$1,468Net operating
working capital$1,000$990$891$953$1,001$1,051Net operating
working capital$1,000$999$907$980$1,039$1,101Total net
operating capital$3,000$3,300$3,564$3,813$4,004$4,204Total
net operating

capital$3,000$3,300$3,564$3,813$4,004$4,204Total net
operating capital$3,000$3,330$3,630$3,920$4,155$4,405Total
net operating
capital$3,000$3,080$3,029$3,241$3,404$3,574Total net
operating capital$3,000$3,108$3,085$3,332$3,532$3,744FCF =
NOPAT – Δ net op capital−$210$30$92$132$210$220FCF =
NOPAT – Δ net op capital−$210$30$92$132$210$220.23FCF =
NOPAT – Δ net op capital−$210-$35$63$102$180$191.14FCF
= NOPAT – Δ net op
capital−$210$183$466$233$305$320.16FCF = NOPAT – Δ net
op capital−$210$121$446$210$285$301.77B5. Estimated
Intrinsic ValueNote: the WACC is rounded to 4 decimal
places.B5. Estimated Intrinsic ValueB5. Estimated Intrinsic
ValueB5. Estimated Intrinsic ValueB5. Estimated Intrinsic
ValueTarget WACC11.50%11.50%11.50%11.50%11.50%Target
WACC11.50%11.50%11.50%11.50%11.50%Target
WACC11.50%11.50%11.50%11.50%11.50%Target
WACC11.50%11.50%11.50%11.50%11.50%Target
WACC11.50%11.50%11.50%11.50%11.50%OP ratio:
NOPAT/Sales6%6.0%6.0%6.0%6.0%6.0%OP ratio:
NOPAT/Sales6%4.1%7.0%7.0%7.0%7.0%CR ratio: (Total op.
cap.)/Sales61%60.0%60.0%60.0%60.0%60.0%CR ratio: (Total
op. cap.)/Sales61%60.0%60.0%60.0%60.0%60.0%CR ratio:
(Total op. cap.)/Sales61%60.0%60.0%60.0%60.0%60.0%CR
ratio: (Total op.
cap.)/Sales61%56.0%51.0%51.0%51.0%51.0%CR ratio: (Total
op. cap.)/Sales61%56.0%51.0%51.0%51.0%51.0%ROIC:
NOPAT/(Total op.
cap.)10.0%10.0%10.0%10.0%10.0%10.0%ROIC: NOPAT/(Total
op. cap.)10.0%10.0%10.0%10.0%10.0%10.0%ROIC:
NOPAT/(Total op.
cap.)10.0%8.9%10.0%10.0%10.0%10.0%ROIC: NOPAT/(Total
op. cap.)10.0%8.5%13.7%13.7%13.7%13.7%ROIC:

NOPAT/(Total op.
cap.)10.0%7.4%13.7%13.7%13.7%13.7%Growth in
FCF208.0%42.7%59.1%5.0%Growth in
FCF208.0%42.7%59.1%5.0%Growth in FCF-
283.4%60.6%77.4%6.0%Growth in FCF154.4%-
50.1%31.0%5.0%Growth in FCF269.2%-52.8%35.3%6.0%Value
of Operations (12/31/2024)Estimated intrinsic stock price
(12/31/2019)Value of Operations (12/31/2024)Estimated
intrinsic stock price (12/31/2019)Value of Operations
(12/31/2024)Estimated intrinsic stock price (12/31/2019)Value
of Operations (12/31/2024)Estimated intrinsic stock price
(12/31/2019)Value of Operations (12/31/2024)Estimated
intrinsic stock price (12/31/2019)Value of
operations$2,524Value of operations$2,524Value of
operations$2,458Value of operations$4,091Value of
operations$4,353=$3,558+ ST investments$10=$3,558+ ST
investments$10=$3,684+ ST investments$10=$5,172+ ST
investments$10=$5,816+ ST investments$10Estimated total
intrinsic value$2,534Estimated total intrinsic
value$2,534Estimated total intrinsic value$2,468Estimated total
intrinsic value$4,101Estimated total intrinsic value$4,363Value
of Operations (12/31/2019)− All debt$670Value of Operations
(12/31/2019)− All debt$670Value of Operations (12/31/2019)−
All debt$670Value of Operations (12/31/2019)− All
debt$670Value of Operations (12/31/2019)− All
debt$670Present value of HV$2,064− Preferred
stock$100Present value of HV$2,064− Preferred
stock$100Present value of HV$3,375− Preferred stock$100+
Present value of FCF$460Estimated intrinsic value of
equity$1,764+ Present value of FCF$460Estimated intrinsic
value of equity$1,764+ Present value of FCF$321Estimated
intrinsic value of equity$1,698+ Present value of
FCF$1,090Estimated intrinsic value of equity$3,331+ Present
value of FCF$978Estimated intrinsic value of

equity$3,593Value of operations =$2,524÷ Number of
shares$60.00Value of operations =$2,524÷ Number of
shares$60.00Estimated intrinsic stock price =$29.40Estimate
intrinsic stock price =$29.40Estimate intrinsic stock price
=$28.31Estimate intrinsic stock price =$55.52Estimate intrinsic
stock price =$59.8812-4 Evaluating MicroDrive's Strategic
InitiativesThe figure below shows key inputs and results for the
four scenarios: Status Quo, Higher Sales Growth (Only),
Improve Operations (Only), and Growth and Operations. The
values for each scenaro can be generated using Scenario
Manager's Summary feature: Data, What-If Analysis, Scenario
Manager, Summary. We show them in the worksheet "Scenario
Summary" as well as in the figure below. Note: we generated
the values in the Figure by manually linking them to the fixed
value output for the scenarios shown above and to the right so
that the reported values in the figure below would not change if
you decide to try the Scenario Summary feature yourself, which
we encourgage.Figure 12-4Key Inputs and Operating Results for
Possible Strategic Initiatives
(Millions, Except for Per Share Data)ScenarioLive(1)
Status Quo(2)
Higher Sales Growth (Only)(3)
Improve Operations (Only)(4)
Operations and GrowthStatus QuoPanel A: Key InputsSales
growth (Year 1)10.0%11.0%10.0%11.0%10.0%Sales growth
(Year 2)8.0%9.0%8.0%9.0%8.0%Sales growth (Year
3)7.0%8.0%7.0%8.0%7.0%Long-term sales growth
(gL)5.0%6.0%5.0%6.0%5.0% (COGS excl. depr.)/Sales (Year
1)78.0%78.0%78.0%78.0%78.0% (COGS excl. depr.)/Sales
(Year 2)78.0%78.0%77.1%77.1%78.0%Inventory/Sales for
(Year 2)20.0%20.0%15.0%15.0%20.0% (Net PP&E)/Sales (Year
1)40.0%40.0%38.0%38.0%40.0% (Net PP&E)/Sales (Year

2)40.0%40.0%36.0%36.0%40.0%Cost of strategic
initiatives$0$50$100$150$0Weighted average cost of capital
(WACC)11.50%11.50%11.50%11.50%11.50%Panel B: Key
Operating Plan ResultsOP, operating profitability (Year
5)6.0%6.0%7.0%7.0%6.0%CR, capital requirement (Year
5)60.0%60.0%51.0%51.0%60.0%ROIC, return on invested
capital (Year 5)10.00%10.00%13.72%13.72%10.00%Sales
(Year 5)$7,007$7,341$7,007$7,341$7,007NOPAT (Year
5)$420$440$490$514$420Total net operating capital ((Year
5)$4,204$4,405$3,574$3,744$4,204FCF (Year
5)$220$191$320$302$220Value of operations (Year
0)$2,524$2,458$4,091$4,353$2,524Intrinsic stock price (Year
0)$29.40$28.31$55.52$59.88$29.40Note: Operating
improvements will be sustained at the Year 2 values.12-5
Projecting MicroDrive's Financial StatementsProjecting
Financial Statements for One YearFigure 12-5, shown below,
projects MicroDrive's financial statements for the upcoming
year for the Status Quo scenario.Operating items are projected
in the identical manner as previously projected for the operating
plan.The preliminary short-term financial policy calls for no
changes in notes payable, long-term bonds, preferred stock, and
common stock, so their values from the previous year are
carried over.The interest on notes payable and long-term bonds
is based on the average amount of debt during the year, defined
as the average of the beginning debt (i.e., the debt at the end of
the previous year) and the ending debt. An identical process is
applied to preferred dividends.The preliminary short-term
financial policy calls for dividends to grow at the same rate as
the long-term sustainable growth rate in earnings (which is the
same as sales in the long-term).Section 3 in the figure below
calculates the additional financing provided by spontaneous
liabilities, external sources, and internal sources. The sum of
these three sources of financing is the total amount of additional
preliminary financing.Section 3 also calculates the total amount
of additional assets required by the operating plan.The
difference between the total additional financing and the total

additional assets is defined as the financing deficit (if the
difference is negative) or the financing surplus (if the
difference is positive).If there is a financing deficit, MicroDrive
will draw on a line of credit. The interest rate on the LOC is
equal to the rate on short-term debt plus the premium shown in
Cell E86. However, MicroDrive assumes that the LOC will be
accessed on the last day of the year, so the new line of credit
(reflected in the end-of-year balance) will not accrue enough
interest to matter. Therefore, the interest on the LOC will be
equal to the LOC balance at the beginning of the year (which is
the same as the LOC balance at the end of the previous year)
multiplied by the LOC interest rate.If there is a financing
surplus, MicroDrive will pay a special dividend.Note: Do not
change inputs here! The "input" cells here are linked to the ones
in Figure 12-2. If you want to change inputs, do so in 12-2 or
use Scenario Manager.Figure 12-5Projected Financial
Statements (Millions of Dollars)Fixed values for each scenario
are shown to the right.Fixed Values for the Scenario Shown
BelowFixed Values for the Scenario Shown BelowFixed Values
for the Scenario Shown BelowFixed Values for the Scenario
Shown BelowStatus QuoStatus QuoHigher Sales Growth
(Only)Improve Operations (Only)Improve Operations and
Growth1. Balance SheetsMost RecentForecast1. Balance
SheetsMost RecentForecast1. Balance SheetsMost
RecentForecast1. Balance SheetsMost RecentForecast1. Balance
SheetsMost RecentForecastAssets2019InputBasis for 2020
Forecast2020Assets2019InputBasis for 2020
Forecast2020Cash$100.02.00% × 2020
Sales$110.00Cash$100.02.00% × 2020
Sales$110.00Cash$100.02.00% × 2020
Sales$111.00Cash$100.02.00% × 2020
Sales$110.00Cash$100.02.00% × 2020 Sales$111.00Short-tem
investments10.0Set to zero$0.00Short-tem invesments10.0Set to

