Sustainable growth rate formula excel

Long-Term Financial Planning and Growth

4

GROWTH RATES ARE IMPORTANT TOOLS for evaluating a company and, as we will see later, for valuing a company’s stock. When thinking about (and calculating) growth rates, a little common sense goes a long way. For example, in 2013, retailing giant Walmart had about 838 million square feet of stores, distribution centers, and so forth. The company expected to increase its square footage by about 4.2 percent over the next year. This doesn’t sound too outrageous, but can Walmart grow its square footage at 4.2 percent indefinitely?

We’ll get into the calculation in our next chapter, but if you assume that Walmart grows at 4.2 percent per year over the next 285 years, the company will have about 100 trillion square feet of property, which is about the total land mass of the entire United States! In other words, if Walmart keeps growing at 4.2 percent, the entire country will eventually be one big Walmart. Scary.

Sirius XM Satellite Radio is another example. The company had total revenues of about $805,000 in 2002 and $3.8 billion in 2013. This represents an annual increase of about 116 percent! How likely do you think it is that the company can continue this growth rate? If this growth continued, the company would have revenues of about $17.93 trillion in just 11 years, which is about twice the gross domestic product (GDP) of the United States. Obviously, Sirius XM Radio’s growth rate will slow substantially in the next several years. So, long-term growth rate estimates must be chosen very carefully. As a rule of thumb, for really long-term growth estimates, you should probably assume that a company will not grow much faster than the economy as a whole, which is about 1 to 3 percent (inflation-adjusted).

Proper management of growth is vital. Thus, this chapter emphasizes the importance of planning for the future and discusses some tools firms use to think about, and manage, growth.

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Learning Objectives

After studying this chapter, you should understand:

LO1

How to apply the percentage of sales method.

LO2

How to compute the external financing needed to fund a firm’s growth.

LO3

The determinants of a firm’s growth.

LO4

Some of the problems in planning for growth.

Page 92A lack of effective long-range planning is a commonly cited reason for financial distress and failure. As we discuss in this chapter, long-range planning is a means of systematically thinking about the future and anticipating possible problems before they arrive. There are no magic mirrors, of course, so the best we can hope for is a logical and organized procedure for exploring the unknown. As one member of GM’s board was heard to say, “Planning is a process that at best helps the firm avoid stumbling into the future backward.”

Financial planning establishes guidelines for change and growth in a firm. It normally focuses on the big picture. This means it is concerned with the major elements of a firm’s financial and investment policies without examining the individual components of those policies in detail.

Our primary goals in this chapter are to discuss financial planning and to illustrate the interrelatedness of the various investment and financing decisions a firm makes. In the chapters ahead, we will examine in much more detail how these decisions are made.

We first describe what is usually meant by financial planning. For the most part, we talk about long-term planning. Short-term financial planning is discussed in a later chapter. We examine what the firm can accomplish by developing a long-term financial plan. To do this, we develop a simple but useful long-range planning technique: the percentage of sales approach. We describe how to apply this approach in some simple cases, and we discuss some extensions.

To develop an explicit financial plan, managers must establish certain basic elements of the firm’s financial policy:

1. The firm’s needed investment in new assets: This will arise from the investment opportunities the firm chooses to undertake, and it is the result of the firm’s capital budgeting decisions.

2. The degree of financial leverage the firm chooses to employ: This will determine the amount of borrowing the firm will use to finance its investments in real assets. This is the firm’s capital structure policy.

3. The amount of cash the firm thinks is necessary and appropriate to pay shareholders: This is the firm’s dividend policy.

4. The amount of liquidity and working capital the firm needs on an ongoing basis: This is the firm’s net working capital decision.

As we will see, the decisions a firm makes in these four areas will directly affect its future profitability, need for external financing, and opportunities for growth.

A key lesson to be learned from this chapter is that a firm’s investment and financing policies interact and thus cannot truly be considered in isolation from one another. The types and amounts of assets a firm plans on purchasing must be considered along with the firm’s ability to raise the capital necessary to fund those investments. Many business students are aware of the classic three Ps (or even four Ps) of marketing. Not to be out-done, financial planners have no fewer than six Ps: Proper Prior Planning Prevents Poor Performance.

Financial planning forces the corporation to think about goals. A goal frequently espoused by corporations is growth, and almost all firms use an explicit, companywide growth rate as a major component of their long-term financial planning. For example, in September 2007, Toyota Motor announced that it planned to sell about 9.8 million vehicles in 2008 and 10.4 million vehicles in 2009, becoming the first auto manufacturer to sell more than 10 million vehicles in a year. Of course, Toyota’s plans didn’t come to fruition. In 2009, the company only sold 7.2 million cars, and it sold 8.6 million in 2010. In 2013, the company sold 9.98 million cars and projected sales of 10.43 million cars in 2014, again hoping to cross over 10 million cars sold in a year.