week 7
| FIN534 Week 7 Scenario Script: Forecasting Operations and Agency Conflicts | ||
| Slide # | Scene/Interaction | Narration |
| Slide 1 | Intro Scene | |
| Slide 2 | Scene 2
| FIN534_7_2_Joe-1: Hello everyone. I wanted to stop by and tell you how great of a job you are doing with this analysis. Your expertise in many financial areas has helped us in making our decision to expand. Before we can move forward with this project, we want to be extremely confident that this move is the best choice for TFC. FIN534_7_2_Linda-1: Joe, we have reviewed: TFC’s financial statements; and Calculated ratios and compared them to the industry averages; Calculated TFC’s stock price using the constant growth model; Calculated a required rate of return for TFC and used it for capital budgeting; And we ran many calculations using the net present value, internal rate of return, the payback period, and evaluated our cash flows, to help in the decision making for this project. So I have to ask, what can possibly be next? FIN534_7_2_Joe-2: Linda, that is quite a list and I can see that a lot of work went into it this by you and your intern. The Strayer MBA program must be providing its students with the necessary concepts to translate to real-world applications. Let's use some more theory to analyze some more data BEFORE we make a decision. Remember, we are a conservative company, so we want to be confident before we make the ultimate decision which will change our present day TFC. FIN534_7_2_Joe-3: What we want you to do with your intern is look at the financial planning side of TFC. There are two main pieces of the financial planning and they consist of the Operating Plan and the Financial Plan. FIN534_7_2_Linda-2: Joe, you are right. We need to look at those areas before making a decision. So, our analyses need a little more work! FIN534_7_2_Joe-4: Right! . But, we are getting close to a decision. Plus you and your intern are doing such a great job we don’t want you to impede your progress. Maybe in a hundred years? <they laugh> FIN534_7_2_Linda-3: Joe, you have that special touch of wanting to do more for the company. That is one of the reasons why it is such a great company to work for; and to workout. (laugh) FIN534_7_2_Joe-5: That is simply the TFC way! Don will be joining you in a bit to discuss the financial planning piece of the project. As always, good luck! |
| Slide 3 | Scene 3
| FIN534_7_3_Don-1: So Joe filled you in on your next part of the project of looking at both the Operating Plan and the Financial Plan. The Operating Plan will look at TFC for future operations in our market segments and will focus on our sales and marketing strategies, growth opportunities and offerings. Typically an operating plan will focus on the immediate five years. Since we are doing a lot in the first year, we will focus on that time horizon. A lot of what-if analyses will be done with the operating plan. FIN534_7_3_Don-2: The Financial Plan will focus on projecting pro forma financial statements. These statements will help in deciding how much free cash flow there will be available in future years to finance parts of the operating plan. We will again just look at the first year. Typically, we would look at five years but since we are doing so much in the coming year, our focus will be on that period. FIN534_7_3_Linda-1: There are also other reasons why we should be forecasting free cash flows. Let’s take a close look at these rationales. |
| Slide 4 | Scene 4
Narrator: In addition to forecasting free cash flow, what are some ways in which managers should want to use pro forma, that is projected financial statements? Select all that apply
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| Slide 5 | Scene 5
| FIN534_7_5_Linda-1: There are many reasons to have pro forma financial statements. Here at our company, these pro forma financial statements assist with the financial planning.. As Joe mentioned, the financial planning is composed of two parts, the Operating Plan and the Financial Plan. Let us look at some of the components of the Operating Plan FIN534_7_5_Linda-2: Don previously mentioned the prime areas that we look at when building our Operating and Financial Plans. One area in particular is forecasting revenue. We are expecting assets to double in size with this expansion project in the first year; therefore, we have to think of sustained growth. This, however, may be difficult to predict. FIN534_7_5_Linda-3: Keep in mind that our Accounting Department has been analyzing many trends to get a forecasted revenue growth rate of ten percent. Also, in anticipation for the cost cutting measures that is being planned, the Accounting Department also projects that Operating Expenses will drop from eighty two percent of sales to seventy five percent. With these changes the pro forma statement in the following year will show a profit margin more than ten percent, which will make our shareholders happy if it is met. |
| Slide 6 | Scene 6
Forecasting any operating accounts; Keeping in line with a company’s policy on taking on debt, equity and paying dividends and; Making sure the operating plan can be funded. | FIN534_7_6_Linda-1: We were able to create some pro forma statements for TFC’s Financial Planning process. This may seem like a pretty straightforward process but there is a lot of work that goes into the decisions. There are three basic points to projecting financial statements and they consist of Forecasting any operating accounts; Keeping in line with a company’s policy on taking on debt, equity and paying dividends and; Making sure the operating plan can be funded. But there is more. During the process a company can go through many iterations of scenario analysis to determine what is best for the company. It is much like going to a show on Broadway, as you only get to see the finished production and not all the leg work behind the scenes. The same can be thought of when it comes to projecting financial statements. Much analysis goes into the decision making as the company plans around it. Here at TFC, we have many departments look over the projections before we sign off on them. |