zero$0.00Short-tem invesments10.0Set to zero$0.00Short-tem
invesments10.0Set to zero$0.00Short-tem invesments10.0Set to
zero$0.00Accounts receivable500.010.00% × 2020
Sales$550.00Accounts receivable500.010.00% × 2020
Sales$555.00Inventories1,000.020.00% × 2020
Sales$1,100.00Inventories1,000.020.00% × 2020
Sales$990.00Inventories1,000.018.00% × 2020
Sales$999.00Total current assets$1,610.0$1,760.00Total current
assets$1,610.0$1,760.00Total current
assets$1,610.0$1,665.00Net PP&E2,000.040.00% × 2020
Sales$2,200.00Net PP&E2,000.040.00% × 2020
Sales$2,200.00Net PP&E2,000.040.00% × 2020
Sales$2,220.00Net PP&E2,000.038.00% × 2020
Sales$2,090.00Net PP&E2,000.038.00% × 2020
Sales$2,109.00Total assets (TA)$3,610.0$3,960.00Total assets
(TA)$3,610.0$3,960.00Total assets (TA)$3,610.0$3,996.00Total
assets (TA)$3,610.0$3,740.00Total assets
(TA)$3,610.0$3,774.00Liabilities and equityLiabilities and
equityLiabilities and equityLiabilities and equityLiabilities and
equityAccounts payable$200.04.00% × 2020
Sales$220.00Accounts payable$200.04.00% × 2020
Sales$222.00Notes payable150.0Carry over from previous
year$150.00Notes payable150.0Carry over from previous

year$150.00Accruals400.08.00% × 2020
Sales$440.00Accruals400.08.00% × 2020
Sales$440.00Accruals400.08.00% × 2020
Sales$444.00Accruals400.08.00% × 2020
Sales$440.00Accruals400.08.00% × 2020 Sales$444.00Line
of credit0.0Draw on LOC if financing deficit$78.00Line of
credit0.0Draw on LOC if financing deficit$78.00Line of
credit0.0Draw on LOC if financing deficit$0.00Total
CL$750.0$888.00Total CL$750.0$888.00Total
CL$750.0$958.50Total CL$750.0$810.00Total
CL$750.0$816.00Long-term bonds520.0Carry over from
previous year$520.00Long-term bonds520.0Carry over from
previous year$520.00Total liabilities$1,270.0$1,408.00Total
liabilities$1,270.0$1,408.00Total
liabilities$1,270.0$1,336.00Preferred stock$100.0Carry over
from previous year$100.00Preferred stock$100.0Carry over
from previous year$100.00Common stock500.0Carry over from
previous year$500.00Common stock500.0Carry over from
previous year$500.00Retained earnings1,740.0 Previous RE +
Add. to RE$1,952Retained earnings1,740.0 Previous RE + Add.
to RE$1,952Retained earnings1,740.0 Previous RE + Add. to
RE$1,918Retained earnings1,740.0 Previous RE + Add. to
RE$1,810Retained earnings1,740.0 Previous RE + Add. to

RE$1,838Total common equity$2,240.0$2,452Total common
equity$2,240.0$2,452Total common equity$2,240.0$2,418Total
common equity$2,240.0$2,310Total common
equity$2,240.0$2,338Total liabs. & equity$3,610.0$3,960Total
liabs. & equity$3,610.0$3,960Total liabs. &
equity$3,610.0$3,996Total liabs. & equity$3,610.0$3,740Total
liabs. & equity$3,610.0$3,774Check: TA − Total Liab. & Eq.
=$0.00Check: TA − Total Liab. & Eq. =$0.00Check: TA − Total
Liab. & Eq. =$0.00Check: TA − Total Liab. & Eq.
=$0.00Check: TA − Total Liab. & Eq. =$0.002. Income
StatementMost RecentForecast2. Income StatementMost
RecentForecast2. Income StatementMost RecentForecast2.
Income StatementMost RecentForecast2. Income
StatementMost RecentForecast2019InputBasis for 2020
Forecast20202019InputBasis for 2020
Forecast20202019InputBasis for 2020 Forecast2020Net
sales$5,000.0110% × 2019 Sales$5,500.00Net
sales$5,000.0110% × 2019 Sales$5,500.00Net
sales$5,000.0111% × 2019 Sales$5,550.00Net
sales$5,000.0110% × 2019 Sales$5,500.00Net
sales$5,000.0111% × 2019 Sales$5,550.00COGS (excl.
depr.)3,900.078.00% × 2020 Sales4,290.00COGS (excl.
depr.)3,900.078.00% × 2020
Sales4,329.00Depreciation200.010.00% × 2020 Net
PP&E220.00Depreciation200.010.00% × 2020 Net
PP&E210.90Other operating expenses500.010.00% × 2020
Sales550.00Other operating expenses500.010.00% × 2020

Sales555.00Cost of strategic initiatives0.0Cost of
implementation0.00Cost of strategic initiatives0.0Cost of
implementation150.00EBIT$400.0$440.00EBIT$400.0$440.00E
BIT$400.0$394.00EBIT$400.0$351.00EBIT$400.0$305.10Less:
Interest on notes20.08.00%× Avg notes$12.00Less: Interest on
notes20.08.00%× Avg notes$12.00Less: Interest on
notes20.08.00%× Avg notes$12.00 Interest on
bonds100.010.00%× Avg bonds$52.00 Interest on
LOC0.09.50%× Beginning LOC$0.00Note: See comment.
Mike Ehrhardt: 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.
The interest rate on the LOC is equal to the rate on ST debt plus
the additional amount shown in Cell E86. Interest on
LOC0.09.50%× Beginning LOC$0.00 Interest on
LOC0.09.50%× Beginning LOC$0.00Pre-tax
earnings$280.0$376.00Pre-tax earnings$280.0$376.00Pre-tax
earnings$280.0$330.00Pre-tax earnings$280.0$287.00Pre-tax
earnings$280.0$241.10Taxes (40%)85.025.00%× Pre-tax
earnings$94.00Taxes (40%)85.025.00%× Pre-tax

earnings$60.27NI before pref. div.$195.0$282.00NI before pref.
div.$195.0$282.00NI before pref. div.$195.0$247.50NI before
pref. div.$195.0$215.25NI before pref.
div.$195.0$180.83Preferred dividend7.07.00%× Avg pref.
stock$7.00Preferred dividend7.07.00%× Avg pref.
stock$7.00Net income$188.0$275.00Net
income$188.0$275.00Net income$188.0$240.50Net
income$188.0$208.25Net income$188.0$173.83Regular
common dividends$60.0105%× 2019 Dividend$63.00Regular
common dividends$60.0105%× 2019 Dividend$63.00Special
dividends$0.0Pay if financing surplus$0.00Special
dividends$0.0Pay if financing surplus$12.82Addition to
RE$128.0Net income – Dividends$212.00Addition to
RE$128.0Net income – Dividends$98.003. Elimination of the
Financial Deficit or Surplus3. Elimination of the Financial
Deficit or Surplus3. Elimination of the Financial Deficit or
Surplus3. Elimination of the Financial Deficit or Surplus3.
Elimination of the Financial Deficit or SurplusIncrease in
spontaneous liabilities (accounts payable and
accruals)$60.00Increase in spontaneous liabilities (accounts
payable and accruals)$60.00Increase in spontaneous liabilities
(accounts payable and accruals)$66.00Increase in spontaneous

liabilities (accounts payable and accruals)$60.00Increase in
spontaneous liabilities (accounts payable and accruals)$66.00+
Increase in notes payable, long-term bonds, preferred stock, and
common stock$0.00+ Increase in notes payable, long-term
bonds, preferred stock, and common stock$0.00+ Increase in
notes payable, long-term bonds, preferred stock, and common
stock$0.00+ Increase in notes payable, long-term bonds,
preferred stock, and common stock$0.00+ Increase in notes
payable, long-term bonds, preferred stock, and common
stock$0.00+ Net income minus regular common
dividends$212.00Note: See comment.
Mike Ehrhardt: This is the planned increase in the retained
earnings account.+ Net income minus regular common
dividends$212.00+ Net income minus regular common
dividends$110.83− Previous line of credit$0.00Note: See
comment.
Mike Ehrhardt: 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.−
Previous line of credit$0.00− Previous line of credit$0.00−
Previous line of credit$0.00− Previous line of
credit$0.00Increase in financing$272.00Increase in
financing$272.00Increase in financing$243.50Increase in
financing$205.25Increase in financing$176.83− Increase in total
assets$350.00− Increase in total assets$350.00− Increase in
total assets$386.00− Increase in total assets$130.00− Increase
in total assets$164.00Amount of deficit or surplus
financing:−$78.00Amount of deficit or surplus
financing:$75.25Amount of deficit or surplus

