BFN3104

Chapter 9
Questions
1.

What is the main purpose of financial planning?

The main purpose of financial planning is to consider the big picture of a companys
activities over the long-term, five or ten years, with regard to its growth and how that
growth may be financed.

2.

What is a forecast? Define qualitative and quantitative forecast.

Forecasts are not plans or budgets but are predictions of future environments, events
and outcomes, and may be derived using both qualitative and quantitative techniques.
Qualitative forecasting uses non-numeric information and considers trends in demand
and behavior.
Quantitative forecasting employs numerical data and probabilities and use historical
data to predict future outcomes.

3.

Explain strategic planning.

A process of deciding on the objectives of an organization, the resources used to
attain these objectives and on the policies that are to govern the acquisition use and
disposition of these resources. The results of this process may be expressed in a
strategic plan, which is a statement of long-term goals along with a definition of the
strategies and policies which will ensure achievement of these goals.

Problem
The financial results for 3 companies in the Marx Group for 2006 are shown below:
Company
Groucho

Chico
Assets
Operating profit
Administrative expenses
Cost of capital per annum

7.5m
1.5m
0.8m
7%

17.5m
1.4m
0.3m
5%

Required:
a.

Calculate the ROCE for each company for 2006.

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Harpo
12.5m
2.0m
0.65m
10%

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Chico
7.5m
1.5m
20%
1

Average net operating assets (ANOA)

Operating profits (OP)
ROCE % (OP/ ANOA)
Ranking of ROCE %
b.

Harpo
12.5m
2.0m
16%
2

Groucho
17.5m
5%
1.4m
0.3m
1.1m
0.875m
0.225m
1

Harpo
12.5m
10%
2.0m
0.65m
1.35m
1.25m
0.1m
3

Calculate the EVA each company for 2006.

Chico
7.5m
7%
1.5m
0.8m
0.7m
0.525m
0.175m
2

Average net operating assets (ANOA)

Divisional WACC
Operating profits (OP)
Administrative expenses (AE)
Net income (OP-AE)
ANOA * WACC
EVA = Net income (ANOA*WACC)
Ranking of EVA
c.

Groucho
17.5m
1.4m
8%
3

If each company is presented with an investment opportunity that is expected to

yield a return of 9%.
i.
Which company(s) would accept and which company(s) would reject the
investment if their performance is measured by ROCE, and why?
The ROCE% of each division is currently above its WACC with Chico being by
for the best performer, followed by Harpo and then Groucho.
Chico and Harpo would be reluctant to pursue as investment opportunity that is
expected to yield a return of 9% because they both currently earn 20% and 10%
respectively.
In the case of Chico this represents a lost opportunity for Marx plc because taking
on the investment would add value since Chicos WACC is 2% lower than project
is 9 %. Harpos decision not to take on the investment is in the best interest of
Marx plc since Harpos WACC is 7% above the projects 9%. Groucho would be
keen to pursue an investment opportunity that is expected to yield a return of 9%
because it currently earns only 8%. Grouchos decision to take on the investment
is also in the best interest of Marx plc since Grouchos WACC is 4% below the
projects 9%.
ii.

Which company(s) would accept and which company(s) would reject the
investment if their performance is measured by EVA, and why?
The current EVA of Groucho is the highest followed by Chico and then Harpo. If
performance is measured using ROI, then Chico and Groucho would take on an
investment opportunity that yield 9% because even after capital charges on net

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operating assets at 7% and 5% respectively it would add to their residual incomes.
If performance is measured using EVA, Harpo would not take on an investment
opportunity that yield 9% because after the capital charge on net operating assets
at 10% there would be a reduction to residual income.

Discussion
Students will prepare some materials for this topic which will take about 10 minutes for
interactions and exchanges. The topic for this week is:

Financial plans are not accurate because in general they do not

differentiate between the behaviour of variable and fixed costs.

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