Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

II. Financial Statements

and Long−Term Financial

Planning

4. Long−Term Financial
   Planning and Growth

(^142) © The McGraw−Hill
Companies, 2002
Figure 4.1 illustrates the connection between growth in sales and external financing
needed in more detail by plotting asset needs and additions to retained earnings from
Table 4.8 against the growth rates. As shown, the need for new assets grows at a much
faster rate than the addition to retained earnings, so the internal financing provided by
the addition to retained earnings rapidly disappears.
As this discussion shows, whether a firm runs a cash surplus or deficit depends on
growth. For example, in the early 1990s, electronics manufacturer Hewlett-Packard
achieved growth rates in sales well above 20 percent annually. However, from 1996 to
1997, HP’s growth slowed to 12 percent. You might think that such a slowdown would
mean that HP would experience cash flow problems. However, according to HP, this
slower growth actually increased its cash generation, leading to a record cash balance of
$5.3 billion in late 1998, nearly double the year-earlier figure. Although much of the
cash came from reductions in inventory, the firm had also decreased its spending for
business expansion.
CHAPTER 4 Long-Term Financial Planning and Growth 111

TABLE 4.8

Growth and Projected

EFN for the Hoffman

Company

Projected Increase Addition to External Projected

Sales in Assets Retained Financing Debt-Equity

Growth Required Earnings Needed, EFN Ratio

0% $ 0 $44.0 
$44.0 .70

5 25 46.2 
21.2 .77

10 50 48.4 1.6 .84

15 75 50.6 24.4 .91

20 100 52.8 47.2 .98

25 125 55.0 70.0 1.05

FIGURE 4.1

Growth and Related

Financing Needed for

the Hoffman Company

Asset needs

and retained

earnings ($)

125

100

75

50

25 EFN

<^0

(surplus)

EFN

>^0

(deficit)

44

Projected

addition

to retained

earnings

Increase

in assets

required

Projected

growth in

(^510152025) sales (%)