Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionII. Financial Statements
and Long−Term Financial
Planning- Long−Term Financial
Planning and Growth
(^140) © The McGraw−Hill
Companies, 2002
EXTERNAL FINANCING AND GROWTH
External financing needed and growth are obviously related. All other things staying the
same, the higher the rate of growth in sales or assets, the greater will be the need for ex-
ternal financing. In the previous section, we took a growth rate as given, and then we de-
termined the amount of external financing needed to support that growth. In this section,
we turn things around a bit. We will take the firm’s financial policy as given and then
examine the relationship between that financial policy and the firm’s ability to finance
new investments and thereby grow.
Once again, we emphasize that we are focusing on growth not because growth is an
appropriate goal; instead, for our purposes, growth is simply a convenient means of ex-
amining the interactions between investment and financing decisions. In effect, we as-
sume that the use of growth as a basis for planning is just a reflection of the very high
level of aggregation used in the planning process.
EFN and Growth
The first thing we need to do is establish the relationship between EFN and growth. To
do this, we introduce the simplified income statement and balance sheet for the Hoffman
Company in Table 4.6. Notice we have simplified the balance sheet by combining short-
term and long-term debt into a single total debt figure. Effectively, we are assuming that
none of the current liabilities vary spontaneously with sales. This assumption isn’t as re-
strictive as it sounds. If any current liabilities (such as accounts payable) vary with sales,
we can assume that any such accounts have been netted out in current assets. Also, we
continue to combine depreciation, interest, and costs on the income statement.
CHAPTER 4 Long-Term Financial Planning and Growth 109
4.4
TABLE 4.6
HOFFMAN COMPANY
Income Statement and Balance Sheet
Income Statement
Sales $500
Costs 400
Taxable income $100
Taxes (34%) 34
Net income $66
Dividends $22
Addition to retained earnings 44
Balance Sheet
Percentage Percentage
$ of Sales $ of Sales
Assets Liabilities and Owners’ Equity
Current assets $200 40% Total debt $250 n/a
Net fixed assets 300 60 Owners’ equity 250 n/a
Total assets $500 100% Total liabilities and owners’ equity $500 n/a