[SOLVED] CS代考计算机代写 Excel ACCT6101 – Session #1: Introduction to Valuation

ACCT6101 – Session #1: Introduction to Valuation

PART 1 – Background

1
ACCT7106 – Session #12: Forecasting & Valuation (cont)
overarching objective:
to conduct the fundamental valuation exercise for the purpose of estimating the ‘intrinsic value’ of a firm’s common shares
requires an understanding of the firm’s ‘value drivers’
need to accumulate a ‘tool kit’ as the basis for developing the pro forma Financial Statements (as an integrated system!)

1

2

STEP 1
Understanding the past

Information collection
Understanding the business
Accounting analysis
Financial ratio analysis
Cash flow analysis


STEP 2
Forecasting the future

Structured forecasting
Income Statement forecasts
Balance sheet forecasts
Cash flow forecasts


STEP 3
Valuation

Cost of capital
Valuation models – AE, FCF, D
Valuation ratios
Complications
Negative values
Value creation and destruction

Figure 1.1Lundholm & Sloan, Framework for Equity Valuation

Sessions #3  #10

Sessions #10  #11
Sessions #1  #3; #11, #12

3
beginning stock
Beginning Balance Sheet
Cash
+ Other assets
= Total Assets
– Liabilities
= Shareholders’ Equity (BVt-1)
Statement of Changes in S/E
 Cash from operations
+ Net Income & OCI
= Net Change in S/E
Cash Flow Statement
Cash from operations
+ Cash from investing
+ Cash from financing
= Net change in cash
Income Statement
Revenue
– Expenses
= Net Income (NPAT)
Ending Balance Sheet
Cash
+ Other assets
= Total Assets
– Liabilities
= Shareholders’ Equity (BVt)

flows
ending stock
‘articulation’Financial Statements constitute an ‘integrated system’

4
Forecasting & Valuation

Objective of the forecasting exercise
to develop objective and realistic expectations of future value-relevant payoffs
unbiased predictions (neither optimistic nor pessimistic  sensitivity analysis)
pro forma F/S should be comprehensiveneed to consider each item, not just assume items will grow at a constant rate with sales
need to make consistent assumptions and maintain the relation between items in the pro forma F/S (i.e., the F/S represent an integrated system)
use external information to ensure that assumptions are realistic

5
Key Steps:
Sales forecast
external environment & macroeconomic forecasts
Industry dynamics & forecasted changes
firm-specific characteristics
Forecast of ‘Core Operating Income from Sales’
forecast asset turnover and calculate NOA implied by forecasted sales and ATO
revise sales forecast (if necessary) in recognition of ‘asset constraints’ and iterate
forecast gross profit margin
forecast core operating expenses (e.g., SG&A, depreciation, advertising, R&D)
forecast the tax rate applicable to ‘core operating income from sales’
Forecasts of ‘Core Other Operating Income’ and ‘Unusual Operating Income’
Calculation of ‘Operating Income (OI) after tax
Forecast OA and OL to obtain (confirm) NOA
Calculate RNOA, FCF, ReOI and value the firm(FCF and AE valuation models; WACC)

6
Key Steps (cont)
Forecast of Comprehensive Income (CI)
forecast of financial leverage (FLEV) and determination of NFO
forecast of net borrowing cost (NBC) and determination of NFE
calculation of comprehensive income (CI)
Forecast of Shareholders’ Equity= NOA – NFO
Forecast of Dividends = CI – S/E  NCC
Forecast of Residual Income
determination of ‘cost of equity capital’ (ke)
calculation of abnormal earnings (residual income) = CI – ke * BVt-1
Selection and justification of terminal growth rate, g
Valuation based on Abnormal Earnings (Residual Income) valuation model
Discounted Dividend (DDM) valuation model
Conduct ‘sensitivity analyses’

Re: ColesSummary of significant assumptions

Sales growth2.5%2.0%2.25%2.25% 2.0%
Terminal growth rate (g) of 3%
ATO constant @ 3.00 (had increased from 2.914 to 3.065)if higher  ROCE 
Gross profit margin @ 0.26 (had increased from 0.234 to 0.250)
Administrative expensesassumed to decline from 0.21 to 0.208(had been 0.215 and 0.212)
Financing costsassumed growth in PPE of 1.5%, NBC up 0.6%
OR
Unchanged capital structure (FLEV)
7