financing:$12.82If deficit in financing (negative), draw on line
of creditLine of credit$78.00If deficit in financing (negative),
draw on line of creditLine of credit$78.00If deficit in financing
(negative), draw on line of creditLine of credit$142.50If deficit
in financing (negative), draw on line of creditLine of
credit$0.00If deficit in financing (negative), draw on line of
creditLine of credit$0.00If surplus in financing (positive), pay
special dividendSpecial dividend$0.00If surplus in financing
(positive), pay special dividendSpecial dividend$0.00If surplus
in financing (positive), pay special dividendSpecial
dividend$0.00If surplus in financing (positive), pay special
dividendSpecial dividend$75.25If surplus in financing
(positive), pay special dividendSpecial
dividend$12.82Projecting Financial Statements for Five
YearsThe following tables are shown only here and not in the
textbook. They provide an example of how to apply the
concepts used in the 1-year projection to now project 5 years of
statements.Projected Financial Statements (Millions of
Dollars)Fixed values for each scenario are shown to the
right.Fixed Values for the Scenario Shown BelowFixed Values
for the Scenario Shown BelowFixed Values for the Scenario
Shown BelowFixed Values for the Scenario Shown BelowStatus
QuoStatus QuoHigher Sales Growth (Only)Improve Operations
(Only)Improve Operations and Growth1. Balance
SheetsActualForecast1. Balance SheetsActualForecast1. Balance
SheetsActualForecast1. Balance SheetsActualForecast1. Balance
SheetsActualForecast20192020202120222023202420192020202
12022202320242019202020212022202320242019202020212022
20232024201920202021202220232024AssetsAssetsAssetsAsset
sAssetsCash$100.0$110.0$118.8$127.1$133.5$140.1Cash$100.0
$110.0$118.8$127.1$133.5$140.1Cash$100.0$111.0$121.0$130.
7$138.5$146.8Cash$100.0$110.0$118.8$127.1$133.5$140.1Cas
h$100.0$111.0$121.0$130.7$138.5$146.8Short-tem
investments$10.0$0.0$0.0$0.0$0.0$0.0Short-tem
invesments$10.0$0.0$0.0$0.0$0.0$0.0Short-tem

invesments$10.0$0.0$0.0$0.0$0.0$0.0Accounts
receivable500.0550.0594.0635.6667.4700.7Accounts
receivable500.0555.0605.0653.3692.5734.1Inventories1,000.01,
100.01,188.01,271.21,334.71,401.5Inventories1,000.01,100.01,1
88.01,271.21,334.71,401.5Inventories1,000.01,110.01,209.91,30
6.71,385.11,468.2Inventories1,000.0990.0891.0953.41,001.01,0
51.1Inventories1,000.0999.0907.4980.01,038.81,101.1Total
current
assets$1,610.0$1,760.0$1,900.8$2,033.9$2,135.5$2,242.3Total
current
assets$1,610.0$1,760.0$1,900.8$2,033.9$2,135.5$2,242.3Total
current
assets$1,610.0$1,776.0$1,935.8$2,090.7$2,216.1$2,349.1Total
current
assets$1,610.0$1,650.0$1,603.8$1,716.1$1,801.9$1,892.0Total
current
assets$1,610.0$1,665.0$1,633.4$1,764.0$1,869.9$1,982.1Net
PP&E2,000.02,200.02,376.02,542.32,669.42,802.9Net
PP&E2,000.02,200.02,376.02,542.32,669.42,802.9Net
PP&E2,000.02,220.02,419.82,613.42,770.22,936.4Net
PP&E2,000.02,090.02,138.42,288.12,402.52,522.6Net
PP&E2,000.02,109.02,177.82,352.02,493.22,642.8Total assets
(TA)$3,610.0$3,960.0$4,276.8$4,576.2$4,805.0$5,045.2Total
assets
(TA)$3,610.0$3,960.0$4,276.8$4,576.2$4,805.0$5,045.2Total
assets
(TA)$3,610.0$3,996.0$4,355.6$4,704.1$4,986.3$5,285.5Total
assets
(TA)$3,610.0$3,740.0$3,742.2$4,004.2$4,204.4$4,414.6Total
assets
(TA)$3,610.0$3,774.0$3,811.2$4,116.1$4,363.0$4,624.8Liabilit
ies and equityLiabilities and equityLiabilities and

equityLiabilities and equityLiabilities and equityAccounts
payable$200.0$220.0$237.6$254.2$266.9$280.3Accounts
payable$200.0$222.0$242.0$261.3$277.0$293.6Notes
payable$150.0$150.0$150.0$150.0$150.0$150.0Notes
payable$150.0$150.0$150.0$150.0$150.0$150.0Notes
payable$150.0$150.0$150.0$150.0$150.0$150.0Notes
payable$150.0$150.0$150.0$150.0$150.0$150.0Notes
payable$150.0$150.0$150.0$150.0$150.0$150.0Accruals400.04
40.0475.2508.5533.9560.6Accruals400.0440.0475.2508.5533.95
60.6Accruals400.0444.0484.0522.7554.0587.3Accruals400.0440
.0475.2508.5533.9560.6Accruals400.0444.0484.0522.7554.0587
.3Line of credit0.078.0112.3112.939.10.0Line of
credit0.078.0112.3112.939.10.0Line of
credit0.0142.5210.5248.4213.7169.3Line of
credit0.00.00.00.00.00.0Line of credit0.00.00.00.00.00.0Total
CL$750.0$888.0$975.1$1,025.6$990.0$990.9Total
CL$750.0$888.0$975.1$1,025.6$990.0$990.9Total
CL$750.0$958.5$1,086.5$1,182.4$1,194.7$1,200.2Total
CL$750.0$810.0$862.8$912.7$950.8$990.9Total
CL$750.0$816.0$875.9$934.0$981.1$1,030.9Long-term
bonds520.0520.0520.0520.0520.0520.0Long-term
bonds520.0520.0520.0520.0520.0520.0Long-term
bonds520.0520.0520.0520.0520.0520.0Long-term
bonds520.0520.0520.0520.0520.0520.0Long-term
bonds520.0520.0520.0520.0520.0520.0Total
liabilities$1,270.0$1,408.0$1,495.1$1,545.6$1,510.0$1,510.9To
tal
liabilities$1,270.0$1,408.0$1,495.1$1,545.6$1,510.0$1,510.9To
tal
liabilities$1,270.0$1,478.5$1,606.5$1,702.4$1,714.7$1,720.2To
tal
liabilities$1,270.0$1,330.0$1,382.8$1,432.7$1,470.8$1,510.9To
tal

liabilities$1,270.0$1,336.0$1,395.9$1,454.0$1,501.1$1,550.9Pr
eferred stock$100.0$100.0$100.0$100.0$100.0$100.0Preferred
stock$100.0$100.0$100.0$100.0$100.0$100.0Preferred
stock$100.0$100.0$100.0$100.0$100.0$100.0Preferred
stock$100.0$100.0$100.0$100.0$100.0$100.0Preferred
stock$100.0$100.0$100.0$100.0$100.0$100.0Common
stock500.0500.0500.0500.0500.0500.0Common
stock500.0500.0500.0500.0500.0500.0Common
stock500.0500.0500.0500.0500.0500.0Common
stock500.0500.0500.0500.0500.0500.0Common
stock500.0500.0500.0500.0500.0500.0Retained
earnings1,740.01,952.02,181.72,430.62,695.02,934.4Retained
earnings1,740.01,838.01,815.22,062.12,262.02,473.9Total
common
equity$2,240.0$2,452.0$2,681.7$2,930.6$3,195.0$3,434.4Total
common
equity$2,240.0$2,452.0$2,681.7$2,930.6$3,195.0$3,434.4Total
common
equity$2,240.0$2,417.5$2,649.2$2,901.7$3,171.6$3,465.3Total
common
equity$2,240.0$2,310.0$2,259.4$2,471.5$2,633.5$2,803.7Total
common
equity$2,240.0$2,338.0$2,315.2$2,562.1$2,762.0$2,973.9Total
liabs. &
equity$3,610.0$3,960.0$4,276.8$4,576.2$4,805.0$5,045.2Total
liabs. &
equity$3,610.0$3,960.0$4,276.8$4,576.2$4,805.0$5,045.2Total
liabs. &
equity$3,610.0$3,996.0$4,355.6$4,704.1$4,986.3$5,285.5Total
liabs. &
equity$3,610.0$3,740.0$3,742.2$4,004.2$4,204.4$4,414.6Total
liabs. &
equity$3,610.0$3,774.0$3,811.2$4,116.1$4,363.0$4,624.8Check

: TA − Total Liab. & Eq. =$0.00$0.00$0.00$0.00$0.00Check:
TA − Total Liab. & Eq. =$0.00$0.00$0.00$0.00$0.00Check: TA
− Total Liab. & Eq. =$0.00$0.00$0.00$0.00$0.00Check: TA −
Total Liab. & Eq. =$0.00$0.00$0.00$0.00$0.00Check: TA −
Total Liab. & Eq. =$0.00$0.00$0.00$0.00$0.002. Income
StatementActualForecast2. Income StatementActualForecast2.
Income StatementActualForecast2. Income
StatementActualForecast2. Income
StatementActualForecast20192020202120222023202420192020
20212022202320242019202020212022202320242019202020212
02220232024201920202021202220232024Net
sales$5,000.0$5,500.0$5,940.0$6,355.8$6,673.6$7,007.3Net
sales$5,000.0$5,500.0$5,940.0$6,355.8$6,673.6$7,007.3Net
sales$5,000.0$5,550.0$6,049.5$6,533.5$6,925.5$7,341.0Net
sales$5,000.0$5,500.0$5,940.0$6,355.8$6,673.6$7,007.3Net
sales$5,000.0$5,550.0$6,049.5$6,533.5$6,925.5$7,341.0COGS
(excl. depr.)3,900.04,290.04,633.24,957.55,205.45,465.7COGS
(excl. depr.)3,900.04,290.04,633.24,957.55,205.45,465.7COGS
(excl. depr.)3,900.04,329.04,718.65,096.15,401.95,726.0COGS
(excl. depr.)3,900.04,290.04,578.04,898.45,143.35,400.5COGS
(excl.
depr.)3,900.04,329.04,662.35,035.35,337.55,657.7Depreciation
200.0220.0237.6254.2266.9280.3Depreciation200.0220.0237.62
54.2266.9280.3Depreciation200.0222.0242.0261.3277.0293.6De
preciation200.0209.0213.8228.8240.2252.3Depreciation200.021
0.9217.8235.2249.3264.3Other operating
expenses500.0550.0594.0635.6667.4700.7Other operating
expenses500.0555.0605.0653.3692.5734.1Cost of strategic
initiatives$0.0$0.0$0.0$0.0$0.0Cost of strategic
initiatives$150.0$0.0$0.0$0.0$0.0EBIT$400.0$440.0$475.2$50

