Chapter 16 Financial Planning and Forecasting 515

(^7) The CFO also loaded the Excel model on his laptop so he could do on-the-spot sensitivity analyses. For exam-
ple, he could change the growth rate and instantly! nd the new AFN. Similarly, he could change the dividend
payout ratio, the pro! t margin, and the other variables to see how those changes would a" ect the! rm’s capital
requirements. Still, the analysis in Table 16-1 provided a useful starting point.
Additional
funds^
needed, or AFN
!
Projected
increase^
in assets

Spontaneous
increase in^
liabilites

Increase in
retained^
earnings
16-1
! (A 0 /S 0 )"S # (L 0 /S 0 )"S # MS 1 (1 – Payout)
Allied Foods’ CFO used Equation 16-1 in the following manner. Every fall the
company’s Executive Committee, which includes the CEO, the CFO, and other top
executives, meets to consider plans for the coming year. The meeting this year is
especially important for two reasons: (1) The national credit crunch is constraining
the! rm’s ability to raise capital, so the amounts needed and available must be
determined. (2) Corporate raiders and private equity! rms have targeted a num-
ber of food processors; and when they take over, heads roll in the acquired! rm.
Allied’s executives are aware of both factors.
Allied’s CFO plans to proceed in two steps. First, he will use the AFN equation
to give the others an idea of how much new capital the! rm will need to support the
targeted 10% growth rate, assuming the various operating ratios remain constant.
Second, he will present the results of a full-scale! nancial planning model. The
model will show forecasted! nancial statements in addition to a set of forecasted
ratios like those discussed in Chapter 4, along with an estimate of the 2009 EPS. The
CFO hopes the EPS forecast will help the company avoid the embarrassment suf-
fered by GE’s Jeff Immelt, which was discussed in this chapter’s opening vignette.
The CFO brought copies of Table 16-1, which is based on Equation 16-1, and
data from the! nancial statements presented in Chapter 3 to the Executive Com-
mittee.^7 Part I of the table picks up selected data from the 2008 balance sheet and
income statement. Part II uses the Part I data to calculate inputs for Equation 16-1.
Note that all the calculations in Part II assume that the company’s operating ratios
in 2009 continue at 2008 levels. Part III uses the items calculated in Part II to calcu-
late the AFN. To increase sales by $300 million, Allied must increase assets by $200
million. The asset increase will be supported by $20 million from spontaneous
increases in payables and accruals, and another $66 million will come from
retained earnings. In total, $114 million of new outside funds will be needed;
and since Allied does not use preferred stock, the amount must come from
interest-bearing debt in addition to new common stock.
As noted, the AFN equation assumes that the 2009 ratios will remain constant
at the 2008 levels. If economic conditions or managerial decisions cause the ratios
to change, the forecasted AFN will change. Part IV of the table shows how some
speci! c input changes will change the forecasted AFN. For example, if the target
growth rate was increased from 10% to 15% with other things held constant, the
AFN would increase from $114 million to $201 million. On the other hand, if the
target growth rate was lowered to 5%, the AFN would be only $27 million. Also, as
shown in Part V, if the company grew at a rate of 3.45% while other things were
held constant, AFN would be zero. Thus 3.45% is called Allied’s sustainable
growth rate.
Finally, note that if the growth rate slowed and other inputs were changed
in the manner speci! ed in Part IV of the table, Allied would end up with a large
negative AFN, indicating that retained earnings and spontaneous capital were far
more than suf! cient to! nance the now smaller amount of additional assets
needed.
Sustainable
Growth Rate
The maximum achievable
growth rate without the
firm having to raise
external funds. In other
words, it is the growth rate
at which the firm’s AFN
equals zero.
Sustainable
Growth Rate
The maximum achievable
growth rate without the
firm having to raise
external funds. In other
words, it is the growth rate
at which the firm’s AFN
equals zero.