8
2021 E2022 E2023 E2024 E2025 E
Revenues38,34339,11039,99040,89041,708
Core OI from Sales (after tax)1,3421,3821,4271,4731,518
%2.98%3.26%3.22%3.06%
Total OI (after tax)1,6921,7321,7771,8231,868
%2.36%2.60%2.59%2.47%
NOA12,78213,03813,33113,63113,904
RNOA0.13240.13280.13330.13370.1344
%RNOA0.02690.00040.00050.00040.0007
FCF1,1151,4761,4841,5231,595
%FCF0.05000.04460.0052.63%4.73%
ReOI(k = 6.25%) (to firm)9299339629901,016
%ReOI0.43%3.11%2.91%2.63%

‘unlevered valuation’  overall value of the firm

9
Abnormal Earnings (Residual Income) valuation model

+

= 12,205 +++++

= $40,015 million
FCF valuation model

=++++

= $43,298 million

10
2021 E2022 E2023 E2024 E2025 E
Revenues38,34339,11039,99040,89041,708
Gross Margin (0.26)9,96910,16910,39710,63110,844
Administrative Expense(8,052)(8,194)(8,358)(8,526)(8,675)
Tax Expense (30%)(575)(593)(612)(632)(651)
Core OI from Sales (after tax)1,3421,3821,4271,4731,518
Core Other OI 500@ (1 – 0.3)350350350350350
Unusual Items 00000
Total OI (after tax)1,6921,7321,7771,8231,868
Core NFE (NFO  1.5%)(389)(395)(401)(407)(413)
Comprehensive Income1,3031,3371,3761,4161,455

** assumes OCI = 0
‘levered valuation’  value to common shareholder

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2021 E2022 E2023 E2024 E2025 E
Revenues38,34339,11039,99040,89041,708
Comprehensive Income1,3031,3371,3761,4161,455
%CI2.61%2.92%2.91%2.75%
NOA12,78213,03813,33113,63113,904
NFO ( 1.5%)9,734988010,02810,17910,331
S/E3,0483,1583,3033,4523,573
%S/E3.61%4.59%4.51%3.51%
Dividends8701,2271,2311,2671,334
%Div3.26%2.92%5.29%
ReCI(k = 7.4%) (to S/E)1,1091,1111,1421,1721,200
%ReOI0.20%2.79%2.63%2.39%

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Abnormal Earnings (Residual Income) valuation model

+

= 2,615 +++++

= $26,905.0 million(** all calculations carried through using an Excel spreadsheet)
DDM valuation model

=++++

= $26,625.3 million

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PART 2 – Sensitivity Analyses: 1st stage = one item at a time, leaving all else as forecasted
AE ValuationDDM Valuation
‘as forecasted’26,905.026,625.3
Terminal growth rate = 2.5% (instead of 3%)
Terminal growth rate = 2.0%24,814.3
23,110.724,929.4
22,402.3
Sales growth = constant 2%
Sales growth = constant 1.75%26,802.3
26,477.626,499.9
27,260.7
ATO = 3.1 (instead of 3.0)
ATO = 2.927,536.5
26,230.227,180.5
26,030.8
Gross Margin = 0.25 (instead of 0.26)20,989.820,708.9
Admin Exp = 0.215 (instead of 0.210  0.208)25,841.025,560.2
Net borrowing cost = 5.0% (instead of 4.0%)
Net borrowing cost = 3.0%24,806.7
29,003.724,525.8
28,722.8
FLEV = 3.67 (instead of NFO @ 1.5%)***27,184.527,683.0
Discount rate = 8.5% (instead of 7.4%)25,794.425,394.9

**
**

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*** re: leverage (FLEV) and net borrowing cost (NBC)
as calculated in Session #10 from Coles reformulated F/S (Slides #44 – 47):
2020:NOA = 12,205NFO = 9,590S/E = 2,615NFE = 322
FLEV = 3.6673NBC = 0.0336PM = 0.0344ATO = 3.065
For primary valuation analyses, assumed: NFO growth of 1.5% (driven by PPE) and NBC = 4%
NOA12,78213,03813,33113,63113,904
NFO (@ 1.5%)9,7349,88010,02810,17910,331
S/E = NOA – NFO3,0483,1583,3033,4523,573
Core NFE389395401407413
Comprehensive Income1,3031,3371,3761,4161,455
ReCI(k = 7.4%)1,1091,1111,1421,1721,200

