University of St.
La Salle – Bacolod City
CLASS CASE 4: GROWING PAINS
USLS Graduate School of Business and Management
In partial fulfillment of the requirement in
MBA 207B
COMPREHENSIVE FINANCIAL MANAGEMENT
Submitted to:
Felix D. Cena,CPA, Ph.D.
Submitted by:
Jean Diane Y. Jovelo
Luis Santillan Jr.
August 31, 2019
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Questions
1. Since this is the first time Jim and Mason will be conducting a financial forecast for
Oats’ R’ Us, how do you think they should proceed? Which approaches or models
can they use? What are the assumptions necessary for utilizing each model?
As firs timers Jim and Mason should begin their planning with a practical sales forecast.
The sales forecast should be based on clearly stated and realistic assumptions about future
economic conditions. Then, they should prepare pro forma financial statements by either
assuming the key items vary proportionately with sales or remain constant (as the case may
be). Based on their asset utilization rate, they would be able to determine the asset
requirements for growth. Funds required to finance growth should consider the best option
the maximize companies bottom line which should consider the external sources such as
accounts payables and accruals and from future retained earnings. The remaining funds
necessary for growth could then be raised from external sources such as new debt and stock
offering.
Jim and Mason can use one of the following approaches:
1. Pro Forma Approach – It models the anticipated results of transactions
with emphasis on projected cash flows, net revenues and taxes. Where
most of the income statement and balance sheet items are assumed to
maintain a constant proportion to sales, but individual items can be
forecasted using statistical techniques and feedback effects involving
changes in interest costs etc. can be included. This will enable to facilitate
comparisons of historic data and projection of future performance.
2. EFN Formula Method – This enable to calculate your external financing
needs. Which is simple to use but does not allow the inclusion of feedback
effects.
3. Internal Growth Rate Model- In this model, the forecast assumes that the
firm will not raise any external capital. The model gives the maximum
growth in sales that can be supported without resorting to external
financing.
2. If Oats’ R’ Us is operating its fixed assets at full capacity, what growth rate can it
support without the need for any additional external financing?
Considering fixed assets in full capacity, below are the recommended steps in computing the
growth rate:
1. Calculate the percent of sales figure for each balance sheet item, as well as the net
profit margin, and the retention rate.
2. Using the External Funds Needed (EFN) formula (shown below), set EFN to 0, plug in
the required data, and solve for the change in sales that could be achieved without any external
financing.
1
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EFN = (Ao/So)*(Change in sales) – (Lo/So)*(Change in Sales) - Net Margin*(So + Change
in sales)*Retention Rate
Let, So = Current sales;
New Sales = S1 = (So + Change in sales)
Retention Rate = 1 – Payout Ratio
EFN = Increase in Assets - Increase in internal equity
2
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EFN = 25.679%*(Change in So) – 2.87*(Change in So) - [4.678%*0.6*(4,700,000 + Change in So)]
0 = 22.807%*(Change in So) – 0.0280*(Change in So) - 131,940
Change in So = $131,919.6/0.2000 = 659,717
Growth rate that can be supported with no external funds = 659,717/4,700,000 = 14.037%
Alternative method
Compute the Internal growth rate.
Internal growth rate = (ROA x Retention Rate)/[1 - (ROA x Retention Rate]
= (18.2% x 0.6)/[1-(18.2% x 0.6)] = 12.26%
3. Oats’ R’ Us has a flexible credit line with the Midway Bank. If Mason decides to
keep the debt-equity ratio constant, up to what rate of growth in revenues can the firm
support? What assumptions are necessary when calculating this rate of growth? Are these
assumptions realistic in the case of Oats’ R’ Us? Please explain.
A higher rate of growth can be achieved if the firm maintained a constant dept-equity ratio. The
assumptions below depend upon the future performance of the company particularly in its sales
3
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and cost control. A constant dept-equity ratio of management policy which quite hard to achieve.
This growth rate is called the sustainable growth rate and is calculated as follows:
Sustainable Growth Rate = ROE x Retention Rate = 38.1%
1 - ROE x Retention Rate
Where ROE = 46% and Retention rate = 60%.
The assumptions necessary when
calculating the sustainable growth rate
include:
1.The firm will maintain a constant
debt-equity ratio.
2.The Net Profit margin will be
constant.
3.Total asset turnover will be constant
4.The retention rate will be constant.
4. Initially Jim assumes that the firm is operating at full capacity. How much
additional financing will it need to support revenue growth rates ranging from 25% to 40%
per year?
4
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5. After conducting an interview with the production manager, Jim realizes that Oats’
R’ Us is operating its plant at 90% capacity, how much additional financing will it need to
support growth rates ranging from 25% to 40%?
6. What are some actions that Mason can take in order to alleviate some of the need
for external financing? Analyze the feasibility and implications of each suggested action.
Below are some of the recommended actions that Mason can take to alleviate some of the need
for external financing;
1. Increase accounts payables by using more trade credit – it’s a favorable for a company for
cash balance, but in the long run could be risky and could not avail anymore discount by
paying cash.
2. Increase accruals – limited scope, but it will allow actual on time pictures of expenses
and income being reported and will help company to conserve cash.
5
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3. Increase profit margins – easier said than done because of competition. But it can be done
by having a cost efficient and effective operations that eliminate unnecessary cost.
4. Increase retention rate – this is a policy decision and is feasible. The scope is limited,
though, because profits are typically only a small portion of sales.
5. Increase sales – a SWOT analysis and good marketing research to identify the best
approached for the company.
7. How critical is the financial condition of Oats’ R’ Us? Is Vicky justified in being
concerned about the need for financial planning? Explain why.
As shown in above computation the company can grow another 11% without the need of external
financing, if the retention rate and profit margin are maintained. With the projected increase of
sales of 25-40% a financial planning is important as they look for the best source of funds when
needed that provide the company the optimal net income with the given increase of sales. The
owners have the option to retain its profit in order to minimize the need for external source of
funds. They should take advantage to possible increase of market share since financing is not an
issue with the healthy ROA and ROE with good liquidity ratio raising funds is not a concern.
Therefore, planning is important in order to maximize the bottom line with increase of sales.
8. Given that Mason prefers not to deviate from the firm's 2004 debt-equity ratio, what
will the firm's pro-forma income statement and balance sheet look like under the scenario
of 40% growth in revenue for 2005 (ignore feedback effects).
6
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7
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