8.5$533.9$560.6EBIT$400.0$440.0$475.2$508.5$533.9$560.6E
BIT$400.0$394.0$484.0$522.7$554.0$587.3EBIT$400.0$351.0$
554.2$593.0$622.6$653.8EBIT$400.0$305.1$564.4$609.6$646.
1$684.9Less: Interest on notes20.012.012.012.012.012.0Less:
Interest on notes20.012.012.012.012.012.0Less: Interest on
notes20.012.012.012.012.012.0Less: Interest on
notes20.012.012.012.012.012.0Less: Interest on
notes20.012.012.012.012.012.0 Interest on
bonds100.052.052.052.052.052.0 Interest on
LOC0.00.07.410.710.73.7Note: See comment.
only on the beginning balance. Interest on
LOC0.00.07.410.710.73.7 Interest on
LOC0.00.013.520.023.620.3 Interest on
LOC0.00.00.00.00.00.0 Interest on
LOC0.00.00.00.00.00.0Pre-tax
earnings$280.0$376.0$403.8$433.8$459.2$492.9Pre-tax
earnings$280.0$376.0$403.8$433.8$459.2$492.9Pre-tax
earnings$280.0$330.0$406.4$438.7$466.4$503.0Pre-tax
earnings$280.0$287.0$490.2$529.0$558.6$589.8Pre-tax
earnings$280.0$241.1$500.4$545.6$582.1$620.9Taxes
(40%)85.094.0100.9108.4114.8123.2Taxes
(40%)85.094.0100.9108.4114.8123.2Taxes
(40%)85.082.5101.6109.7116.6125.7Taxes
(40%)85.071.8122.6132.2139.7147.4Taxes
(40%)85.060.3125.1136.4145.5155.2NI before pref.
div.$195.0$282.0$302.8$325.3$344.4$369.6NI before pref.

div.$195.0$180.8$375.3$409.2$436.6$465.7Preferred
div.7.07.07.07.07.07.0Preferred div.7.07.07.07.07.07.0Preferred
div.7.07.07.07.07.07.0Preferred div.7.07.07.07.07.07.0Preferred
div.7.07.07.07.07.07.0Net
income$188.0$275.0$295.8$318.3$337.4$362.6Net
income$188.0$275.0$295.8$318.3$337.4$362.6Net
income$188.0$240.5$297.8$322.0$342.8$370.2Net
income$188.0$208.3$360.7$389.7$412.0$435.3Net
income$188.0$173.8$368.3$402.2$429.6$458.7Regular
common dividends$60.0$63.0$66.2$69.5$72.9$76.6Regular
common dividends$60.0$63.0$66.2$69.5$72.9$76.6Special
dividends$0.0$0.0$0.0$0.0$0.0$46.7Special
dividends$0.0$12.8$324.9$85.9$156.8$170.2Addition to
RE$128.0$212.0$229.7$248.9$264.4$239.3Addition to
RE$128.0$212.0$229.7$248.9$264.4$239.3Addition to
RE$128.0$177.5$231.7$252.5$269.9$293.7Addition to
RE$128.0$70.0-$50.6$212.1$162.1$170.2Addition to
RE$128.0$98.0-$22.8$246.8$199.9$211.93. Incorporating the
Financial Deficit or Surplus3. Incorporating the Financial
Deficit or Surplus3. Incorporating the Financial Deficit or
Surplus3. Incorporating the Financial Deficit or Surplus3.
Incorporating the Financial Deficit or SurplusIncrease in
spontaneous liabilities (accounts payable and
accruals)$60.0$52.8$49.9$38.1$40.0Increase in spontaneous
liabilities (accounts payable and

accruals)$66.0$59.9$58.1$47.0$49.9+ Increase in notes
payable, long-term bonds, preferred stock and common
stock$0.0$0.0$0.0$0.0$0.0+ Increase in notes payable, long-
term bonds, preferred stock and common
stock$0.0$0.0$0.0$0.0$0.0+ Net income minus regular common
dividends$212.0$229.7$248.9$264.4$286.1Note: See comment.
earnings account.+ Net income minus regular common
dividends$212.0$229.7$248.9$264.4$286.1+ Net income minus
regular common dividends$177.5$231.7$252.5$269.9$293.7+
Net income minus regular common
dividends$145.3$294.5$320.3$339.1$358.8+ Net income minus
regular common dividends$110.8$302.2$332.7$356.7$382.1−
Previous line of credit$0.0$78.0$112.3$112.9$39.1Note: See
comment.
day of the year and then drawing on a new line of credit.−
Previous line of credit$0.0$78.0$112.3$112.9$39.1− Previous
line of credit$0.0$142.5$210.5$248.4$213.7− Previous line of
credit$0.0$0.0$0.0$0.0$0.0− Previous line of
credit$0.0$0.0$0.0$0.0$0.0Increase in
financing$272.0$204.5$186.5$189.7$287.0Increase in

financing$176.8$362.1$390.8$403.7$432.0− Increase in total
assets$350.0$316.8$299.4$228.8$240.2− Increase in total
assets$164.0$37.2$304.9$247.0$261.8Amount of deficit or
surplus financing:−$78.0−$112.3−$112.9−$39.1$46.7Amount of
deficit or surplus
financing:−$78.0−$112.3−$112.9−$39.1$46.7Amount of deficit
or surplus
financing:−$142.5−$210.5−$248.4−$213.7−$169.3Amount of
deficit or surplus
financing:$75.3$345.1$108.2$177.0$188.6Amount of deficit or
surplus financing:$12.8$324.9$85.9$156.8$170.2Line of
credit$78.0$112.3$112.9$39.1$0.0Line of
credit$78.0$112.3$112.9$39.1$0.0Line of
credit$142.5$210.5$248.4$213.7$169.3Line of
credit$0.0$0.0$0.0$0.0$0.0Line of
credit$0.0$0.0$0.0$0.0$0.0Special
dividend$0.0$0.0$0.0$0.0$46.7Special
dividend$12.8$324.9$85.9$156.8$170.2 Statement of Cash
Flows (Millions of Dollars)Status
QuoActualForecastForecastForecastForecastForecast201920202
021202220232024Operating ActivitiesNet Income before
preferred
dividends$255.0$282.0$302.8$325.3$344.4$369.6Noncash
adjustmentsDepreciation$200.0$220.0$237.6$254.2$266.9$280.
3Working capital adjustments Increase(-)/Decrease(+) in
accounts receivable($116.0)($50.0)($44.0)($41.6)($31.8)($33.4)
Increase(-)/Decrease(+) in
inventories($226.0)($100.0)($88.0)($83.2)($63.6)($66.7)

payables$20.0$20.0$17.6$16.6$12.7$13.3 Increase(-
)/Decrease(+) in accruals$122.0$40.0$35.2$33.3$25.4$26.7Net
cash provided (used) by operating
activities$255.0$412.0$461.2$504.7$554.1$589.9Investing
ActivitiesCash used to acquire fixed
assets($420.0)($420.0)($413.6)($420.6)($394.1)($413.8)Sale of
short-term investments$30.0$0.0$0.0$0.0$0.0$0.0Net cash
provided (used) by investing
activities($390.0)($420.0)($413.6)($420.6)($394.1)($413.8)Fina
ncing Activities Increase(+)/Decrease(-) in notes
payable$30.0$0.0$0.0$0.0$0.0$0.0 Increase(+)/Decrease(-) in
line of credit$0.0$78.0$34.3$0.6($73.8)($39.1)
Increase(+)/Decrease(-) in bonds$170.0$0.0$0.0$0.0$0.0$0.0
Preferred stock issue(+)/repurchase(-)$0.0$0.0$0.0$0.0$0.0$0.0
Payment of common and preferred
dividends($67.0)($70.0)($73.2)($76.5)($79.9)($130.3)
Common stock issue(+)/repurchase(-
)$0.0$0.0$0.0$0.0$0.0$0.0Net cash provided by financing
activities$133.0$8.0($38.8)($75.9)($153.7)($169.4)SummaryNe
t change in cash and
equivalents($2.0)$0.0$8.8$8.3$6.4$6.7Cash and securities at
beginning of the
year$102.0$100.0$110.0$118.8$127.1$133.5Cash and securities
at end of the year$100.0$100.0$118.8$127.1$133.5$140.112-6
Analysis and Selection of a Strategic PlanThe figure below
shows key inputs and outcomes for the financial plan for each
of the the four scenarios: Status Quo, Higher Sales Growth
(Only), Improve Operations (Only), and Growth and Operations.
The values for each scenaro can be generated using Scenario
Manager's Summary feature: Data, What-If Analysis, Scenario
Manager, Summary. Note: we generated the values in the Figure
by manually linking them to the fixed value output for the
scenarios' 5-year projections shown above and to the right so
that the reported values in the figure below would not change if
you decide to try the Scenario Summary feature yourself, which
we encourgage.Figure 12-6Key Inputs and Financial Plan

Outcomes for Possible Strategic Initiatives
(Millions, Except for per Share Data)ScenarioLive(1)
Status Quo(2)
Higher Sales Growth (Only)(3)
Improve Operations (Only)(4)
Operations and GrowthStatus QuoPanel A: Key InputsSales
growth (Year 1)10.0%11.0%10.0%11.0%10.0%Sales growth
(Year 2)8.0%9.0%8.0%9.0%8.0%Sales growth (Year
3)7.0%8.0%7.0%8.0%7.0%Long-term sales growth
(gL)5.0%6.0%5.0%6.0%5.0% (COGS excl. depr.)/Sales (Year
1)78.0%78.0%78.0%78.0%78.0% (COGS excl. depr.)/Sales
(Year 2)20.0%20.0%15.0%15.0%20.0% (Net PP&E)/Sales (Year
1)40.0%40.0%38.0%38.0%40.0% (Net PP&E)/Sales (Year
2)40.0%40.0%36.0%36.0%40.0%Cost of strategic
initiatives$0$50$100$150$0Weighted average cost of capital
(WACC)11.5%11.5%11.5%11.5%11.5%Panel B: Key Financial
Plan ResultsLine of credit (Year 1)$78$143$0$0$78Line of
credit (Year 5)$0$169$0$0$0Minimum LOC in
forecast$0$143$0$0$0Maximum LOC in
forecast$113$248$0$0$113Regular dividends (Year
1)$63$63$63$63$63Regular dividends (Year
5)$77$77$77$77$77Special dividends (Year
1)$0$0$75$13$0Special dividends (Year
5)$47$0$189$170$47Total special dividends in
forecast$47$0$894$751$47Value of operations (Year
0)$2,524$2,458$4,091$4,353$2,524Intrinsic stock price (Year
0)$29.40$28.31$55.52$59.88$29.40The Figure shown below is
"live" and shows the current values of the scenario that is
chosen. The Figure to its right is fixed for the Operations and
Growth scenario, which is shown in the textbook.Note: Do not
change inputs here! The "input" cells here are linked to the ones
in Figure 12-2. If you want to change inputs, do so in Figure 12-
2 or use Scenario Manager.Figure 12-7 Fixed values for the
Operations and Growth scenario are shown to the right.Figure

