The role of financial planning in making investment decisions ii

Executive Summary

The understanding of industry specific cycles with upturns and downtrends has strategic implications for firms already competing in the industry or contemplating entry. Every crisis offers also chances, so that decisions for investments should be taken or reviewed even in a downtrend. As the macroeconomic environment can change quickly the window of opportunity for investments might be short in time and the dynamic of changes in the targeted market can be quite high. A solid framework of financial planning models can deliver immediate responses to changed input variables when analyzing investments decisions. Financial planning will not answer the question for an investment decision, nor will it provide solutions how to finance the investment, but it will help to compare different investment strategies and to ask the right questions. Financial planning bears the danger of crystal ball predictions. It needs to be based on a solid understanding of the limitations of the models used and the assumptions made.

The objective of this assignment is to review how financial planning can support the management in validating potential investment decisions. Based on a practical example the role of financial planning was analyzed.

“Knowing where you stand today is a necessary prelude to contemplating where you might be in the future.” (Brealey et al, 2008 p. 786) The understanding of a company’s overall performance and its current financial standing is the key for any planning activities.

In a first step the financial situation of KLA-Tencor Corporation was reviewed using public available data of last year’s financial statements and press releases. In a second step the data was discussed in comparison to industry peers and financial ratios were calculated. Long term financial planning approaches were reviewed and planning models were discussed. In a last step a “percentage of sales” model was applied to develop a potential scenario for KLA-Tencor Corp. over the next 4 years until 2012 based on forecasts of market research institutes. The assignment ends with potential conclusions how KLA-Tencor could use its financial strength for a rapid growth over the next years. There are a lot possible investment options for KLA-Tencor Corp. By varying the forecasted revenue into both directions a more aggressive investment scenario was validated to provide sufficient elasticity to deal with ~ 50…100 percent lower market growth than forecasted and still ensuring a stable growth of the company.

The  role of financial planning in making investment decisions  iii

Table of Contents

1  INTRODUCTION  1

2  PROBLEM DEFINITION.  1

3  OBJECTIVES  1

4  METHODOLOGY  1

5  THE ROLE OF FINANCIAL PLANNING  2

5.1  FINANCIAL SITUATION OF KLA-TENCOR CORPORATION.  2

5.2  NET WORKING CAPITAL AND CASH FLOW.  4

5.3  FINANCIAL RATIOS.  6

5.4  LONG TERM FINANCIAL PLANNING AND GROWTH  7

5.5  FINANCIAL PLANNING MODELS.  8

5.6  AN EXAMPLE FOR FINANCIAL PLANNING.  8

6  CONCLUSIONS  10

APPENDIX -  ITM CHECKLIST  11

BIBLIOGRAPHY   12

List  of Figures  

Figure  1 Comparison of key numbers in common-size balance sheets of KLA-Tencor Corp.  2

Figure  2 Calculated pro forma internal growth rates for KLA-Tencor Corp.  10

List  of Tables  

Table 1  Balance Sheets of KLA-Tencor Corporation  3

Table 2  Income Statements of KLA-Tencor Corporation.  4

Table 3  Cash Flow Statements of KLA-Tencor Corp.  5

Table 4  Intangibles of KLA-Tencor Corp.  5

Table 5  Financial Ratios for KLA-Tencor Corp. 2008  6

Table 6  Latest and pro forma statements of KLA-Tencor Corp  9

The role of financial planning in making investment decisions 1

1 Introduction

The understanding of industry specific cycles with upturns and downtrends has strategic implications for firms already competing in the industry or contemplating entry. Every crisis offers also chances, so that decisions for investments (or disinvestment) should be taken or reviewed even in a downtrend. As the macroeconomic environment can change quickly the window of opportunity for investments might be short in time and the dynamic of changes in the targeted market can be quite high. Beside a good “gut feeling” there should be a solid framework of financial planning models when analysing investments, as those models deliver immediate responses to changed input variables. Financial planning will not answer the question for an investment decision, nor will it provide solutions how to finance the investment, but it will help to compare different investment strategies and to ask the right questions.

2 Problem Definition

Financial planning bears the danger of crystal ball predictions. It needs to be based on a solid under-standing of the limitations of the models used and the assumptions made. On the other side, investment decisions should be made after thorough investigation of potential options. Financial planning can help to reveal short and long term implications of different investment options.

3 Objectives

The objective of this assignment is to review how financial planning can support the management in validating potential investment decisions.

4 Methodology

Based on a practical example the role of financial planning was analyzed. In a first step the financial situation of KLA-Tencor Corporation was reviewed using public available data of last year’s financial statements and press releases. In a second step the data was discussed in comparison to industry peers and financial ratios were calculated. Long term financial planning approaches were reviewed and planning models were discussed. In a last step a “percentage of sales” model was applied to develop a potential scenario for KLA-Tencor Corp. over the next 4 years until 2012 based on forecasts of market research institutes. The assignment ends with potential conclusions how KLA-Tencor could use its financial strength for a rapid growth over the next years.

The role of financial planning in making investment decisions 2

5 The Role of Financial Planning

5.1 Financial Situation of KLA-Tencor Corporation

“Knowing where you stand today is a necessary prelude to contemplating where you might be in the future.”: (Brealey et al, 2008 p. 786). The understanding of a company’s overall performance and its current financial standing is the key for any planning activities. The financial statements of a company will help to assess that information. In addition several key financial ratios calculated based on these statements will help to ask the right questions as an investor, a creditor or even as the owner or shareholder.

Table 1 shows the balance sheet of the KLA-Tencor Corporation, a metrology supplier for the semi-conductor industry, for the last two years. The relatively high amount of cash and equivalents versus the total balance is typical for this type of business. As shown in Figure 1, the common size numbers match pretty well the one for semiconductor industry average in Standard & Poor’s Composite Index. Compared to 2005 there are a few remarkable changes in the financial statements for 2008. The higher amount of long term debt compared to industry average has its root cause in the issuance of $750 million aggregate principal amount of Senior Notes ¹ due May 1, 2018, with a coupon of 6.90% and will be discussed later. Through several acquisitions over the last two years the company has build up a quite high amount of intangible assets in its balance sheet of ~ $900Mio. These intangibles will be discussed later as well.

Figure 1 Comparison of key numbers in common-size balance sheets of KLA-Tencor Corp.

to Semiconductor Industry average in Standard & Poor’s Composite Index

Source: own calculations based on balance sheet data in Zacks 2009 and data in (Brealey et al, 2008 p. 801)

1 A Senior Note is debt that takes priority over other unsecured debt owed by the issuer.