FA 7 - Forecasting and Valuation

Question 1

Pro forma financial statements

Answer 1

depiction of what the financial reports of the business will look like over a certain period of time if the assumptions made while preparing them hold true

Question 2

Percent of sales forecasting

Answer 2

i. determine future potential revenue and trends from previous statements - i.e. expected sales;
ii. calculate related costs based on the trends and relationships
iii. liabilities and equity are calculated differently

Question 3

Free cash flows

Answer 3

FCF = (1-t)xEBIT + DEP - CAPX - d.NWC

t = tax rate
EBIT = earnings before tax and interest
DEP = depreciation and amortization
CAPX = Capital expenditure
d.NWC = change in net working capital

Question 4

EBIT, EBIAT, NWC

Answer 4

EBIT = Net Income + Tax expense + Interest expense
EBIAT = (1-t) x EBIT
NWC = Current assets - Current liabilities

Question 5

Time value of money

Answer 5

The concept that a unit of money received today is of more value than the same unit received in the future because -

i. opportunity cost of what you could do with it;
ii. inflation; and
iii. the future dollar is uncertain while this one isn’t.

Question 6

Converting cash flows

Answer 6

“Cash flows of different time periods are analogous to cash flows expressed in different currencies”

i.e. you have to convert to the same currency before you can add or subtract them

Question 7

Calculating terminal value of infinite cash flows

Answer 7

Gordon Growth Model
Present value of infinite cash flows =
(Cash flows in the final year of our projection/ (Discount rate - Growth rate)

Question 8

[EXCEL] Present value

Answer 8

=PV(rate, nper, pmt)

rate of interest - i.e. discount rate
no. of payment periods
payment or cash flow

Question 9

Net Present Value

Answer 9

NPV
net of present values of all the cash inflows and outflows of a project
Single number that gives an indication of what a business or investment is worth today

Question 10

Relevant cash flows for NPV

Answer 10

don’t include sunk costs and costs that would occur irrespective of whether a project will happen or not - i.e. those irrelevant to the decision at hand

Question 11

[EXCEL] NPV

Answer 11

=NPV(rate, value 1, value 2….)

array not including initial investment - this has to be added back to get the real NPV

Question 12

[EXCEL] IRR

Answer 12

Internal Rate of Return
=IRR(array)
including initial investment

Question 13

Internal Rate of Return

Answer 13

IRR
discount rate that sets the NPV of a project equal to zero
allows us to see the percentage rate that would be earned for a given set of cash flows
incorporates time value of money

Question 14

Payback period

Answer 14

tells us how fast investors can expect to have their money returned
ignores the time value of money