Web3ch14 - CHAPTER FOURTEEN Simple Forecasting and Simple...

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CHAPTER FOURTEEN Simple Forecasting and Simple Valuation Stephen H. Penman The web page for this chapter runs under the following headings: What this Chapter is Doing Example of a Simple Valuation Example of a Simple Valuation: Electronic Data Systems (EDS) Analysts Forecasts and Simple Valuations Two-stage Growth Forecasting Interpreting the Growth Rate (g) for Residual Earnings and Abnormal Earnings Growth Sensitivity Analysis: Electronic Data Systems (EDS) What this Chapter is Doing Simplicity is a virtue, provided it is not too simple. So we prefer simple methods to complicated ones, all else equal. Complexity in valuation arises from the amount of information we have to process. The simple valuations in this chapter rely solely on information in the financial statements. They are the valuations that the financial statements imply. And they are the valuations that utilize the financial statement analysis of earlier chapters. Sometimes they work. But, in any case, they are starting points for a more thorough valuation (in Chapter 15). In understanding these valuations, you will understand what else needs to be brought to the table to complete the valuation. But the simple valuations also provide the framework for sensitivity analysis – and for challenging a stock’s price -- as the chapter demonstrates at its close. They also provide the framework for reverse engineering. The simple valuations are built up gradually, successively using more financial statement information. SF1 uses just the balance sheet; SF2 uses just the income statement; then SF3 uses both the income statement and the balance sheet.
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Example of a Simple Valuation The condensed versions of the reformulated balance sheet and income statement for a firm’s 2004 fiscal year are given below. Balance Sheet 2004 2003 Net operating assets 3,160 2,900 Net financial obligations 1,290 1,470 Common shareholders’ equity 1,870 1,430 Comprehensive Income Statement Sales 3726 Operating expenses (3204) OI before stock compensation 522 Compensation with options (22) Operating income 500 Interest expense 98 Interest income (15) 83 Tax benefit 29 54 Unrealized gain on investments (50) Losses on stock repurchases 120 (124) Comprehensive income 376
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At the end of 2004, sales were forecasted to grow at 6% per year in the future on a constant asset turnover of 1.25. Operating profit margins of 14% (after tax) are expected each year. The firm’s tax rate is 35%. With the reformulated financial statements as a base and these few forecasts, we can value the equity at the end of 2004. First, forecast return on net operating assets (RNOA) for 2005. 17.5% 1.25 14% ATO PM RNOA = × = × = Second, forecast residual operating income for 2005. Use a required return for operations of 9%. 268.6
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This note was uploaded on 10/07/2010 for the course ECTCS ec12947322 taught by Professor Johnathayeri during the Spring '10 term at Life.

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Web3ch14 - CHAPTER FOURTEEN Simple Forecasting and Simple...

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