12-7 Operating Results and Financial Outcomes for the Selected
Scenario (Millions Except Percentages and per Share
Data)Operating Results and Financial Outcomes for the Selected
Scenario (Millions Except Percentages and per Share
Data)Status QuoIndustryMicroDriveImprove Operations and
GrowthIndustryMicroDriveActualActualForecastActualActualFo
recastPanel A: Inputs2019201920202021202220232024Panel A:
Inputs2019201920202021202220232024Sales growth
rate5%4%10%8%7%5%5%Sales growth
rate5%4%11%9%8%6%6%(COGS excl.
depr.)/Sales76%78%78%78%78%78%78%(COGS excl.
depr.)/Sales76%78%78%77%77%77%77%Inventory/Sales15%2
0%20%20%20%20%20%Inventory/Sales15%20%18%15%15%1
5%15%(Net PP&E)/Sales33%40%40%40%40%40%40%(Net
PP&E)/Sales33%40%38%36%36%36%36%Cost of strategic
initiativesNANA$0$0$0$0$0Cost of strategic
initiativesNANA$150$0$0$0$0IndustryMicroDriveIndustryMicr
oDrivePanel B: Key OutputActualActualForecastPanel B: Key
OutputActualActualForecast20192019202020212022202320242
019201920202021202220232024Return on invested
capital15.0%10.00%10.00%10.00%10.00%10.00%10.00%Return
on invested
capital15.0%10.00%7.36%13.72%13.72%13.72%13.72%Free
cash flowNA−$210$30$92$132$210$220Free cash
flowNA−$210$121$446$210$285$302Line of
creditNA$0$78$112$113$39$0Line of
creditNA$0$0$0$0$0$0Special
dividendsNA$0$0$0$0$0$47Special
dividendsNA$0$13$325$86$157$170(Total
debt)/TA25.0%18.6%18.9%18.3%17.1%14.8%13.3%(Total
debt)/TA25.0%18.6%17.8%17.6%16.3%15.4%14.5%Times
interest earned 10.03.36.96.76.87.18.3Times interest earned
10.03.34.88.89.510.110.7Return on assets
(ROA)11.0%5.2%6.9%6.9%7.0%7.0%7.2%Return on assets
(ROA)11.0%5.2%4.6%9.7%9.8%9.8%9.9%Return on equity
(ROE)19.0%8.4%11.2%11.0%10.9%10.6%10.6%Return on

equity (ROE)19.0%8.4%7.4%15.9%15.7%15.6%15.4%Earnings
per shareNA$3.13$4.58$4.93$5.31$5.62$6.04Earnings per
shareNA$3.13$2.90$6.14$6.70$7.16$7.64Payout
ratio35.0%31.9%22.9%22.4%21.8%21.6%34.0%Payout
ratio35.0%31.9%43.6%106.2%38.6%53.5%53.8%Regular
dividends per shareNA$1.00$1.05$1.10$1.16$1.22$1.28Regular
dividends per shareNA$1.00$1.05$1.10$1.16$1.22$1.28Special
dividends per shareNA$0.00$0.00$0.00$0.00$0.00$0.78Special
dividends per shareNA$0.00$0.21$5.42$1.43$2.61$2.84Panel C:
ValuationPanel C: ValuationWeighted average cost of capital
=11.50%Weighted average cost of capital
=11.50%12/31/2019Estimated value of operations
=$2,52412/31/2019Estimated value of operations
=$4,35312/31/2019Estimated intrinsic stock price
=$29.4012/31/2019Estimated intrinsic stock price =$59.8812-7
The CFO’s ModelThe CFO’s final model, shown in the
worksheet named CFO Model, has several refinements to the
basic model presented in the previous sections, including the
incorporation of financing feedback and implementation of the
target capital structure.12-8 Additional Funds Needed (AFN)
Equation MethodThe AFN model forecasts MicroDrive's need
for external funds to support its forecasted next year's sales.
Figure 12-8Additional Funds Needed (AFN) (Millions of
Dollars)Panel A. Inputs and DefinitionsS0:Most recent year's
sales =$5,000g:Forecasted growth rate in sales =10.0%See
comment.
Michael Ehrhardt: Note: this is a fixed value so that Goal Seek
may be used to determine the self sustaining growth rate as
shown below this figure.
earnings account.

day of the year and then drawing on a new line of credit.
earnings account.
day of the year and then drawing on a new line of credit.
only on the beginning balance.
The interest rate on the LOC is equal to the rate on ST debt plus
the additional amount shown in Cell E86.
only on the beginning balance. S1:Next year's sales: S0 × (1 +
g) =$5,500gS0: Forecasted change in sales = S1 – S0 = ΔS
=$500A0*:Most recent year's operating assets
=$3,600A0*/S0:Required assets per dollar of sales
=72.00%L0*: Most recent year's spontaneous liabilities
=$600L0*/S0: Spontaneous liabilities per dollar of sales
=12.00%Profit margin (M):Most recent profit margin = NI/sales
=4.96%Payout ratio (POR):Most recent year's dividends/NI = %
of income paid out =24.19%Panel B. Additional Funds Needed
(AFN) to Support GrowthAdditional
funds =
needed Required
increase
in assets−Increase in
spontaneous

liabilities−Increase in
retained
earningsAFN = (A0*/S0)∆S − (L0*/S0)∆S −S1 × M × (1 –
POR) = (A0*/S0)(gS0) − (L0*/S0)(gS0) −(1+g)S0 × M ×
(1 – POR) =(0.72)($500)−(0.12)($500)−$5,500(0.0496)(1
– 0.2419) =$360−$60.00−$206.80AFN = $93.20Self-
Supporting Growth RateThis 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. 1. Using
algebra. The sustainable growth rate can also be found by
solving the equation as shown on the 3rd row above g, then
finding the value of g that causes AFN to equal zero.
Sustainable g =PM(1 – POR)(S0)=$188.00 =6.7% A0* – L0*
– PM(1 – POR)S0 $2,812.00To print a window, use CTRL +
ALT + PrintScreen. This puts it into memory. After exiting the
window, use paste to show it.2. Using Goal Seek. The
sustainable growth rate can also be found by using Goal Seek.
In the figure above, set the AFN in the orange cell to zero by
changing the growth rate in the blue cell. 12-8 Forecasting
When the Ratios ChangeExcess Capacity AdjustmentsWe
assumed that all operating assets grow at the same rate of sales,
but this is not necessarily correct. For instance, suppose the
firm is using its fixed assets at only partial capacity. This
means that it could achieve a greater level of production with its
fixed assets. Here are the steps to determine the AFN if there
is excess capacity. 1. Calculate the AFN ignoring the excess
capacity. 2. Calculate the required new fixed assets ignoring the
excess capacity. 3. Calculate the firm's full capacity sales. 4.
Calculate a revised target fixed assets-to-sales ratio. 5.
Calculate the required fixed assets given the excess capacity. 6.
Calculate the increase in required fixed assets given excess
capacity. 7. Calculate the reduction in required fixed assets
from the result when excess capacity is ignored versus the
required fixed assets when excess capacity is considered. 8.
Subtract this difference in required fixed assets from the
previously calculated AFN.Inputs2019 Percent utilization of

fixed assets capacity =96%2019 Sales =$5,0002019 Fixed assets
=$2,0002019 Fixed assets/Sales=40.00%2020 Sales
=$5,500Required increase in FA if no excess capacity =(2019
FA/Sales) (Change in Sales)Required increase in FA if no
excess capacity =$200Full capacity sales =Actual sales/capacity
utilizationFull capacity sales =$5,208Actual fixed assets/Full
capacity salesTarget fixed assets/Sales =38.40%Required fixed
assets =(Target FA/Sales) (Forecast sales)Required fixed assets
=$2,112Required increase in fixed assets =$112Difference
between required increase assuming no excess capacity and
required increase if there is excess capacity =$88AFN if no
excess capacity =$93AFN if there is excess capacity =$5
12-8SECTION 12-8SOLUTIONS 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
rate15%S0$5,000millionA0*/ S072.000%L0*/ S012.000%Profit
margin (M)4.960%Payout ratio24.194%Δ
Sales$750.00millionS1$5,750.00millionAFN$233.80million
CFO Model11/21/18Financing Feedback and Specifying the
Capital Structure12-7 The CFO’s ModelThe CFO's model
incorporates financing feedback caused by the new interest
incurred by new debt. The model also ensures that the actual
capital structure will match the target capital structure.For the
user's convenience, we repeat the basic information for
MicroDrive.The following data are linked to the Chapter
worksheet--do not change here! To change a scenario, go to the
worksheet named "Chapter" and choose a scenario using
Scenario Manager.Figure 12-1. Repeated for
convenience.MicroDrive’s Most Recent Financial Statements
(Millions, Except for Per Share Data)INCOME
STATEMENTSBALANCE
SHEETS20182019Assets20182019Net sales$ 4,800$
5,000Cash$ 102$ 100COGS (excl. depr.)3,7103,900ST
Investments4010Depreciation180200Accounts
receivable384500Other operating
expenses470500Inventories7741,000EBIT$ 440$ 400Total