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re: leverage (FLEV) and net borrowing cost (NBC)
what if alternatively assumed FLEV constant at 3.67 and NBC = 4%
FLEV == 3.67NFO = 3.67 * S/E
S/E = NOA – NFOS/E = NOA – 3.67 * S/E S/E = NOA  4.67
ATO = 3.0 = sales  NOANOA = sales  3S/E = sales  (3 * 4.67)
NFO = NOA – S/E =–= 0.26196 * sales
NOA12,78213,03813,33113,63113,904
NFO (based on FLEV = 3.67)10,00410,24510,47610,71210,926
S/E = NOA – NFO2,7382,7932,8552,9192,978
Core NFE402410419428437
Comprehensive Income1,2901,3231,3591,3961,431
ReCI(k = 7.4%)1,0971,1201,1521,1841,215

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NOA12,78213,03813,33113,63113,904
NFO (@ 1.5%)9,7349,88010,02810,17910,331
S/E = NOA – NFO3,0483,1583,3033,4523,573
Core NFE389395401407413
Comprehensive Income1,3031,3371,3761,4161,455
ReCI(k = 7.4%)1,1091,1111,1421,1721,200

NOA12,78213,03813,33113,63113,904
NFO (based on FLEV = 3.67)10,00410,24510,47610,71210,926
S/E = NOA – NFO2,7382,7932,8552,9192,978
Core NFE402410419428437
Comprehensive Income1,2901,3231,3591,3961,431
ReCI(k = 7.4%)1,0971,1201,1521,1841,215





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Sensitivity Analyses – terminal growth rategross margin(appear to be the greatest sensitivities)
Terminal Growth Rate
1.5%2.0%2.5%3.0%
0.26524,019.6
23,151.425,606.6
24,898.327,517.5
27,001.629,862.7
29,583.0
0.26021,695.8
20,827.723,110.7
22,402.324,814.3
24,298.426,905.0
26,625.3
Gross Margin0.25519,372.1
18,503.920,614.7
19,906.422,111.0
21,595.123,947.3
23,667.6
0.25017,048.3
16,180.218,118.8
17,410.519,407.8
18,891.820,989.6
20,709.9
0.24514,724.6
13,856.415,622.9
14,914.516,704.5
16,188.618,031.9
17,752.2

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PART 3 – Alternative Approach to Valuation: Use of ‘Heuristics’

‘multiplier approach’

Implementation of the formal AE valuation model (and also the DDM and FCF models) is a relatively involved and complex process

The alternative, both less rigorous and less demanding, is to focus on multipliers such as the P/E or M/B ratios.

In general terms, the “multiplier approach” can be represented as:

P0 =xM

where M is the multiplier and x is the valuation basis (e.g., earnings, book value)

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The two most commonly cited multipliers are:
Market-to-Book (M/B) ratio(price-to-book ratio)
Price-Earnings (P/E) ratio
The P/E ratio is clearly a flows-based (income statement) measure whereas the M/B ratio is a stock-based (balance sheet) measure.
Of these, the P/E ratio typically receives the greater attention
Coles (price  $18)Woolworths (price  $40)
Market-to-Book (M/B) == 9.18 == 5.70
Price-Earnings (P/E) = 24.56

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Market-to-Book (M/B) ratio(price-to-book ratio)
Abnormal Earnings Valuation Model

(CI – k * BVt-1) = (CI – k * BVt-1) = ( – k) =(ROCE – k)



=

+

21

=

Profitability

Growth
Market-to-Book ratio driven by combined effects of
profitability
growth in book value

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>

since from the AE valuation model +

>

>does not required ‘abnormal earnings growth’ (AEG), although it does not preclude it either

whereAEGAEt>AEt-1

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PART 4 – Heuristics (cont)

Price-Earnings (P/E) ratio(price-to-book ratio)
initially assume the firm’s earnings are expected to remain constant in perpetuity
P0 =  = orP0 = E0
alternatively, assume that the earnings will grow at a constant rate, g
P0==E0=

reveals immediately that in these two ‘simplistic worlds’, the P/E ratio is related to
risk as reflected in the firm’s cost of equity capital (k)
growth in future earnings (g)

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However, these two factors (risk and growth) have been found by empirical studies to explain only slightly more than 50% of the difference in P/E ratios across firms.
 in the empirical domain, other factors clearly influence the magnitude of the P/E ratio.
additional factors often advanced as potentially influencing the P/E ratio include earnings persistence and choice of accounting policy

re: risk
in equilibrium, investors will impose a greater risk premium on firms they perceive to have greater business risk.
as such, ke will be higher for firms with greater risk and the P/E ratio (related to 1/ ke) will be lower, all else held equal.