| Slide 7 | Scene 7
| FIN534_7_7_Don-1: Linda is right about the final projected financial statements process. Since we are a conservative company who is always thinking about how to maximize shareholder wealth, our process takes time to go through the proper channels. For this expansion project, we don’t have the same luxury as other projects, but we still have to look at each area before making an informed decision. FIN534_7_7_Don-2: As a publicly traded company, we have an obligation to do the right thing for many stakeholders including shareholders, creditors, employees, and others who have a vested interest in TFC. With that comes Agency Conflicts. FIN534_7_7_Linda-1: Oh, yes. Agency Conflicts. Do you think this will hurt our chances to expand? FIN534_7_7_Don-3: Before we think that way, let’s have Joe talk to us about Agency Conflicts. He has first-hand experience in the area. |
| Slide 8 | Scene 8
| FIN534_7_8_Joe-1: Agency Conflicts is an area that I am involved with on a daily basis. To better understand it, TFC sets up agency relationships by hiring Agents to act on behalf of the company. The typical agency relationships include stockholders versus creditors; controlling interest owners versus non-controlling interest owners; and stockholders versus managers. We try to keep agency conflicts down as we have a set of rules that managers need to follow; however, there are always exceptions. Our belief is if we can keep agency conflicts down, the costs around those conflicts, called agency costs, will be lower. And, we all know that lower costs means more profit for TFC! Let’s look at each of the agency relationships and see if we are doing an adequate job of keeping agency costs down. |
| Slide 9 | Scene 9 –
SHOW OON THE SCREEN for EMPHASIS...... One choice would be to have our creditors raise the interest rate they are charging us to do the project. Second choice: to spell out in detail what the increased debt will be used for as well as put in place company performance measures. | FIN534_7_9_Joe-1: When looking at stockholder versus creditors there is a difference in points of views. Creditors are lending to TFC so they have a vested interest in seeing the investment pay off. Our creditors want to make sure we don’t default on our loans. But the decision making is not coming from the creditors but instead our mangers, acting for our shareholders. In other words, the Creditors lend to TFC and our managers are responsible for keeping the company growing. The potential agency conflicts arise because Creditors want to get paid, but managers are making decisions with company assets that can potentially affect the Creditors payment schedule. FIN534_7_9_Joe-2: Our expansion project is a great example of this. Based on our capital structure for this project, we are going to have to take on a lot of new debt. So, TFC will be taking on more risk in doing the project, which is what we saw with our cash account, but creditors would rather have risk minimized. Hence, an agency conflict. So what can be done? One choice would be to have our creditors raise the interest rate they are charging us to do the project. That is not TFC’s first choice as it can raise our debt expense considerably; thereby, increasing risk for us. The second approach and the one that has been adopted by TFC is to spell out in detail what the increased debt will be used for as well as put in place company performance measures. These debt covenants act as a watch guard for TFC. We understand that our Creditors want to see risk kept low, but we also want to grow. |
| Slide 10 | Scene 10
| FIN534_7_10_Joe-1: With the second agency conflict of inside owners versus outside owners, it results to who is bearing the cost. Take for example, when TFC was a private company, My family bore all the costs but also reaped the benefits. This included some well-deserved vacations at the company’s expense. When we decided to go public, we now took on outside owners. We still had the company pay for well-deserved company vacations, but the expense was now also being consumed by our external owners. As a result, our external owners demanded a higher rate of return. Financially, we were doing fine, but the external owners felt that the money should have gone back into the business. FIN534_7_10_Joe-2: What did we do? Well, my family met and decided that it was in the best interest of TFC to stop having the company pay for our vacations. We felt that when we decided to go public we gave up that luxury. We communicated our new policy and added additional language regarding equality across all the owners. That is why we don’t have any preferred stock or special interest stock. We want everyone to be on the same “workout” field. This new policy has worked out great for the company and for establishing relationships. |
| Slide 11 | Scene 11