CA$ 1,300$ 1,610Interest expense4060Net
PP&E1,7802,000Pretax earnings$ 400$ 340Total assets$
3,080$ 3,610Taxes (40%)10085NI before pref. div.$ 300$
255Liabilities and equityPreferred div.77Accounts payable$
180$ 200Net income$ 293$ 248Notes
payable28150Accruals370400Other DataTotal CL$ 578$
750Common dividends$59$60Long-term bonds350520Addition
to RE$234$188Total liabilities$ 928$ 1,270Tax
rate25%25%Preferred stock100100Shares of common
stock6060Common stock500500Earnings per
share$4.88$4.13Retained earnings1,5521,740Dividends per
share$0.99$1.00Total common equity$ 2,052$ 2,240Price per
share$45.00$31.00Total liabs. & equity$ 3,080$ 3,610The
figure below shows all the inputs required to project the
financial statements for the scenario that has been selected in
the worksheet "Chapter" with the Scenario Manager: Data,
What-If Analysis, Scenario Manager. There are two scenarios.
The first is named Status Quo because all operating ratios
except the sales growth rate are assumed to remain unchanged.
The initial sales growth rate was chosen by MicroDrive's
managers based on the existing product lines. The growth rate
declines over time until it eventually levels off at a sustainable
rate. The other scenario is named Final because it is the set of
inputs chosen by MicroDrive's management team.Section 1
shows the inputs required to estimate the items in an operating
plan. For each of these inputs, Section 1 shows the industry
averages, the actual values for the past two years for
MicroDrive, and the forecasted values for the next five years.
The managers assumed the inputs for future years (except the
sales growth rate) would be equal to the inputs in the first
projected year.MicroDrive's managers assume that sales will
eventually level off at a sustaniable constant rate.Sections 2 and
3 show the data required to estimate the weighted average cost
of capital. Section 4 shows the forecasted growth rate in
dividends.The following data are linked to the Chapter
worksheet--do not change here! To change a scenario, go to the

worksheet named "Chapter" and choose a scenario using
Scenario Manager.Figure 12-2. Repeated here for
convenience.MicroDrive's Forecast: Inputs for the Selected
ScenarioStatus
QuoIndustryMicroDriveMicroDriveInputsActualActualForecast1
. Operations20192018201920202021202220232024Sales growth
rate5%10%4%10%8%7%5%5%(COGS excl.
depr.)/Sales76%77%78%78%78%78%78%78%Depreciation/(Ne
t PP&E)9%10%10%10%10%10%10%10%(Other op.
exp.)/Sales10%10%10%10%10%10%10%10%Cash/Sales1%2%2
%2%2%2%2%2%Actual Historical Financing(Acc.
rec.)/Sales8%8%10%10%10%10%10%10%20182019Inventory/S
ales15%16%20%20%20%20%20%20%Long-term
debt$350$520(Net
PP&E)/Sales33%37%40%40%40%40%40%40%Short-term
debt$370$400(Acc.
pay.)/Sales4%4%4%4%4%4%4%4%Preferred
stock$100$100Accruals/Sales7%8%8%8%8%8%8%8%Market
value of equity = (Price x # shares)$2,700$1,860Tax
rate25%25%25%25%25%25%25%25%Total$3,520$2,880Cost
of strategic initiativesNANANA$0$0$0$0$02. Capital
StructureActual Market WeightsTarget Market Weights% Long-
term debt20%11%20%20%20%20%20%20%See the box to the
right for calculations of the actual capital structures, based on
market values, for the past two years.Percent long-term
debt10%18%% Short-term debt4%1%6%4%4%4%4%4%Percent
short-term debt11%14%% Preferred
stock2%3%4%2%2%2%2%2%Percent preferred stock3%3%%
Common stock74%85%71%74%74%74%74%74%Percent
market value of equity77%65%3. Costs of
CapitalForecastTotal100%100%Rate on LT bonds,
rLTD10.0%10%10%10%10%Rate on ST debt,
rSTD8.0%8%8%8%8%Rate on preferred stock (ignoring
flotation costs), rps7.0%7%7%7%7%Cost of equity,
rs13.00%13%13%13%13%4. Target Dividend
PolicyActualGrowth rate of

dividends11%1.0%5%5%5%5%5%5. Capital Structure
Choices% Long-term debt,
wLTD19.8%19.817%19.863%19.909%19.954%20.000%%
Short-term debt, wSTD5.7%5.4%5.0%4.7%4.3%4%% Preferred
stock, wps3.8%3.4%3.1%2.7%2.4%2%% Common stock,
ws70.7%71.4%72.0%72.7%73.3%74%The following projections
incorporate the impact of financing feedback. They also ensure
that the actual capital structure matches the target capital
structure. Following are explanations of these two issues,
beginning with the capital structure.Implementing the Target
Capital StructureThe preliminary financial policy held external
financing constant—with no additional borrowing or repayment
of debt (other than the line of credit) and no new issues or
repurchases of preferred stock or common stock. However, this
ignores the target capital structure. Fortunately, there is a
simple way to implement the target capital structure in the
projected statements.
Notice that the WACC depends on the target weights, not the
actual weights. This means the value of operations does not
depend on the actual amounts of debt and preferred stock.
Therefore, it is easy to estimate the value of operations for each
year of the forecast (starting at the horizon and working
backward) before specifying the dollar amounts of debt and
preferred stock. Given the yearly value of operations, the yearly
values of debt and preferred stock can be found by multiplying
their target weights by the value of operations. Note that there
are no short-term invesments in the target capital structure.We
implement this approach in the figure below.Incorporating
Financing FeedbackThe basic model assumed that no interest
would accrue on the line of credit because the LOC would be
added at the end of the year. However, if interest is calculated
on the LOC’s average balance during the year, which is more
realistic, here is what happens:1.The line of credit required to
make the balance sheets balance is added to the balance
sheet.2.Interest expense increases due to the LOC.3.Net income
decreases because interest expenses are higher.4.Internally

generated financing decreases because net income
decreases.5.The financing deficit increases because internally
generated financing decreases.6.An additional amount of the
LOC is added to the balance sheets to make them balance.7.Go
to step 2 and repeat the loop.If you were to go through these
steps manually, then each time you add some additional LOC in
Step 6, the amount would be less than the previous amount
because the additional LOC is just large enough to cover the
additional interest estimated in Step 2. If you repeated this
process manually enough times, then the change in the
additional LOC would become so small that it would be
neglible. In fact, sometimes it is possible to set Excel to Iterate
automatically and determine the correct amount of debt.
However, in complicated models it is possible for this automatic
iteration to cause Excel to "freeze." Fortunately, there is a
simple solution.As noted above, the additional LOC required by
each additional iteration becomes smaller and smaller. In fact,
the additional LOC eventually converges to zero. Because the
LOC converges to a value, it is possible to use a relatively
simple formula to calculate the final LOC needed when there is
financing feeback. This formula is based on the amount of LOC
needed if feedback is ignored and on the interest rates (and
preferred dividend yield). We explain this formula below at the
point where we specify the final LOC.The silver rows in the
tables indicate the rows that differ from those in the basic
model in the worksheet named "Chapter".Projected Financial
Statements (Millions of Dollars)Status Quo1. Balance
SheetsActualForecast201920202021202220232024AssetsCash$1
00.0$110.0$118.8$127.1$133.5$140.1Short-term
investments$10.0$0.0
Michael Ehrhardt: The optimal capital structure does not have
short-term investments.$0.0$0.0$0.0$0.0Accounts
receivable500.0550.0594.0635.6667.4700.7Inventories1,000.01,
100.01,188.01,271.21,334.71,401.5Total current
assets$1,610.0$1,760.0$1,900.8$2,033.9$2,135.5$2,242.3Net

PP&E2,000.02,200.02,376.02,542.32,669.42,802.9Total assets
(TA)$3,610.0$3,960.0$4,276.8$4,576.2$4,805.0$5,045.2Liabilit
ies and equityAccounts
payable$200.0$220.0$237.6$254.2$266.9$280.3Accruals400.04
40.0475.2508.5533.9560.6Notes payable (wSTD x
Vop)150.0149.3151.3151.1147.1142.3Line of credit (After
adjustment for feedback effects)0.054.044.57.00.00.0Total
CL$750.0$863.3$908.6$920.8$947.9$983.2Long-term bonds
(wLTD x Vop)520.0551.8598.3642.4676.1711.5Total
liabilities$1,270.0$1,415.1$1,506.9$1,563.2$1,624.0$1,694.7Pr
eferred stock (wps x
Vop)$100.0$95.8$92.8$87.8$80.0$71.2Common
stock500.0500.0500.0500.0500.0500.0Retained
earnings1,740.01,949.12,177.02,425.22,601.02,779.4Total
common
equity$2,240.0$2,449.1$2,677.0$2,925.2$3,101.0$3,279.4Total
liabs. &
equity$3,610.0$3,960.0$4,276.8$4,576.2$4,805.0$5,045.2Check
: TA − Total Liab. & Eq. =$0.00$0.00$0.00$0.00$0.002.
Income
StatementActualForecast201920202021202220232024Net
sales$5,000.0$5,500.0$5,940.0$6,355.8$6,673.6$7,007.3COGS
(excl.
depr.)3,900.04,290.04,633.24,957.55,205.45,465.7Depreciation
200.0220.0237.6254.2266.9280.3Other operating
expenses500.0550.0594.0635.6667.4700.7Cost of strategic
initiatives0.00.00.00.00.0EBIT$400.0$440.0$475.2$508.5$533.
9$560.6Less: Interest on notes payable, based on average NP
and rSTD20.012.012.012.111.911.6 Interest on bonds,
based on average LT bonds and
rLTD100.053.657.562.065.969.4 Interest on LOC, based
on average LOC and rLOC = rSTD
+1.5%0.02.64.72.40.30.0Pre-tax
earnings$280.0$371.9$401.0$431.9$455.7$479.6Taxes
(25%)85.093.0100.2108.0113.9119.9NI before pref.
div.$195.0$278.9$300.7$323.9$341.8$359.7Preferred dividend,