re: growth
as is also clear from the theoretical models above, firms with greater earnings growth will have higher P/E ratios, all else held equal, because market price will reflect the anticipated higher future earnings.
note, however, the market only prices anticipated permanent growth

re: earnings persistence
a firm’s P/E ratio will deviate from its the theoretical model if current period earnings are a poor predictor of expected future (permanent) earnings e.g., if the current period earnings include either an extraordinary gain or an extraordinary loss.
these transitory components should lead to only a temporary change in the P/E ratio.
alternatively, a permanent change in earnings should not significantly affect the P/E ratio because both the earnings figure and the market price will be affected in the same direction
re: accounting policy choice
when otherwise identical firms select different accounting policies for cosmetic reasons alone, these differences will be reflected in P/E ratios e.g., a firm selecting a more conservative accounting policy (accelerated depreciation) will report lower earnings than a firm using less conservative policies (straight-line depreciation).
if the market assesses the only difference between the two firms to be their choice of accounting policies, the firm selecting the more conservative policies will have the higher P/E ratio (since the market prices will be the same)

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Application of the multiplier approach:
Valuation developed through ‘fundamental analysis’ and implemented through the ‘abnormal earnings’, ‘DDM, and ‘FCF’ valuation models requires detailed, multi-year forecasts
An alternative approach is to base valuation on multipliers such as the P/E and M/B ratios
Such an approach simply requires the investor (analyst) to estimate the appropriate value for the selected multiplier and for the estimation base (earnings or book value)
Perhaps the greatest advantage of using the “multiplier approach” to valuation is that the P/E and M/B ratios of comparable firms can be used as the basis of the valuation
Having selected the appropriate comparable firm, the investor (analyst) implicitly assumes that the pricing of the comparable is applicable to the firm of interest

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Unfortunately, application of pricing multiples is not as simple as it might seem. Reasons for the difficulty include:
the need to identify an appropriate comparable(s)
the question of whether valuation should be based on actual figures (past performance) or forecasted figures (expected future performance)
the need to understand why multiples vary across firms, and of the determinants of the multiples, in order to make adjustments, if deemed appropriate

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re: choice of comparable firms
empirical research suggests that industry membership is the best basis for selecting comparable firms
one reason advanced as to why industry membership provides the most effective comparisons is that firms in the same industry usually experience similar profitability, face similar risks, and grow at similar rates
one problem however, is that many large firms operate within many different industry segments
one way of dealing with this problem is to use industry average multiples. Another is to search for the firm within the industry that is most similar

30
re: forecasts versus realized
market prices reflect future expected performance by definition.
use of historical data in the denominator of a price multiple is justified only if history is viewed as a reasonable indicator of the future (trailing P/E)
if a reliable forecast is available, it would generally be preferred as the basis for a multiple (forward P/E)
trailing P/E multiples can be distorted by transitory gains or losses or other unusual performance.
forward multiples (based on forecasts) can also be distorted but are less likely to include one-time gains/losses

31
re: adjustments
P/E and M/B ratios can vary substantially across apparently similar firms for a number of reasons e.g.,
P/E ratios can vary because of differences in risk, expected future (abnormal) earnings, and accounting policy choice
M/B ratios can vary because of differences in future ROEs, growth in book value, and risk
the differences that exist across firms, even apparently closely related firms, render pricing based on multiples an inherently crude technique.
the investor (analyst) can attempt to mitigate the effect of the differences either through using industry averages or by attempting to make “informed” adjustments

32
PART 5 – Heuristics (cont)

Finally, returning to the key issue of ‘growth’, as discussed it is ‘growth in residual income (abnormal earnings) that matters for valuation.

whereabnormal earnings growth (AEGt)=AEt–AEt-1
Note – growing earnings is not enough; it must be growth in abnormal earnings!

To illustrate:
consider a firm with S/E of $100 million that current earns $12 million per year, pays dividends of $12 million per year, and has a COEC of 10%
suppose it raises additional equity capital of $20m and invests it in a project that produces $1.5m earnings per year and then increases it dividend to $13.5 million
What will happen to earnings and the value of the firm after the issuance?

