Lecture 8

Question 1

1. What are the two drivers of ReOI (residual operating income)

2 .What is the formula which captures both these drivers
What is the formula for core sales PM

3. What is the primary driver for ReOI,
   What is the formula for sales.
4. When forecasting sales what is the primary drivers of sales
5. Explain what the Core sales Profit margin is.
   What is meant when the ratio is 20%

Answer 1

1. RNOA and Growth in NOA
2. Look at the formula sheet
3. Sales is the primary driver:
   Sales = number of units sold x Price/unit
4. Demand and price are the main drivers of sales
5. How much operating income i reaped form each dollar of sales. If the ratio is 20% then out of every dollar of sales 80 cents absorbed by operating expenses or 20 cents is part of operating income.

Question 2

1. Explain what it means when drivers usually exhibit mean reversion.

What does ________ tend to converge to.

(a) Core other income
(b) Unusual items
(c) Unusual sales growth rate
(d) Change in sales PM
(e) Change in asset turnover

What is the rate reversion to the long run level referred to as.
What is the period in which a driver fades to a typical level or is around for

3. What are the drivers you factor for changes.

Answer 2

1. Value drivers tend to become more like the industry average over time. High levels of growth will tend to merge to the industry average, as your competitors will imitate you and drive your comparative advantage away.

(a) Core other/NOA: tend to converge towards a certain percentage
(b) Unusual items tend to disappear quickly.
(c) Unusual Sales growth rates tend to fade quickly
(d) Change in sales PM fades quickly toward zero on average the sale will be zero + 10% , -5%, -5% …
(e) Change in asset turnover: fades quickly towards common level.

The rate of reversion to the long run level, called fade rate or persistence rate.

Competitive advantage period is the period over which a driver fades to a typical level

3. Modify typical driver pattern for forecasted changes in the industry, economy and firm.

Question 3

When doing a full information forecasting and pro forma analysis what does the process involve.

What are the full set of ReOI drivers.

What are the most important drivers.

Answer 3

This process involves forecasting all economic factors and the full set of ReOI drivers.

1. Sales : the starting point
2. Core PM : to calculate operating income
3. ATO: needed to calculate ReIO and NOA
4. Other core OI
5. Unusual items

The first three are the most important drivers.

Question 4

1. When doing pro forma forecasts. What is the ATO expected to grow at
2. What is the formula for core operating expense
3. What is an alternative to the normal free cash flow (C - I)

Answer 4

1. When doing pro forma analysis ATO is expected to grow at the same rate as sales
2. Look at the notes
3. Look at the notes

Do not worry about the ratios below the free cash flows go back to slide 25 and try to replicate the model.

Question 5

What type of companies is best to value with a constant growth rate.

Answer 5

Constant growth rate is best for mature well established companies. As they have a constant stream of income and growth on average.

Question 6

1, What is the formula for value of the Equity

2. What is the formula for value of net operating assets, why can we use a perpetuity

Answer 6

1. Look at the notes

2. Look at the notes, we can use a perpetuity as we are assuming that the ReOI is growing at a constant rate