based on average preferred stock and rps7.06.96.66.35.95.3Net
income$188.0$272.1$294.1$317.6$335.9$354.4Regular
common dividends$60.0$63.0$66.2$69.5$72.9$76.6Special
dividends$0.0$0.0$0.0$0.0$87.1$99.5Addition to
RE$128.0$209.1$228.0$248.1$175.9$178.43. Eliminating the
Financial Deficit or SurplusIncrease in spontaneous liabilities
(accounts payable and accruals)$60.0$52.8$49.9$38.1$40.0+
Increase in notes payable, long-term bonds, preferred stock and
common stock$27.0$45.5$38.8$21.9$21.8− Previous line of
credit $0.0$54.0$44.5$7.0$0.0Note:We subtract the previous
LOC because the plan does not call for any projected LOC
unless necessary.+ Planned increase in retained earnings+
After-tax operating income: EBIT (1-
T)$330.0$356.4$381.3$400.4$420.4− After-tax interest on notes
payable (INTSTD x (1-T)$9.0$9.0$9.1$8.9$8.7− After-tax
interest on bonds (INTLTD x (1-T)$40.2$43.1$46.5$49.4$52.0−
After-tax interest on previous LOC: (rLOC x 0.5 x LOCt-1 x (1-
T)$0.0$1.9$1.6$0.3$0.0Note:Note: interest expense is incurred
on the planned LOC. Because the plan does not call for any
LOC, the average balance is equal to
(LOCt-1 + 0)/2 = 0.5*LOCt-1.− Preferred
dividends$6.9$6.6$6.3$5.9$5.3− Regular common
dividends$63.0$66.2$69.5$72.9$76.6 Total planned increase
in the retained earnings
account$211.0$229.6$248.4$263.0$277.9Increase in
financing$297.9$273.8$292.6$315.9$339.7Note:The increase in
financing is equal to the sum of spontaneous liabilities, planned
external financing, and the planned addition to the retained
earnings account.− Increase in total
assets$350.0$316.8$299.4$228.8$240.2Amount of unadjusted
deficit or surplus financing:−$52.1−$43.0−$6.8$87.1$99.5If
there is a surplus (the financing need is positive), pay a special
dividend:$0.0$0.0$0.0$87.1$99.5If there is a deficit (the
financing need is positive), draw on the LOC:Unadjusted line of
credit =$52.1$43.0$6.8$0.0$0.0Adjustment factor (see note
below) =0.960.960.960.960.96Adjusted line of credit =

Unadjusted LOC / Adjustment factor
=$54.0$44.5$7.0$0.0$0.0The adjustment factor takes into
account the financing feedback. The formula for the factor is:
Adjustment factor =1-[0.5 x rLOC x (1-T)]
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 purposes, so it is only the after-tax impact
that determines the adjusted LOC.The following section shows
how to determine capital structure components that are
consistent with the target capital structure.The value of
operations for the last year in the forecast is equal to the
horizon value, which is the present value of all free cash flows
beyond the horizon, discounted back to the horizon using the
target WACC. The value of operations in the year prior to the
horizon is equal to the value of all free cash flows beyond the
year prior to the horizon, discounted back to the year prior to
the horizon at the target WACC. But this present value is
equivalent to the present value of the value of operations one
year ahead plus the free cash flow one year ahead, discounted
back one period at the target WACC. Thus, we can estimate the
annual values of operations by starting at the horizon and
working backward one year at a time.Here is the procedure. The
value of operations at the horizon, Year t, is equal to: VHV =
Vop,t = [FCFt (1+g)]/(WACC-g).The value of operations at any
year prior to the horizon is:Vop,t-1 = [FCFt
+Vop,t]/(1+WACC).The choices for the yearly values of the
capital components are equal to weights in the target capital
structure multiplied by the value of operations.4. Determining
Consistent Capital Structure ComponentsActualForecastStatus
Quo201920202021202220232024Net operating working
capital$710$1,000$1,100$1,188$1,271$1,335$1,401Total net
operating
capital$2,490$3,000$3,300$3,564$3,813$4,004$4,204NOPAT$3
00$330$356$381$400$420FCF-
$210$30$92$132$210$220Growth rate in

FCF208.0%42.7%59.1%5.0%Target WACC (rounded to 4
decimal places)11.50%11.50%11.50%11.50%11.50%Horizon
value: VHV = Vop,2023 = [FCF2023 (1+g)]/(WACC-
g).$3,557.537Value of operations: Vop,t-1 = [FCFt
+Vop,t]/(1+WACC).$2,524$2,784$3,012$3,227$3,388.130$3,55
7.537Note: The value of operations at the horizon is equal to
the horizon value.Choice of long-term bonds (wLTD x
Vop)$520$552$598$642$676.080$711.507Choice of notes
payable (wSTD x
Vop)$150$149$151$151$147.068$142.301Choice of preferred
stock (wps x Vop)$100$96$93$88$79.975$71.1515. Estimating
the Intrinsic Stock PriceStatus Quo12/31/19Value of
operations$2,524+ ST investments$10Estimated total intrinsic
value$2,534− All debt$920− Preferred stock$100Estimated
intrinsic value of equity$1,514÷ Number of shares$60Estimated
intrinsic stock price =$25.24 Statement of Cash Flows (Millions
of Dollars)Status
QuoActualForecastForecastForecastForecastForecast201920202
021202220232024Operating ActivitiesNet Income before
preferred
dividends$255.0$278.9$300.7$323.9$341.8$359.7Noncash
adjustmentsDepreciation$200.0$220.0$237.6$254.2$266.9$280.
3Working capital adjustments Increase(-)/Decrease(+) in
accounts receivable($116.0)($50.0)($44.0)($41.6)($31.8)($33.4)
inventories($226.0)($100.0)($88.0)($83.2)($63.6)($66.7)
payables$20.0$20.0$17.6$16.6$12.7$13.3 Increase(-
)/Decrease(+) in accruals$122.0$40.0$35.2$33.3$25.4$26.7Net
cash provided (used) by operating
activities$255.0$408.9$459.1$503.3$551.5$579.9Investing
ActivitiesCash used to acquire fixed
assets($420.0)($420.0)($413.6)($420.6)($394.1)($413.8)Sale of
short-term investments$30.0$10.0$0.0$0.0$0.0$0.0Net cash
provided (used) by investing
activities($390.0)($410.0)($413.6)($420.6)($394.1)($413.8)Fina

ncing Activities Increase(+)/Decrease(-) in notes
payable$30.0($0.7)$2.0($0.2)($4.0)($4.8)
Increase(+)/Decrease(-) in line of
credit$0.0$54.0($9.4)($37.5)($7.0)$0.0 Increase(+)/Decrease(-
) in bonds$170.0$31.8$46.5$44.1$33.7$35.4 Preferred stock
issue(+)/repurchase(-)$0.0($4.2)($3.0)($5.0)($7.8)($8.8)
Payment of common and preferred
dividends($67.0)($69.9)($72.8)($75.8)($165.9)($181.3)
Common stock issue(+)/repurchase(-
)$0.0$0.0$0.0$0.0$0.0$0.0Net cash provided by financing
activities$133.0$11.1($36.7)($74.4)($151.1)($159.5)SummaryN
et change in cash and
equivalents($2.0)$10.0$8.8$8.3$6.4$6.7Cash and securities at
beginning of the
year$102.0$100.0$110.0$118.8$127.1$133.5Cash and securities
at end of the year$100.0$110.0$118.8$127.1$133.5$140.1
Summary of Key Results for Forecasted Scenarios (Millions
Except Percentages and Per Share Data)Status
QuoIndustryMicroDriveActualActualForecast1.
Operations2019201920202021202220232024Free cash
flowNA−$210$30$92$132$210$220Return on invested
capital15.0%10.0%10.0%10.0%10.0%10.0%10.0%NOPAT/Sales
6.9%6.0%6.0%6.0%6.0%6.0%6.0%(Total op.
capital)/Sales46.0%60.0%60.0%60.0%60.0%60.0%60.0%Invent
ory turnover5.04.14.14.14.14.14.1Days sales
outstanding30.036.536.536.536.536.536.5Fixed asset
turnover3.02.52.52.52.52.52.52. Financing(Total
liabilities)/TA45.0%35.2%35.7%35.2%34.2%33.8%33.6%(Net
income)/Sales6.2%3.8%4.9%5.0%5.0%5.0%5.1%Return on
assets (ROA)11.0%5.2%6.9%6.9%6.9%7.0%7.0%Return on
equity (ROE)19.0%8.4%11.1%11.0%10.9%10.8%10.8%Times
interest earned 10.03.36.56.46.66.86.9Line of
creditNA$0$54$45$7$0$0Payout
ratio35.0%31.9%23.2%22.5%21.9%47.6%49.7%Regular
dividends/shareNA$1.00$1.05$1.10$1.16$2.67$2.93Special
dividends/shareNA$0.00$0.00$0.00$0.00$1.45$1.66Earnings

per shareNA$3.13$4.53$4.90$5.29$5.60$5.913. Estimated
intrinsic value12/31/2019Estimated intrinsic stock price
=$25.24
Mini Case Data11/21/18Chapter 12 Mini CaseHatfield Medical
Supply’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 Supply: Balance Sheet
(Millions of Dollars), December 31Hatfield Medical Supply:
Income Statement (Millions of Dollars Except per
Share)20192019Cash$90Sales$9,000.9Accts. rec.1,260Op. costs
(excl. depr.)8,100.9Inventories1,440Depreciation360.0Total
CA$2,790EBIT$540.0Net fixed assets3,600Interest144.0Total
assets$6,390Pretax earnings$396.0Taxes (25%)99.0Accts. pay.
& accruals$1,620Net income$297.0Line of credit0Total
CL$1,620Dividends$100Long-term debt1,800Add. to
RE$197Total liabilities$3,420Common shares50Common
stock2,100EPS$5.94Retained earnings870DPS$2.00 Total
common equ.$2,970Ending stock price$41.00Total liab. &
equity$6,390Selected Ratios, Calculations, and Other Data,
2019Operating Ratios and DataHatfieldIndustryOther
RatiosHatfieldIndustry(Op. costs)/Sales90%88%Profit margin
(M)3.30%5.60%Depr./FA10%12%Return on assets
(ROA)4.6%9.5%Cash/Sales1%1%Return on equity
(ROE)10.0%15.1%Receivables/Sales14%11%Sales/Assets1.411.
69Inventories/Sales16%15%Asset/Equity2.151.59Fixed