33
CurrentRevised
Earnings = 12Earnings = 12 + 1.5 = 13.5
BV = 100BV = 120
AE = 12 – 0.10(100) = 2AE = 13.5 -0.10(120) = 1.5
V = 100 + V = 120 +

The firm’s earnings have grown but its abnormal earnings have not – the new investment does not promise a return equal to COEC

‘value added’ has been reduced100  120versus 120  135

34
note:normal forward P/E = but the trailing P/E =
why?the trailing P/E is taken one year earlier and has one extra year of return i.e.,
trailing P/E == assumes that dividends are reinvested to earn k

Ultimately, the ‘abnormal earnings valuation model’ can be recast in terms of ‘abnormal earnings growth’
V0 =
and
P/E =–

35

P/E =–

Abnormal earnings growth (AEG)

Dividend payout ratio
Price-Earnings ratio driven by combined effects of
abnormal earnings growth
dividend payout ratio

36
Returning to the Market-to-Book (M/B) ratio
from the Abnormal Earnings valuation model +
M/B > 1AE > 0

Alternatively, for the Price-Earnings (P/E) ratio
trailing P/E = ifP/E > trailing P/EAEG > 0

M/B>0AE>0
P/E> normal P/EAEG>0i.e., AEt>AEt-1

37
Interpretations include –

high (above normal) PB and PE:
 future abnormal earnings are expected to be positive and increase
i.e., AE > 0 and AEG > 0

high PB and low PE (below normal):
 future abnormal earnings are expected to be positive but decrease
i.e., AE > 0 but AEG < 0(AEt<AEt-1)‘confusion’ surrounding M/B as an indication of a ‘growth stock’ ……… BUT……..M/Brelates to whether AE is positive or notP/Erelates to whether AE are growing (i.e., AEt>AEt-1 AEG > 0)

our interest is in ‘abnormal earnings growth’, not just ‘earnings growth’ !

M/B is not an indication of AEG growth !(even though high M/B firms are often labelled as ‘growth stocks’)

38

39
PART 6 – Additional Worked Examples

E14.1E14.4E14.5E14.7

E16.1E16.10E16.11

Nike 2005 – 2009 illustration of the ‘forecasting & valuation’ process

40
ke = 12%kdebt = 10%WACC = 11%

ReOI = 1,400 – 0.11 * 10,000 = 300

41

2011:ReOI = 2,300 – 0.10 * 18,500 = 450

2012: ReOI = 2,700 – 0.10 * 20,000 = 700

growth in ReOI=25055.56%(250 / 450)

42

Rf = 4.3%mkt price of risk = 5.0%beta = 1.3ke = 0.043 + 1.3(0.05) = 0.108

NBC = 7.5%0.075 (1 – 0.36) = 4.8% after tax

Vequity = 40.70 * 58 = 2,360.6 VNFO = 1,750  Vfirm = 2,360.6 + 1,750 = 4110.6

WACC == 0.0825  8.25%

43

2013201420152016
ReOI = OI – k*NOAt-172.36577.43182.85588.648
%ReOI7.0%7.0%7.0%

assume terminal growth rate = 7%

Vfirm = 1,135 + 2,334.29 = 3,469.29based on the ‘abnormal earnings’ valuation model

Vequity = Vfirm – NFO = 3,469.29 – 720 = 2,749.29

44

OI = 0.05(1,276) = 63.8NOA = 1,276 / 2.2 = 580
a) ReOI = 63.8 – (0.09*580) = 63.8 – 52.2 = 11.6
b) ReOI = 0.045(1,276) – (0.09*580) = 57.42 – 52.2 = 5.22ReOI  6.38
c) ReOI = 0 = 0.05(1,276) – (0.09*NOA)  NOA = 708.889  ATO = 1,276 / 708.889 = 1.8
ATO < 1.8(if ATO < 1.8  NOA > 708.889)

45

2010:OI profit margin = 1,805 / 14,797 = 0.12198ATO = 14,797 / 11,461 = 1.29107
given“core profit margins and asset turnovers will be the same as 2010”
PART 7 – Additional Worked Examples (cont)

46
20102011E2012E2013E2014E
Sales growth (%)7%7%6%6%
 Sales14,79715,832.7916,941.0917,957.5519,035.00
 NOA @ ATO = 1.2910711,46112,263.3113,121.7413,909.0414,743.59
 OI @ PM = 0.121981,8051,931.282,066.472,190.462,321.89
ReOI = OI – 0.08*NOA1,014.401,085.411,140.721,209.17

11,461 ++++
= $38,233.245

NFO = 11,461 – 5,403 = 6,05838,233.245 – 6,058 = 32,175.245

= 32,175.245 / 656.5=$49.01 per share

47

2008:NOA = 5,806S/E = 7,797NFA = 7,797 – 5,806 = 1,991
givenkfirm = 8.6%terminal growth rate (g) = 4%