Use tablet to put the six main ways in which the actions of our managers may affect the value that our shareholders desire. | FIN534_7_11_Joe-1: The third agency conflict is the one that we encounter the most which is conflicts between the decision making managers and the shareholders of TFC. Shareholders want to see TFC’s value go up. Remember, stock price maximization? But our managers also have personal and company goals that they want to meet as well. And if the actions by the managers to meet their goals are not in line with stock price maximization, conflicts can arise. FIN534_7_11_Joe-2: There are six main ways in which the actions of our managers may affect the value that our shareholders desire. I’ve created an activity for you to use on this tablet as we discuss each of the main ways in which actions of our managers may affect the value that our shareholders desire. FIN534_7_11_Joe-3: First, Efforts by TFC’s managers regarding profit maximization. If our managers are spending more time at “extracurricular” activities for the company instead of seeking ways to build the company. We like it where our managers, including myself, are out there marketing TFC, but we also need to be in house. To try to alleviate this conflict, TFC has encouraged managers to be selective in those additional activities. So far this initiative has really been paying off. FIN534_7_11_Joe-4: Second, Managers overspending on non-essential items. At TFC we are cash conscious so managers have to go through an approval process to ensure they are spending within company guidelines. We are cash focused therefore extravagant purchases are not permissible. FIN534_7_11_Joe-5: Third, Inability to act prudently when it involves closer relationships. At times our managers are put in a bind and they need to act accordingly even though it may affect someone who is close to them. All of our managers know that they need to separate business from their personal feelings. This is easier said than done. However, prudent decisions need to be made if we want to grow our business. Our business model takes into consideration the personal side of the business and that is why we do so several analyses before making a decision. I am pleased to say that our model has been quite successful as we have never laid off an employee in the history of our company. FIN534_7_11_Joe-6: The fourth involves Risk Taking. With this conflict, managers may be reluctant to take on a project with risk even if it is projected to be a winner. Take for example our expansion project. It is very risky and if not successful the result can be bleak for TFC. The blame would then go to me and the management staff involved in the project. As a result of this managers may be reluctant to take on the risk even though shareholders stand to benefit from it. To alleviate this conflict, we treat it much in the same way as the other conflicts and complete a detailed review of any high exposure project to ensure we are comfortable. FIN534_7_11_Joe-7: The fifth is Cash Management Decision Making. It is no secret that TFC is a cash conscious business. Cash is good but too much cash may not be. Remember the saying, "Cash is king". Cash flow is important to the general health of the business. It might sound odd but think of it from the point of view of the shareholder. They like to see some immediate returns on their investment. If a company is continuing to hold on to their cash, shareholders are not reaping the benefits. Also, extra cash may entice managers to make poor investment decisions down the road. Cash is also important but it also needs to be regulated here. In order to regulate this cash we have a policy in place to keep cash at an adequate level that will help us be financially strong while also giving back to our investors in stock growth and dividends. FIN534_7_11_Joe-8: The sixth and last area involves Information Sharing. With this conflict, managers may not share all available information in a timely manner as they don’t want their competitors to gain an advantage. Also, if the company is not doing well, they may delay the release of bad information or change it to not look as bad. At TFC, we are an open book company. Our policy is to share all available information as soon as possible. We are more focused on our company image and believe that being up front is the best way to go. |
| Slide 12 | Scene 12
| FIN534_7_12_Linda-1: Joe, thank you so much for explaining the potential agency conflicts. I never realized how much there is to this concept. FIN534_7_12_Joe-1: You are welcome Linda and I am always learning something new every day. That is why we are putting so much effort into analyzing this expansion project. We still have not made a final decision, but the numbers may speak for themselves. However, we have to consider the effects on the interested parties. FIN534_7_12_Linda-2: I guess you can say it is a continuous learning process. |
| Slide 13 | Scene 13
As part of your understanding about Agency Conflicts, please select all those that can be considered potential Agency Conflicts between managers and shareholders
Answer – They all can be considered potential agency costs. Shareholders want managers to maximize their wealth but managers also have their own goals which can cause conflicts.
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| Slide 14 | Scene 14
| FIN534_7_14_Don-1: Wow – great information by everyone. We first learned that pro forma statements are an important part of Financial Planning which includes the Operating and Financial Plans. A lot of research is needed in developing these statements as company projections which then help in establishing projected cash flows which in turn assist in valuation projections. We also learned about Agency conflicts. The three typical Agency Conflicts are stockholders versus creditors; controlling interest owners versus non-controlling interest owners; and stockholders versus managers. The conflicts can arise as profit maximization measures may not be implemented to the fullest due to a number of factors. Interested parties are then faced with some decisions. If the core values of the company are kept in mind, this may help in the decision making process. FIN534_7_14_Linda-1: While we did not do a lot of calculations this time around, we did do a lot of examination of policies and procedures. These are also very important whenever we evaluate a project not to mention one as big as this expansion project. All of this hard work has really made me ready to join one of those TFC Intense Exercise classes. One of them is starting in a few minutes. Let’s go exercise! |
| Slide 15 | Scene 15
| Closing slide |