assets/Sales40%32%Debt/TA28.2%16.9%(Acc. pay. &
accr.)/Sales18%12%(Total liabilities)/(Total
assets)53.5%37.3%Tax rate25%25%Times interest
earned3.811.7Target WACC10%11%P/E ratio6.916.0Interest
rate on debt8%7%OP ratio: NOPAT/Sales4.5%6.1%CR ratio:
(Total op. capital)/Sales53.0%47.0%ROIC8.5%13.0%
1. Mini Case11/21/18Chapter 12 Mini CaseHatfield Medical
Supply’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 Supply: Balance Sheet
(Millions of Dollars), December 31Hatfield Medical Supply:
Income Statement (Millions of Dollars Except per
Share)20182018Cash$90Sales$9,000.9Accts. rec.1,260Op. costs
(excl. depr.)8,100.9Inventories1,440Depreciation360.0Total
CA$2,790EBIT$540.0Net fixed assets3,600Interest144.0Total
assets$6,390Pretax earnings$396.0Taxes (25%)99.0Accts. pay.
& accruals$1,620Net income$297.0Line of credit0Total
CL$1,620Dividends$100Long-term debt1,800Add. to
RE$197Total liabilities$3,420Common shares50Common
stock2,100EPS$5.94Retained earnings870DPS$2.00 Total
common equ.$2,970Ending stock price$41.00Total liab. &
equity$6,390Selected Ratios, Calculations, and Other Data,
2018Operating Ratios and DataHatfieldIndustryOther
RatiosHatfieldIndustry(Op. costs)/Sales90%88%Profit margin

(M)3.30%5.60%Depr./FA10%12%Return on assets
(ROA)4.6%9.5%Cash/Sales1%1%Return on equity
(ROE)10.0%15.1%Receivables/Sales14%11%Sales/Assets1.411.
69Inventories/Sales16%15%Asset/Equity2.151.59Fixed
assets/Sales40%32%Debt/TA28.2%16.9%(Acc. pay. &
accr.)/Sales18%12%(Total liabilities)/(Total
assets)53.5%37.3%Tax rate25%25%Times interest
earned3.811.7Target WACC10%11%P/E ratio6.916.0Interest
rate on debt8%7%OP ratio: NOPAT/Sales4.5%6.1%CR ratio:
(Total op. capital)/Sales53.0%47.0%ROIC8.5%13.0%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 DuPont equation (see Chapter 3) as
one part of your analysis.Hatfield has lower operating
profitability as shown by operating profitability (OP) ratio:
4.5% vs. 6.1%. Hatfield utilizes operating capital less
efficiently, as shown by capital requirement (CR) ratio: 53% vs.
47%. As a consequence, Hatfield has a lower ROIC: 8.5% vs.
13%. In fact, Hatfield’s ROIC is less than its 10% WACC.The
debt/TA ratio and the TL/TA ratio indicate that Hatfield has
more leverage than its industry competitors. The combination of
higher interest payments and lower operating profitability cause
Hatfield's times interest earned ratio to be much lower than the
industry average.Du Pont ROEM x
Sales/AssetsxAssets/Equity=ROE
Hatfield3.30%1.412.15=10.0%Industry5.60%1.691.59=15.1%Th
e DuPont analysis confirms the conclusions.b. Use the AFN
equation to estimate Hatfield’s required new external capital for
2019 if the sale growth rate is 11.1%. Assume that the firm’s
2018 ratios will remain the same in 2019. (Hint: Hatfield was
operating at full capacity in 2018.)Data for AFN MethodGrowth
rate in sales (g)11.1%Sales (S0)$9,001Required assets
(A0*)$6,390Spontaneous liabilities (L0*)$1,620Forecasted
sales (S1)$10,000Increase in sales (ΔS = gS0)$999Profit margin

(M)3.30%Assets/Sales (A0*/S0)71.0%Payout ratio
(POR)33.7%Spont. Liab./Sales (L0*/S0)18.0%AFNHatfield
=Required increase
in assets−Increase in spontaneous liabilities−Increase in
retained earnings= (A0*/S0)∆S − (L0*/S0)∆S − M ×S1 × (1–
POR)=(0.7099)(999.1)−(0.18)(999.1)−(0.033)(10000)(0.6633)=
$709.3−$179.8−$218.9AFNHatfield =$310.60 millionc. 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 Showd. Define the term self-supporting growth rate.
What is Hatfield’s self-supporting 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? Answer: See PowerPoint ShowSelf-Supporting
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 self-supporting growth
rate can also be found by setting the AFN equation to zero and
then solving for g.M(1 – POR)(S0)Self-Supporting g ==
─────────────────────── A0* – L0* – M(1 –
POR)S0 M =3.30%33.300%POR =33.7%333.700%1-POR
=66.3%66.300%S0 =$9,000.90$9,001.0A* =$6,3900$6,390.0L*
=$1,6200$1,620.0M(1 – POR)(S0)$197.00Self-Supporting g =
───────────────────=──────── =4.3% A0* –
L0* – M(1 – POR)S0 $4,573.002. Using Goal Seek. To find
the self-supporting growth rate with Goal Seek, select Data,

What-If Analysis, and Goal Seek; then choose cell with the
AFN (B96) 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 the cell with the growth rate (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 11.1%, 8%, 5%, and 5% for the next four
years. (3) The target weighted average cost of capital (WACC)
is 10%. 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, What-If Analysis, Scenario Manager, and
select the scenario named No Change.Scenario:No
ChangeActualForecastFor inputs:
Mike Ehrhardt: The last 2 years of growth must have same
value to get constant growth in FCF. The last 3 years of the
operating ratios must have same value to get constant growth in
FCF. An error message will appear if this condition is
violated.Inputs20182019202020212022Error CheckSales growth
rate:11.1%8%5%5%Ok(Op.
costs)/Sales:90.00%90.0%90%90%90%OkDepr./FA10.00%10%
10%10%10%OkCash/Sales:1.00%1%1%1%1%Ok(Acct.
rec.)/Sales14.00%14%14%14%14%OkInv./Sales:16.00%16%16
%16%16%OkFA/Sales:40.00%40%40%40%40%Ok(AP &
accr.)/ Sales:18.00%18%18%18%18%OkTax
rate:25.00%25%25%25%25%OkRate on all
debt8%8%8%8%Div. growth rate:5.00%10%8%5%5%Target
WACC10%10%10%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:No
ChangeActualForecast20182019202020212022Net
sales$9,000.9$10,000$10,800$11,340$11,907Op. costs (excl.

depr.)$8,100.9$9,000$9,720$10,206$10,716Depreciation$360.0
$400$432$454$476EBIT$540.0$600$648$680$714Cash$90.0$1
00$108$113$119Accounts
receivable$1,260.0$1,400$1,512$1,588$1,667Inventories$1,440
.0$1,600$1,728$1,814$1,905Net fixed
assets$3,600.0$4,000$4,320$4,536$4,763Accts. pay. &
accruals$1,620.0$1,800$1,944$2,041$2,143e. (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:ActualForecastNo
Change20182019202020212022Definitions:NOPAT$405$450$4
86$510$536NOPAT = EBIT(1-
T)NOWC$1,170$1,300$1,404$1,474$1,548NOWC = (Cash +
accounts receivable + inventories) − (Accounts payable &
accruals)Total op. capital$4,770$5,300$5,724$6,010$6,311Total
operating capital = NOWC + Net fixed assetsFCF
−$80$62$224$235.30FCF = NOPAT − Change in total operating
capitalGrowth in FCF-
177.5%261.5%5.0%ROIC8.5%8.5%8.5%8.5%8.5%ROIC =
NOPAT/Total operating capitale. (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 2022?
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 2019 through 2022). What is the current value of
operations? Using information from the 2018 financial
statements, what is the current estimated intrinsic stock
price?Scenario:No ChangeHorizon Value:Value of
operations$3,683+ ST investments$0$4,941Estimated total
intrinsic value$3,683− All debt$1,800Value of Operations:−

Preferred stock$0Present value of HV$3,375Estimated intrinsic
value of equity$1,883+ Present value of FCF$308÷ Number of
shares$50Value of operations =$3,683Estimated intrinsic stock
price =$37.65f. Continue with the same assumptions for the No
Change scenario from the previous question, but now forecast
the balance sheet and income statements for 2019 (but not for
the following three years) using the following preliminary
financial policy. (1) Regular dividends will grow by 10%. (2)
No additional long-term debt or common stock will be issued.
(3) The interest rate on all debt is 8%. (4) Interest expense for
long-term debt is based on the average balance during the year.
(5) If the operating results and the preliminary financing plan
cause a financing deficit, eliminate the deficit by drawing on a
line of credit. The line of credit would be tapped on the last day
of the year, so it would create no additional interest expenses
for that year. (6) If there is a financing surplus, eliminate it by
paying a special dividend. After forecasting the 2019 financial
statements, answer the following questions.Values, Not LiveNo
ChangeNo Change1. Balance SheetsMost RecentForecastNote:
see to right for the "No Change" financial statements with fixed
values and not variables.1. Balance SheetsMost
RecentForecast2018InputBasis for 2019
Forecast2020AssetsAssetsCash$ 901.00% × 2019 Sales$
100Cash$90.01.00% × 2020 Sales$100.00Accts.
rec.1,26014.00% × 2019 Sales1,400Accts. rec.1,260.014.00%
× 2020 Sales$1,400.00Inventories1,44016.00% × 2019
Sales1,600Inventories1,440.016.00% × 2020
Sales$1,600.00Total CA$ 2,790$ 3,100Total
CA$2,790.0$3,100.00Net fixed assets3,60040.00% × 2019
Sales4,000Net fixed assets3,600.040.00% × 2020
Sales$4,000.00Total assets$ 6,390$ 7,100Total
assets$6,390.0$7,100.00Liabilities and equityLiabilities and
equityAccts. pay. & accruals$ 1,62018.00% × 2019 Sales$
1,800Accts. pay. & accruals$1,620.018.00% × 2020
Sales$1,800.00Line of credit-Draw on LOC if financing

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