ATO = 18,627 / 5,806 = 3.2assume 2009 ATO = 3.3

48
20102009E2010E2011E2012E
Sales growth (%)10%9%8%7%
 Sales18,62720,489.7022,333,7724,120.4725,808.91
ATOassumed 3.33.43.53.6
 NOA @ ATO5,8066,209.006,568.766,891.567,169.14
Core profit margin9.0%8.5%8.0%7.5%
 OI @ PM1,844.071,898.371,929.641,935.67
ReOI = OI – 0.086*NOA1,344.761,364.401,364.721,342.99

Notes:OI consistently increasingwill it continue to grow?
if trends continue into 2013 i.e., sales growth = 6% & PM = 7.0%OI = 1,915.02
ReOI initially increases and then starts to decrease(i.e., AEG < 0)why?2011 – 2012:growth in OI = 0.31%growth in NOA = 4.0%495,806 ++++= $32,060.9514NFA = 7,797 – 5,806 = 1,99132,060.9514+ 1,991 = $34,051.951434,051.9514 / 491.1=$65.28 per share50Comprehensive Illustration: NikeAfter reformulating Nike’s financial statements for 2004, an analyst prepares a series of forecast in order to value Nike’s shares. With a thorough knowledge of the business, its customers and the outlook for athletic and fashion footwear, the analyst first prepares a sales forecast. Then, understanding the production process and the components of cost of good sold, they forecast Nike’s gross profit marginAdding forecasts of expense ratios – particularly the all-important driver, the advertising-to-sales ratio – they finalise their pro forma income statements with a forecast of operating income. Finally, the forecasted balance sheet models accounts receivable, inventory, PPE, and other net operating assets based on their assessment of turnover ratios for these items. From this process, the analyst arrives at the following forecasts:51Income statement forecasts: Sales for 2005 will be $13,500 million, followed by $14,600 for 2006. For 2007-2009, sales are expected to grow at a rate of 9 percent per year.The gross margin of 42.9 percent in 2004 is expected to increase to 44.5% in 2005 and 2006 with the benefits of off-shore manufacturing, but then to decline to 42% in 2007 and subsequently to 41% as labor costs increase and more costly, high-end shoes are brought to market.Advertising, standing at 11.25% of sales in 2004, will increase to 11.6% of sales to maintain the ambitious sales growth. The recruitment of visible sports stars to promote the brand will also add to advertising costs. Other before-tax expenses are expected to be 19.6% of sales, the same level as in 2004. The effective tax rate on operating income will be 34.6%.No unusual items are expected or their expected value is zero. 52Balance sheet forecasts: To maintain sales, the carrying value of inventory will be 12.38 cents per dollar of sales (an inventory turnover ratio of 8.08).Receivables will be 16.5 cents per dollar of sales (a turnover ratio of 6.06)PPE will fall to 12.8 cents per dollar of sales in 2005 and 2006, from the 13.1 cents in 2004, because of more sales from existing plant. However, with new production facilities coming on line, at higher construction costs, to support sales growth, PPE will increase to 13.9 cents on a dollar of sales (a turnover ratio of 7.19). Holdings of other net operating assets, dominated by OL, will be– 6.0% of sales.Additional Information:2004 NFO = 743Terminal growth rate for AE g = 5%# Common shares outstanding = 263.1 millionPro forma Income Statements2004A2005E2006E2007E2008E2009ESales12,25313,50014,60015,91417,34618,907Cost of sales(7,001)(7,492)(8,103)(9,230)(10,234)(11,155)Gross margin5,2526,0086,4976,6847,1127,752Advertising(1,378)(1,566)(1,694)(1,846)(2,012)(2,193)Operating expenses(2,400)(2,646)(2,862)(3,119)(3,400)(3,706)Operating income before tax1,4741,7961,9411,7191,7001,853Tax at 34.6 %(513)(621)(672)(595)(588)(641)Operating income after tax9611,1751,2691,1241,1121,212Core profit margin7.84%8.69%8.69%7.06%6.41%6.41%53Pro forma Balance Sheets2004A2005E2006E2007E2008E2009EAccounts receivable2,1202,2282,4092,6262,8623,120Inventory1,6341,6711,8071,9702,1472,341PPE1,5871,7281,8692,2122,4112,628Other NOA(790)(810)(876)(955)(1,041)(1,134)Net operating assets4,5514,8175,2095,8536,3796,955Asset