chapter 11 - revised slidedeck in class

Question 1

why is forecasting important

Answer 1

managers use forecasts to set targets for future performance and also to make decision about and help plan future purchases of assets, sources of financing etc

creditors use forecasts to determine whether their debtors can repay

IB make forecasts pertaining to firms or divisions of firms which they think are potential takeover targets

Analysts make forecasts to communicate their view of a firm’s future prospects

Question 2

what’s the valuation formula for forecasting using projected future payoffs

Answer 2

the sum of projected future payoffs divided by (1+discount rate)^t

Question 3

what are the general principles of forecasting financial statements

Answer 3

product unbiased, reliable estimated of future earnings
future =/= looking like past
best forecasts = comprehensive + internally consistent forecasts
benchmark forecasts against other analysts, industry average past performance, etc (

Question 4

what’s the point of a sensitivity analysis

Answer 4

to observe the effects of assumptions

Question 5

why forecast annualy

Answer 5

too much forecasting frequency = overkill

Question 6

how to adjust financial statements for forecasting

Answer 6

begin with retrospective analysis
identify + eliminate transitory items

Question 7

why is revenue forecast most importantn

Answer 7

bc other income statement and balance sheet accounts derive from the revenue forecast

Question 8

what are the two approaches to forecasting sales growth

Answer 8

top-down
bottom-up

Question 9

what’s the top-down approach

Answer 9

forecast industry sales growth
- macroeconomic data –> industry data –> firm=specific data

reliable macroeconomic data + strong link between macro economy + industry

consider competitive landscape
works well for large players in the industry

Question 10

what’s teh bottom-up apporach

Answer 10

start at product/segment level
- clear revenue driver, established business model
- small players
- less defined industry; lack of clear boundaries, overlapping/niche area, rapidly evolving market,

Question 11

how to forecast sales growth for firm’s with relatively homogenous assets

Answer 11

sales growth = (1+growth rate in new assets)*(1+ growth in sales per asset) -1

Question 12

what’s the overview for forecasting income statement

Answer 12

estimate sales growth rate (e.g 1% growth)
estimate expenses;
- COGS + SG&A = % of sales
- depreciation expense = beginning of year PP&E x estimated depreciation rate
- interest expenses = average interest-bearing dent x estimated interest rate
- nonoperating expenses = assume no change and adjust later
- for 1-time item, not expected to recur, thus forecast = $0
- other nonoperating expenses = use a 5 year average
- income tax = based on company’s guidance of pretax income
- noncontrolling interest = no change in historic ratio

Question 13

what’s the overview to forecasting balance sheet

Answer 13

• working capital accounts = % of sales
• PP&E = increase by estimated CAPEX and reduce by forecasted depreciation expense
• intangible assets = subtract forecasted amortization expense
• current + long-term debt = assume company makes all contractual payments of long-term debt, assume total debt remains unchanged
• SE = no change for paid-in capital accounts except for planned treasury stock transactions
• retained earnings = increase by forecasted net income and reduced by estimated dividends
• estimated dividends = (current year dividends/current year net income) x forecasted net income
• no change in goodwill
• short term debt remains constant
• long-term debt reduced by current maturities and increase by new borrowing to yield _% cash target

Question 14

how to forecast CAPEX without comapny guidance

Answer 14

forecasted CAPEX = (current year CAPEX/current year sales) x forecasted sales

Question 15

how to forecast depreciation expense + Forecasted PP&E, net

Answer 15

find historic depreciation expense rate = current year depreciation expense/ prior year PP&E, gross

then use the historic depreciation expense for the forecasted depreciation expense
= current year PP&E, gross x forecasted depreciation rate

forecasted PP&E, net = current year PP&E, net + forecasted CAPEX - forecasted depreciation expense

Question 16

what does it mean if the cash balance is much higher or lower than normal?

Answer 16

if higher than normal - assume excess liquidity can be; invested in marketable securities, used to pay down debt, repurchase stock or increase dividends payments

if much lower than normal, expect company would; borrow money, sell stock, and/or liquidate marketable securities

Question 17

should we attempt to maintain the historic debt to equity ratio when forecasting?

Answer 17

yes, especially when forecasting additional borrowing, debt repayment, stock sales or stock repurchases

Question 18

how to forecast cash flow statement

Answer 18

begin with net income, adds back or deduct any noncash expense or revenues
then determine the cash flow effect of changes in working capital and remaining asset, liability and equity items

compute changes in each line item on forecasted balance sheet + classify changes as operating, investing or financing

Question 19

why would analysis and managers need or use multi-year forecasts

Answer 19

analysts use it to value a firm’s equity valuation, asses ability to repay debt, assign credit ratings

manager’s use it for cash flow budgets, capital expenditure plans, divesture decisions, mergers + acquisitions

Question 20

how is the forecasted balance sheet typically balanced

Answer 20

using the cash account as a plug

Question 21

What’s the parsimonious method

Answer 21

Needs 3 inputs;
1. Sales growth
2. Net operating profit margin (NOPM) = NOPAT/Sales
3. Net operating asset Turnover (NOAT) = sales/year-end NOA

We use year end NOA instead of average NOA because we want to forecast year end values.

Forecasted sales = prior year sales x (1+ sales growth rate)
Forecasted NOPAT = forecasted sales x NOPM
Forecasted NOA = forecasted sales/NOAT