Forecasting and Valuation Flashcards
To forecast liabilities and equity, the current portion of long-term debt is determined based on
the part of a long-term loan that becomes current, or is to be repaid within one year. Since they are linked, interest expense and borrowings can be tricky to forecast and may take some trial and error. For example, a company that may need additional funding, meaning an increase in borrowings, will have increased interest expense. In some cases, borrowings will be a plug to make the balance sheet balance.
How to calculate forecasted net sales?
In order to calculate, multiply the prior year’s revenue by % increase and add next years revenue.
To calculate the long term debt balance, we will
subtract this year’s current portion of long term debt from the prior year’s balance of long term debt.
For example, the long term debt balance for 2004 is 30.4. This is 2003’s long term debt balance of 31.4 less 2004’s current portion of long term debt, 1.0.
Common stock reflects the amount of
funding raised by issuing shares of stock to individuals that will hold a stake in the company. We would generally expect common stock to stay the same from year to year, unless the business is planning on issuing more stock or buying back its own outstanding shares. In our example below, we’ll assume it is going to stay constant from one year to the next.
Retained earnings reflects
the earnings that have been retained in the business to finance growth or future operations. For any given year, we can forecast retained earnings by adding the amount of prior year retained earnings plus current year net income, excluding amounts to be distributed to shareholders.
Projecting Free Cash Flows: 1st step
The first step in calculating free cash flows is to eliminate the impact of how the business or investment is financed.
To do this we first calculate Earnings Before Interest and Taxes or EBIT for short. The information for calculating EBIT comes from the income statement. Starting with the bottom line, net income, we add back the interest expense and income taxes expense lines. The result is EBIT.
With all cash flows determined, the value of the project can be calculated by
using the net present value, or NPV, of the cash flows. The NPV nets out the present values of all the cash inflows and outflows of the project. The result is a single number that gives a good indication of what a business or a particular investment is worth today. It is important that the NPV uses only relevant cash flows in the analysis.
To calculate EBIAT we
multiply EBIT by 1 minus the tax rate. So at this stage, we have merely taken away the impact of interest from the income statement. We have re-applied the tax rate to the EBIT in arriving at EBIAT.
(1-t) x EBIT
Projecting Free Cash Flows: 2nd step. Once EBIAT has been calculated, we have to add
Once EBIAT has been calculated, we have to add depreciation back in the calculation of free cash flows.
Projecting Free Cash Flows: 3rd step.
Next we’ll take into account cash inflow and outflow for capital expenditures. Remember that this refers to when cash is actually paid for property and equipment regardless of when the depreciation is recognized on the asset.
Net working capital refers to
the business having cash tied up in operations. As the business grows, it will typically need more cash to fund day to day operations. For example, as a business increases its sales, and services more customers, it will often need to increase the amount of inventory that it carries. This is cash that will be dedicated to the business and won’t be available for other purposes.
how to calculate present value using a spreadsheet.
The function in a spreadsheet is:
=PV(rate,nper,pmt)
Rate is the interest rate (also known as discount rate) for the period.
Nper is the number of payment periods for the given cash flow.
Pmt is the payment, or cash flow, to be discounted.
The Gordon Growth Model
Terminal Value = Cash Flow / (discount rate - growth rate)
Calculating Net Present Value: Using a Spreadsheet
=NPV(rate,value1,value2, …)
Rate is the interest rate (also known as discount rate) for the period.
Value1, value2, … are equally spaced cash flows that occur at the end of each period.
Calculating Payback Period
The best way to calculate the payback period is to calculate the cumulative cash flows. Another way to think of the payback period is that it is the “breakeven” point, or the point at which positive cash flows and negative cash flows incurred to date net to zero. By calculating the cumulative cash flows, it is easy to see when the cash flows flip from being negative to being positive. If it doesn’t flip exactly at a certain year, then you just need to find the portion of the following year that it takes to recover the remaining cash outlay.