turnover (ATO)2.8032.8032.7192.7192.71954552004A2005E2006E2007E2008E2009EOperating income after tax9611,1751,2691,1241,1121,212Net operating assets4,5514,8175,2095,8536,3796,955ReOI = OI – 0.086*NOA783.614854.738676.026608.642663.406FCF = OI –  NOA 909877480586636AE valuation modelNFO = 749Common shares = 263.1P = 19,461.9 / 263.1 = $73.97aside:FCF valuation model15,077.6has not reached ‘steady state’ require a different ‘g’ for FCF56overarching objective: to conduct fundamental value for the purpose of estimating the ‘intrinsic value’ of a firm’s common sharesrequires an understanding of the firm’s ‘value drivers’need to accumulate a ‘tool kit’ as the basis for developing the pro forma Financial Statements STEP 1Understanding the past Information collectionUnderstanding the businessAccounting analysisFinancial ratio analysisCash flow analysis        STEP 2Forecasting the future Structured forecastingIncome Statement forecastsBalance sheet forecastsCash flow forecasts        STEP 3Valuation Cost of capitalValuation models – AE, FCF, DValuation ratiosComplicationsNegative valuesValue creation and destructionPART 8 – Summary57external environment economic prospectsmacroeconomic factorssocio-cultural forcespolitical / regulatoryIndustry dynamics  Porter’s five forces(suppliers, buyers, new entrants, substitutes, rivalry)Analysis of Financial Statements understanding current F/Sre-formulating the F/Saccounting qualityratio analysisanalysts’ reportsmanagement forecastsfinancial press???Forecasts and Valuation0V =tx( 1+ tkt)t =1∞∑ =E( tx )t(1+k)t=1n∑ +E( nx ) (1+ g)k − g1n(1+k)0V=tx(1+tkt)t=1¥å=E(tx)t(1+k)t=1nå+E(nx)(1+g)k-g1n(1+k)AHigh P/B; High P/E BNormal P/B; High P/E CLow P/B; High P/E Nike, Inc. The market gave Nike a P/B of4.1 and a P/E of 21 in 2005, both high relative to normal ratios. Current residual earnings were $642 million and analysts were forecasting earnings that indicated higher residual earnings in the future. Westcorp Westcorp, a financial services holding company, reported earnings for 1998 of 0.65 per share and an ROCE of 5.4%.Analysts in 1999 forecasted earnings of $1.72 for 1999 and $2.00 for 2000, which translate into an ROCE of 13.6% and 14.1% respectively.With a forecasted ROCE at about the (presumed) cost of capital but increasing from the current level this is a cell B firm.The market gave the firm a P/B of 1.10 and a P/E of 24. Rocky Shoes & Boots, Inc. Like Nike, a footwear manufacturer, Rocky Shoes reported an ROCE of 1.8% for 1998 with earnings of 0.21 per share.Analysts forecast an ROCE of 6.2% for 1999 and 7.8% for 2000, on earnings of 0.72 and 0.95 respectively.The market gave the firm aP/B of 0.6 and a P/E of 33, appropriate for a firm with forecasted ROCE less than the (presumed) cost of capital but with increasing ROCE. DHigh P/B; Normal P/E E Normal P/B, Normal P/E FLow P/B; Normal P/E Whirlpool Corp. Whirlpool, with a positivebut constant RE was a cell D firm in 1994.Whirlpool was priced at 11 times earnings (cum-dividend), as we saw, and at 1.8 times book value.Horizon Financial Corp. Horizon Financial Corp., a bank holding company, reported an ROCE of 10.3% for fiscal 1999.Analysts forecasted that ROCE would be 10.6% for 2000 and after, roughly at the same level.If the equity cost of capital is 10%, this firm should have a normal P/B and a normal P/E.The stock traded at 11 times earnings and 1.0 times book value.Rainforest Cafe Inc. In 1999, analysts covering Rainforest Cafe, the theme restaurant (“a wild place to eat”), forecasted earnings of $0.62 per share for 1999 and $0.71 for 2000, or an ROCE of 6.8% and 7.2%.The stock traded at a P/B of 0.6, reflecting the low anticipated ROCE.The ROCE for 1998 was 6.5%.With 1998 profitability similar to forecasted profitability, the stock should sell at a normal P/E ratio.And indeed it did:the P/E at the time of the forecasts was 11.GHigh P/B; Low P/E HNormal P/B; Low P/E ILow P/B; Low P/E US Airways Group US Airways reported an ROCE of 81% in 