Lecture 5

Question 1

Why carying about prospective analysis? (forecasting & valuation)

Answer 1

Because you want to know how expected changes in performance drivers affect future performance

Question 2

Where is Market capitalization based on?

Answer 2

Market capitalization is based on assumptions about future:
- Macro-economic and industry-wide changes, and growth of companies
- Any changes in these assumptions will affect share prices / market value of companies

Question 3

Forecasting involves a three-step process:

Answer 3

Step 1: Predict change in environmental and firm-specific factors
Macro-economic analysis:
Industry and business strategy analysis:
Accounting analysis
Step 2: Assess relationship between step 1 factors and performance
How much has Ford’s past performance responded to economic conditions? What has been the impact of industry-wide trends on sales, R&D, investments?
Step 3: Forecast condensed financial statements
‘Condensed’ entails a focus on key items, rather than on details.
E.g.: Ford and automotive industry:
Translate expectations about economy, industry, strategy into forecasts of Ford’s future performance.

Question 4

Sensitivity Analysis

Answer 4

Two most likely alternative scenarios;
- Upside scenario
- Downside scenario

Question 5

At some point ‘superior’ companies will return to ‘normal’ performance, due to the following factors:

Answer 5

Saturated markets
Size-growth relationship
Increased competition
Industry-wide developments

Question 6

Why did Few companies have been able to sustain a competitive advantage?

Answer 6

due to the strength of their product
or by ‘reinventing’ themselves.

Question 7

Why do Pharmaceutical companies have consistently high performance?

Answer 7

This is mainly due to their main economic assets (R&D) not being shown on the balance sheet.

Question 8

What means a high or a low ROE/profitability?

Answer 8

High profitability attracts competition.
Low profitability means either ‘bankruptcy’ or capital moving away.

Question 9

As what can Statistical properties of key measures be used?

Answer 9

can be used to analyze trends and provide benchmarks for forecasts

Question 10

Firm value

Answer 10

represents the present value of the cash payoffs that an equity investor can expect to receive

Question 11

What are the four different methods to derive Firm value?

Answer 11

Discounted dividends
Discounted cash flows
Discounted abnormal earnings
Price multiples

Question 12

What is the present value of future cashflows to shareholders?

Answer 12

Equity Value0 = Dividend/(1+Re)

Question 13

How is the cost of equity determined?

Answer 13

By a risk-free rate plus a risk premium

Question 14

Equity value perpetuity

Answer 14

Equity value = dividends/(r-g)

Question 15

What are two assumptions of the gordon growth model?

Answer 15

• Model assumes constant growth in dividends.
• Model is very sensitive to assumed growth rate, so can only be used for companies with stable dividend growth rates

Question 16

Terminal Value

Answer 16

((1+g)Free Cash Flows)/((Re-g)(1+Re)^t)
The present value of either abnormal profits or free cash flows occuring beyond the terminal year.

Question 17

Terminal growth rate

Answer 17

Terminal growth rate is usually assumed to be around the long-term economic growth rate (2-3%).

Question 18

Price multiple relation and Steps

Answer 18

A price multiple relates a firm’s share price to a per-share accounting-based metric and provides an easy-to-use valuation benchmark.

Price multiples valuation employs three steps:
1. Select base measure.
- For example: Price-to-earnings (P/E) ratio.
2. Calculate price multiples for comparable firms or compute industry averages.
3. Apply comparable firm multiple to firm analyzed.

Question 19

Areas of difficulty for price multiples valuation:

Answer 19

How to select comparable firms, especially for private companies?
- If no comparable firm is found, industry averages may be used.
How to treat loss-making firms?
- Exclude ‘non-recurring’ items or use forecasts

Question 20

Compute the price‐to‐expected‐earnings ratio for the three companies. What do you conclude based on this comparison? ABI’s multiple is lower than the ones of Heineken and Carlsberg

Answer 20

This suggests that the company may be somewhat undervalued.

Question 21

SUMMARY & OUTLOOK
Where do Forecasted financials serve for?

Answer 21

Forecasted financials serve as inputs to valuation models that seek to determine a company’s equity value.
- We focused on one-period models that yield a simplified valuation.
- Also, our approach was to impute the growth rate implied by a firm’s current share price