Lecture 8 - The 6 Steps Approach Step 1: Forecast Sales and...

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Unformatted text preview: The 6 Steps Approach Step 1: Forecast Sales and growth in Sales Step 2: Project the Income Statement Step 3: Project the Balance Sheet Step 4: Derive Free Cash Flow use the balance sheet and income statements to derive the SCF. Step 5: Compute the Terminal Value what is the firm value after the explicit forecast period explicit forecast period? Step 6: Check for Economic Consistency inspect the forecasted financial ratios Forecasting – Part II Lecture 8 2 St Step 2: Project the I/S th I/S Forecast other line items using margins as a percentage of sales or other relevant accounts. 2006 6,583,098 860,676 343,168 1,203,844 7,786,942 (3,178,791) (479,386) (2,687,815) (253,724) (387,211) 93,937 20,691 (8,400) 906,243 (324,770) (17,214) 564,259 2007 7,998,265 Retail 1,026,338 Licensing 386,894 Foodservice/Other 1,413,232 Total Specialty 9,411,497 Total Revenues (3,999,124) (489,249) (3,215,889) (294,136) (467,160) 108,006 40,619 (38,200) Cost of Sales General & Admin Exp Store Operating Exp Other Operating Exp Depr & Amort Exp Income from Investee Interest and Oth Inc Interest Expense Forecast as: 1,056,364 Earnings before Tax (383,726) Income Tax Expense - Accounting Change 672,638 Net Income (Loss) 3 5 Step 3: Project the Balance Sheet BALANCE SHEET Current Assets Cash AFS Securities Trading Securities Receivables, Net Inventories Deferred Tax Asset Deferred Tax Asset-net Other Current Assets Total Current Assets Non Current Assets PPE, Net Debt Securities Other Investments Goodwill and Intangibles Other Intangible Assets Other Assets Total Assets Current Liabilities Accounts Payable Accrued Compensation Accrued Expenses Other Current Liabilities Current Portion LTD Commercial Paper Deferred Revenue Total Current Liab. Non Current Liabilities Non Current Liabilities Long-term Debt Deferred Income Taxes Other Long-term Liab. Total Non-Cur. Liab. Total Equity Total Liab. & Equity 2006 312,606 87,542 53,496 224,271 636,222 88,777 126,874 1,529,788 2,287,899 5,811 219,093 161,478 37,955 186,917 4,428,941 340,937 288,963 224,154 148,878 762 700,000 231,926 1,935,620 1,958 262,857 264,815 2,228,506 4,428,941 2007 281,261 83,845 73,588 287,925 691,658 129 129,453 148,757 1,696,487 2,890,433 21,022 258,846 215 215,625 42,043 219,422 5,343,878 390,836 332,331 257,369 167,107 775 710,248 296,900 2,155,566 550,121 354,074 904,195 2,284,117 5,343,878 Assumptions Steps in Forecasting a Balance Sheet 1. Forecasting operating assets and liabilities Working capital accounts (and usually PPE) are expected to grow with the level of sales. Hence, forecast future turnover levels for these accounts using historical turnover ratios as a guide. Are recent turnover ratios likely to change? ratios likely to change? 2. Forecasting Intangible Assets These do not necessarily grow with sales. Thus, we often just take the do not necessarily grow with sales Thus we often just take the balance of intangibles. This might vary depending on the company specifics. 3. Forecasting Other non-operating assets and liabilities Forecasting Other non assets and liabilities Often these are not predictable and, hence, the best future prediction is to leave these at the current level, or as a constant percentage of sales. 4. Forecasting Long-term liabilities The projected amount of LTD will depend on the ‘optimal’ capital structure for the firm. useful starting point is the current capital structure for the firm. A useful starting point is the current capital structure. Consider a long-term capital structure that matches industry averages. 6 8 Steps in Forecasting a Balance Sheet 5. Forecasting Shareholders Equity Equity will increase with net income and decrease with net payments to equity holders (dividends and repurchases) For simplicity collapse equity into single repurchases). For simplicity, collapse equity into a single line-item. Alternatively, you can plug debt. Step 4: Derive Free Cash Flow Derive Free Cash Flow Given a beginning balance sheet, an ending balance sheet, and an income statement for the period, we can compute the statement of cash flows. Once the statement of cash flows is computed, we can calculate free cash flow to equity. FCFE = Net income – Increase in Common Equity FCFE = CFO – CFI – Net debt payments – Increase in cash + Other financing cash flows 9 10 Step 5: Compute the Terminal Value Step 6: Check for Economic Consistency You should include one year past the forecasting horizon for your terminal year. In the SBUX example, we forecast for 10 years (2008-2017), and use 2018 as the terminal year. This step is critical to keep all relations (other than sales growth) constant with the immediately preceding year (i.e. assume the firm has reached steady state). This will ensure your valuations converge under the residual income and discounted cash flow models. Sales growth can be projected at the growth in GDP. We will come back to this in the lectures on valuation. After you have ensured the mathematical you have ensured the mathematical consistency of your forecast (via balancing the balance sheet and reconciling the balance sheet with the reconciling the balance sheet with the statement of cash flows), you should check for economic consistency. Check to see that near the end of the forecasting horizon, the ROA, ROE, asset turnovers and profit margins appear turnovers, and profit margins appear attainable and plausible. In particular, ROE at the end of the forecast horizon should be close to the cost of equity capital. 11 12 ...
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This note was uploaded on 04/09/2010 for the course NBA 5090 taught by Professor Yehuda,nir during the Fall '10 term at Cornell University (Engineering School).

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