Ch_09 - Chapter 09 - Prospective Analysis 9-1 Chapter 9...

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Unformatted text preview: Chapter 09 - Prospective Analysis 9-1 Chapter 9 Prospective Analysis REVIEW Prospective analysis is the final step in the financial statement analysis process. It includes forecasting of the balance sheet, income statement and statement of cash flows. Prospective analysis is central to security valuation. Both the free cash flow and residual income valuation models described in Chapter 1 require estimates of future financial statements. We provide a detailed example of the forecasting process to project the income statement, the balance sheet, and the statement of cash flows. We describe the relevance of forecasting for security valuation and provide an example utilizing forecasted financial statements to implement the residual income valuation model. We discuss the concept of value drivers and their reversion to long-run equilibrium levels. In the appendix, we provide a detailed example of short-term cash flow forecasting. Chapter 09 - Prospective Analysis 9-2 OUTLINE The Projection Process Projecting Financial Statements Application of Prospective Analysis in the Residual Income Valuation Model Trends in Value Drivers Short-term Forecasting (Appendix) Chapter 09 - Prospective Analysis 9-3 ANALYSIS OBJECTIVES Describe the importance of prospective analysis. Explain the process of projecting the income statement, the balance sheet and the statement of cash flows. Discuss and illustrate the Importance of Sensitivity Analysis. Describe the implementation of the projection process in the valuation of equity securities. Discuss the concept of value drivers and their reversion to long-run equilibrium levels. Chapter 09 - Prospective Analysis 9-4 QUESTIONS 1. Prospective analysis is central to security valuation. All valuation models rely on forecasts of earnings or cash flows that are, then, discounted back to the present to arrive at the estimated value of the security. Prospective analysis is also useful to examine the viability of companies strategic plans, that is, whether they will be able to generate sufficient cash flows from operations to finance expected growth or whether they will be required to seek external financing. In addition, prospective analysis is useful to examine whether announcing strategies will yield the benefits expected by management. Finally, prospective analysis can be used by creditors to assess companies ability to meet debt service requirements. 2. Prior to the forecasting process, financial statements can be recast to better portray economic reality. Adjustments might include elimination of transitory items or reallocating them to past or future years, capitalizing (expensing) items that have been expensed (capitalized) by management, capitalizing operating leases and other forms of off-balance sheet financing, and so forth....
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Ch_09 - Chapter 09 - Prospective Analysis 9-1 Chapter 9...

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