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Valuation

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  1. Valuation FIN 449Michael Dimond

  2. Financial Forecasting • Why might the simplest approach not work? • How detailed should be the analysis? • Does history tell the future? • How long of a trend should be observed? • Are the line items independent? • Is growth in a line item really growth in the firm? • Have earnings been manipulated in the past? • Are the cash flows sustainable – can the operation continue this way?

  3. General Guidelines for Good Forecasting • The steps are interdependent. Make adjustments in an order that makes sense for the business model. • For example, revenue forecasts may first require forecasts of new stores • The financial statements must interconnect • For example, the change in depreciation on the BS should equal the depreciation expense for the year. • Simple errors can be avoided if the spreadsheet is dynamic. • Allow for the firm’s need for capital in at least one account with a “TBD” balance • For example, Extra Funds Needed (EFN) may come from debt or somewhere else. What has been the firm’s history? What is likely to be its future? • GIGO – Garbage In, Garbage Out • All assumptions must make sense historically, economically and strategically. The forecast is only as good as the assumptions • Sensitivity Analysis will test key assumptions • Those inputs which make the biggest difference when they change are those which require the most thought care and monitoring.

  4. High-level Forecasting • Projected Sales & Income Approach • Projected Total Assets Approach • Problems with these approaches?

  5. Maybe Something More Sophisticated? • Remember our friends at DuPont? • What’s the Implied Growth Rate of Average Assets?

  6. What problems exist with this approach?

  7. Detailed Forecasting • Project Operating Revenues • Project Operating Expenses • Project Operating Assets & Liabilities • Project Financial Need & Capital Structure • Build Pro Forma Balance Sheet • Project Other IS Items • Build Pro Forma Income Statement • Project Dividends & Change in Retained Earnings • Build Pro Forma Statement of Retained Earnings • Project Cash Flows from Operations, Investing & Financing Activities • Build Statement of Cash Flows Adjusting as needed Adapted from Stickney et al, Financial Reporting and Statement Analysis

  8. Operating Revenues • Projecting Sales • Segments • Volume • Price • Projecting Other Revenue • Watch for unusual gains, such as from the sale of assets (ask, “is this a sustainable cash flow?”) • Forecasting errors • Some assumptions will be incorrect, but the significance of each needs to be understood. • For example, high DOL means more potential for forecasting error. A small error in sales projections can lever up into larger errors in projected cash flows.

  9. Projecting Sales

  10. Been to a video store lately? The 80s video store Video chains Delivery Streaming

  11. Netflix Sales $ growth 46%, 21%, 13%, 22%, 29% respectively Sales $ CAGR 26%

  12. Netflix Sales Vol growth 51%, 18% 26%, 31%, 63% respectively Sales Vol CAGR 37%

  13. Netflix Sales Price growth… Sales Price CAGR…

  14. Netflix

  15. Been to a video store lately? How has Netflix revenue model changed?

  16. Been to a video store lately? The 80s video store Video chains Delivery Streaming Better streaming NPD, not R&D The extra dollar Customer Satisfaction Proposition (not Customer “Value” Proposition, IMHO) Forecasting Graduation

  17. Operating Expenses Percent of Sales: • Cost of Goods Sold • Selling, General & Administrative Expenses • Other Operating Expenses • Watch for “one time” expenditures. These may be legitimately unique or be an indication of manipulation.

  18. Projecting Operating Expenses

  19. Assets • Cash & Marketable Securities • Accounts Receivable • Inventories • Other Current Assets • Investments in Unconsolidated Affiliates • Property, Plant & Equipment • Other Assets • What assets vary as a function of Total Assets?

  20. Assets • Cash & Marketable Securities (Days Sales) • Accounts Receivable (Days Sales) • Inventories (COGS x Inventory Turnover) • Other Current Assets (% of Total Assets?) • Investments in Unconsolidated Affiliates (TBD) • Property, Plant & Equipment (explicit model) • Other Assets (TBD) • Few assets vary as a % of Total Assets

  21. Projecting Assets