Module 3 Lecture 6b

FINANCIAL FEASIBILITY

Financial Planning
Financial Statement Analysis
Financial Feasibility Details
 Major Assumptions
• Project timetable and projection years
• Sales and collection
• Operating assumptions
• Financial assumptions
 Projected Financial statements
• Pre-operating
• Operating
 Financial Statement Analysis
Financing Study
 Determine the specific requirements of the project
 Identify alternative sources of financing
 Determine the desirable Debt-Equity ratio
 Establish the project’s financing policy
 Determine the effective cost of financing
 Determine the maximum amount of financing from each
source
 Work out a financing scheme
 Leverage
 Break-Even Point (BEP)
BEP = Fixed Operating Costs + Interest Expenses
Unit Price – Unit Variable Cost

 Operating Leverage – incurrence of fixed operating costs in the firm’s

income stream.

Degree of Operating Leverage (DOL) = % Change in Net Operating Income

% Change in Sales

DOL = Peso Sales – Variables Costs______

Peso Sales – Variable Costs – Fixed Costs
 Leverage

 Financial Leverage – financing a portion of the firm’s assets with

securities bearing a fixed or limited rate of return.

Degree of Financial Leverage (DFL) = % Change in Earnings per Share

% Change in Net Operating Income

DFL = Net Operating Income____

Net Operating Income - Interest
FINANCIAL STUDY:
Tools for Financial Planning
 Funds-flow statement
• Uses and sources of funds
 Cash budget
• Short-term cash needs and short-term financing
 Pro-forma statements
• Shows effects of policy decisions on future financial
condition and performance of a firm
 Sustainable growth modeling
• Determines whether sales growth objectives are
consistent with operating efficiency and financial ratios
Sources and Uses of Funds:
 Sources:
• Net decrease in any asset other than cash or fixed assets
• Gross decrease in fixed assets
• Net increase in any liability
• Proceeds from sale of stock
• Funds provided by operations
 Uses:
• Net increase in any asset other than cash or fixed assets
• Gross increase in fixed assets
• Net decrease in any liability
• Retirement or purchase of stock
• Cash dividends
 Sample Problem: Financial Planning
The balance sheet of Magnolia Inc. as of November 30, 2008 is as follows:
ASSETS: EQUITIES:
Cash 12,000 Accounts Payable-suppliers P 135,000
Accounts receivable 108,000 Notes payable 22,500
Inventory 45,000 Capital Stock 630,000
Plant and equipment, net 750,000 Retained earnings 127,500
Total Assets P 915,000 Total Equities P 915,000

For December, sales are budgeted at P375,000 of which P120,000 will be in cash and the
remainder will be on credit. 50% of the month’s credit sales are collected in the month of
sale and the balance collected the following month. All of the accounts receivable in
November will be collected in December. The notes and accounts payable in November
will be paid in December. The company will pay interest for December amounting to
P750 and it will borrow P27,000 by giving a new note payable due in one year.
Purchases of inventory in December are expected to be P300,000, on account. 40% of
all inventory purchases are paid for during the month of purchase and the balance paid in
the following month. The December 31 inventory balance is budgeted at P60,000. New
equipment costing P13,500 will be purchased in cash in December. Cash operating
expenses for December are budgeted at P76,500, exclusive of depreciation. Depreciation
is budgeted at P3,000 monthly.

Prepare a cash budget for December supported by schedules and proforma income
statement and balance sheet for the same period.
Solution: Magnolia Inc.
Cash Budget
Dec Jan
Cash, Beg. 12000
Cash IN
Sales 120000
Collection of A/r 127500 127500
New Notes Payable 27000
108000
Cash, Avail 394500
CASH OUT
Payment of Payables 157500
Interest 750
Pirchase of Inventory 120000
Operating Expenses 76500
Cash, end 39750
Magnolia, Inc.: Balance Sheet
As of December 31, 2008

ASSETS: EQUITIES:

Cash 39750 A/P 180000

A/R 127500 Notes 27000
Inventory 60000 Capital 630000
PPE 747000 R/E 137250
TOTAL 974250 TOTAL 974250
Magnolia, Inc.: Income Statement

