Economic

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Financial Management
Financial Planning and Forecasting
Key Chapter Concepts
1. Firms need to conduct two types of planning —strategic planning, and a subset, operational planning. a. Strategic planning is long range in nature and deals with the overall direction of the firm. b. Operational planning serves as a blueprint detailing where the firm wants to be at some future point in time and what resources are needed to get there. 2. Financial forecasting involves the estimation of the firm’s future needs for funds. Pro forma financial statements, i.e., balance sheets, income statements, and cash budgets, are an integral part of financial forecasting. They show the results of assumed events rather than actual events. 3. Cash flows are the ultimate source of financial value. Therefore, cash flow analysis and forecasting are important parts of a firm’s financial plans. 4. After-tax cash flow is equal to earnings after tax plus noncash charges. 5. The statement of cash flows shows the effects of a firm’s operating, investing, and financing activities on its cash balance. 6. The percentage of sales forecasting method is used in estimating the amount of additional financing that a firm will need for a given increase in sales, based on certain assumptions about the relationship between sales and the various asset and liability accounts. A cash budget is the projection of a firm’s cash receipts and disbursements over a future time period and is useful in determining the amount of short-term funds the firm will need to borrow. Financial Forecasting in the Telecom Industry: What Went Wrong? The 1990’s technology boom saw investments of over $750 billion in telecom company stocks and bonds. Many companies built fiber -optic data transmission networks based on the expectation that demand (i.e., Internet traffic) would continue growing at extremely high rates. This led to massive overcapacity and plummeting prices in 2001 and 2002. It is estimated that only 2.7 percent of the total fiber -optic capacity is actually being used. Much of the remaining fiber -optic network, known as “dark fiber”, may remain unused forever. As a result, more than 60 telecom businesses were forced to file for bankruptcy, including such well -known companies as WorldCom and Global Crossing. Many of the equipment suppliers to the industry, such as JDS Uniphase, Nortel Networks, and Lucent Technologies, were also forced to make massive cutbacks to avoid a similar fate. What factors led so many investors and telecom company investors to make such wildly optimistic estimates of the returns from investments in this industry? Although many factors were involved, including technological innovation that outpaced the marketplace, biased investment banking analysts, and questionable accounting practices, the most damaging factor may have been the forecast in the telecom industry that Internet traffic was doubling every 100 days. If this forecast had been correct, it would have implied a growth rate of over 1,000 percent per year. The problem was that demand was not growing at nearly this rate. Many industry analysts now believe that the true rate was closer to 100 percent per year. For 2003, the estimated growth rate in Internet traffic was 40 percent. The first company to state that Internet traffic was doubling every 100 days was UUNet, a subsidiary of WorldCom. The first formal mention of this forecast was in an Inktomi Company report in 1997, which also quoted UUNet’s chief scientist as saying that “demand will far outstrip supply for the foreseeable future.” This forecast spread like wildfire among journalists, financial analysts, telecom executives, and government regulators. UUNet officers were still espousing this figure as late as September 2002 in a Washington Post article. Government agencies, such as the Federal Communications Commission (FCC) and the Department of Commerce, repeated this forecast as if it were the gospel truth. As the...
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