1998.Analysts deemed 1998 to be a particularly good year and forecast ROCE for 1999 and 2000 down to 29% and 33%.The stock traded at 12.6 times book value, consistent with high ROCE in the future, but at a P/E of only 4. America West Holdings America West Holdings, the holding company for America West Airlines had an ROCE of 15.0% in 1998.Analysts forecasted in 1999 that the ROCE would decline to 11.7% by 2000.Th e market gave the stock a P/B of 1.0 in 1999, in line with the forecasted ROCE equaling the cost of capital.But the P/E was 7, consistent with the expected drop in the ROCE. UAL Corporation United Airlines’ holding company traded at a P/B of 0.7 in mid-1999 and a P/E of 6.It reported an ROCE of 29.2% for 1998, but its ROCE was expected by analysts to drop to 10.6% (before a special gain) in 1999 and to 9.1% in 2000.AHigh P/B; High P/EBNormal P/B; High P/ECLow P/B; High P/ENike, Inc.The market gave Nike a P/B of 4.1 and a P/E of 21 in 2005, both high relative to normal ratios. Current residual earnings were $642 million and analysts were forecasting earnings that indicated higher residual earnings in the future.WestcorpWestcorp, a financial services holding company, reported earnings for 1998 of 0.65 per share and an ROCE of 5.4%.Analysts in 1999 forecasted earnings of $1.72 for 1999 and $2.00 for 2000, which translate into an ROCE of 13.6% and 14.1% respectively.With a forecasted ROCE at about the (presumed) cost of capital but increasing from the current level this is a cell B firm.The market gave the firm a P/B of 1.10 and a P/E of 24.Rocky Shoes & Boots, Inc.Like Nike, a footwear manufacturer, Rocky Shoes reported an ROCE of 1.8% for 1998 with earnings of 0.21 per share.Analysts forecast an ROCE of 6.2% for 1999 and 7.8% for 2000, on earnings of 0.72 and 0.95 respectively.The market gave the firm a P/B of 0.6 and a P/E of 33, appropriate for a firm with forecasted ROCE less than the (presumed) cost of capital but with increasing ROCE.DHigh P/B; Normal P/EENormal P/B, Normal P/EFLow P/B; Normal P/EWhirlpool Corp.Whirlpool, with a positive but constant RE was a cell D firm in 1994.Whirlpool was priced at 11 times earnings (cum-dividend), as we saw, and at 1.8 times book value.Horizon Financial Corp.Horizon Financial Corp., a bank holding company, reported an ROCE of 10.3% for fiscal 1999.Analysts forecasted that ROCE would be 10.6% for 2000 and after, roughly at the same level.If the equity cost of capital is 10%, this firm should have a normal P/B and a normal P/E.The stock traded at 11 times earnings and 1.0 times book value.Rainforest Cafe Inc.In 1999, analysts covering Rainforest Cafe, the theme restaurant (“a wild place to eat”), forecasted earnings of $0.62 per share for 1999 and $0.71 for 2000, or an ROCE of 6.8% and 7.2%.The stock traded at a P/B of 0.6, reflecting the low anticipated ROCE.The ROCE for 1998 was 6.5%.With 1998 profitability similar to forecasted profitability, the stock should sell at a normal P/E ratio.And indeed it did:the P/E at the time of the forecasts was 11.GHigh P/B; Low P/EHNormal P/B; Low P/EILow P/B; Low P/EUS Airways GroupUS Airways reported an ROCE of 81% in 1998.Analysts deemed 1998 to be a particularly good year and forecast ROCE for 1999 and 2000 down to 29% and 33%.The stock traded at 12.6 times book value, consistent with high ROCE in the future, but at a P/E of only 4.America West HoldingsAmerica West Holdings, the holding company for America West Airlines had an ROCE of 15.0% in 1998.Analysts forecasted in 1999 that the ROCE would decline to 11.7% by 2000.The market gave the stock a P/B of 1.0 in 1999, in line with the forecasted ROCE equaling the cost of capital.But the P/E was 7, consistent with the expected drop in the ROCE.UAL CorporationUnited Airlines’ holding company traded at a P/B of 0.7 in mid-1999 and a P/E of 6.It reported an ROCE of 29.2% for 1998, but its ROCE was expected by analysts to drop to 10.6% (before a special gain) in 1999 and to 9.1% in 2000./docProps/thumbnail.jpeg