For the month ended December 31, 2008

Sales 375000
COGS 285000
GP 90000
Operating Expenses 76500
Dep'n 3000
Interest 750
NI 9750
Financial Statement Analysis
 All analyses of financial data involve comparisons
 Comparisons make the financial data meaningful
 Comparisons are essentially intended to shed light
on how well a company is achieving its objectives
 Structure of analysis:
• Longitudinal or trend
• Vertical or common-size
Overall Performance Measures
 Price/earnings ratio (P/E)
= Market price per share
Net income per share
 Return on assets (ROA) or Earning Power
= Net income + Interest (1 – tax rate)
Total Assets
 Return on shareholders’ equity (ROE)
= Net Income____
Shareholders’ equity
 Overall Performance Measures
 Return on invested capital (ROIC)
= Net income + Interest (1 – tax rate)______
Long-term liabilities + Shareholders’ Equity

 Operating Income Return on Investment (OIROI)

= Operating income
Total assets
= Operating profit x Total asset
margin turnover
= Operating income x Sales
Sales Total assets
Profitability Measures
 Gross Margin Percentage
= Gross margin_
Net sales revenue

 Profit Margin (PM)

= Net income___
Net sales revenue
 Earnings per share (EPS)
= Net income_ __
No. of shares outstanding
 Cash realization
= Cash generated by operations
Net income
Tests of Investment Utilization (1)
 Asset turnover
= Sales revenues
Total assets
 Invested capital turnover
= Sales revenues
Long-term liabilities + Shareholders’ equity
 Equity turnover
= Sales revenues
Shareholders’ equity
 Capital intensity
= Sales revenues
Property, plant and equipment
 Days’ cash
= Cash
Cash expenses / 365
 Tests of Investment Utilization (2)
 Days’ receivables (collection period) Receivable turnover
= Accounts receivable = Annual credit sales
Credit Sales / 365 Accounts receivable
 Days’ inventory
= Inventory____
Cost of sales / 365
 Inventory turnover
= Cost of sales
Ave. Inventory
 Working capital turnover
= Sales revenues___
Working capital
 Current ratio
= Current assets____
Current liabilities
 Acid-test (quick) ratio
= Monetary current assets or Current assets less inventories
Current liabilities Current liabilities
Tests of Financial Condition
 Financial leverage ratio
= Assets
Shareholders’ equity
 Debt/equity ratio
= Long-term liabilities or Total liabilities___
Shareholders’ equity Shareholders’ equity
 Debt/capitalization
= Long-term liabilities
Long-term liabilities + Shareholders’ equity
 Times interest earned
= Pre-tax operating profit + Interest
Interest
 Cash flow/debt
= Cash generated by operations*
Total debt
*Earnings before interest, taxes, depreciation and amortization
Tests of Dividend Policy
 Dividend yield
= Dividends per share
Market price per share

 Dividend payout
= Dividend
Net income
Percentage analysis of Financial Statements
 Common Size
• Balance sheet and income statement items are expressed as
percentages of totals
 Index analysis
• Balance sheet and income statement items are expressed as
percentages of some base year

 Gives insight on improvement or deterioration in financial

condition and performance
 Sample Problem: Financial Statement

Huff and Puff Industries had sales of P125,000 in 2002 which was subjected to a 50%
tax rate. Given the following financial ratios for year, reconstruct the firm’s balance
sheet and income statement (Rounded to the nearest peso). Show all relevant
computations.

2002
Current ratio 1.84
Acid-test ratio 0.78
Average collection periods (based on a 365-day year and end-of- 36.50
year figures)
Inventory turnover 2.59
Debt ratio 50%
Times interest earned 4.00
Gross profit margin 40%
Operating profit margin 9.6%
Total asset turnover 1.11
Fixed asset turnover 2.02
Return on common equity 8.0%
Return on total assets 4.0%
Sample Problem: Financial Statement Analysis

Estrella Stores has sales of P6 million, an asset turnover

ratio of 6 for the year and net profits of P120,000. What is
the company’s return on assets? The company will install
new point-of-sales cash registers throughout its stores
which are expected to increase efficiency in inventory
control, reduce clerical errors and improve record keeping.
This new equipment will increase the investments in
assets by 20% and is expected to increase the net profit
margin from 2% now to 3%. No change in sales is
expected. What is the effect of the new equipment on the
earning power?
Solution:

 Total Assets = Sales/Asset turnover = 6million/6 = 1

million
 Return on Assets = Net Profits/Total Assets =
120,000/1,000,000 = 0.12 = 12%
 Effect of New Equipment
• Total Assets = 1.2(1) = P1.2 million
• Net Profit = 6 million (0.03) = P180,000
• Return on Assets = 180,000/1.2 million = 0.15 = 15%
 Therefore the new equipment will increase earning
power 25% [(15%-12%)/12%].