Chapter 6: The Role of Financial In as long as mation in Valuation Learning objectives: T

Chapter 6: The Role of Financial In as long as mation in Valuation Learning objectives: T www.phwiki.com

Chapter 6: The Role of Financial In as long as mation in Valuation Learning objectives: T

Merrett, Chelli, Office Manager;Traffic, Accounting, IT Manager has reference to this Academic Journal, PHwiki organized this Journal Chapter 6: The Role of Financial In as long as mation in Valuation Learning objectives: To learn the basic steps in business valuation. Forecast a company’s financial statements. Using the discounted free cash flow approach in addition to the abnormal earnings approach to valuation. 6- Learning objectives: concluded What factors contribute to variation in price-earnings multiples. What factors influence earnings quality. How stock returns relate to “good news” in addition to “bad news” about earnings 6- Framework as long as Business Valuation: There are three steps involved in valuing a company: Step 1: Underst in addition to the past (Ch. 5) Step 2: Forecasting the Future Step 3: Valuation of Equity Price Free cash flow model Abnormal earnings approach

Budapest Buddhist University HU www.phwiki.com

This Particular University is Related to this Particular Journal

Business valuation (contd.): Step 2 in addition to Step 3 Step 2: Step 3: Forecast future amounts of the financial attribute that ultimately determines how much a company is worth. a. Determine the risk or uncertainty associated with the as long as ecastedfuture amounts. b. Determine the discounted present value of the expected future amounts using a discount rate that reflects the risk from Step 2 a. Free cash flows Accounting earnings Balance sheet book values 6- Equity Valuation Step 1: Underst in addition to ing the past In as long as mation Collection Underst in addition to ing the business Accounting Analysis Financial Ratio Analysis Cash Flow Analysis Equity Valuation Step 2: Forecasting the Future Forecast future amounts of value- relevant financial attributes using a structured as long as ecasting which includes: Income statement as long as ecasts Balance sheet as long as ecasts Cash flow as long as ecasts Examples of Value-relevant financial attributes: cash flows, earnings in addition to book value.

Procedures in financial statement as long as ecasting (see Appendix B) Project sales revenue as long as each period in the horizon (i.e., next 5 years). Forecast operating expenses such as COGS, selling in addition to general administration expenses (but not depreciation, interest, or taxes) using expense margin. Forecast balance sheet assets in addition to liabilities (excl. long-term liabilities) needed to support the projected operations in 1 in addition to 2. Procedures in financial statement as long as ecasting (contd.) Forecast depreciation expense in addition to the income tax expense. Forecast financial structure ( in addition to there as long as e, long-term debt), dividend paid, in addition to interest expense. Derive projected cash flow statements from the as long as ecasted income statements in addition to balance sheets. Thus, expected future amounts of value-relevant financial attributes such as cash flows, earnings in addition to book value are obtained. Financial Statement Forecasts Example (source: P6-21 of RCJM textbook, 4th edition) Using the steps outlined in previous pages in addition to the following in as long as mation to as long as ecast 2003 in addition to 2004 financial statements of Krispy Kreme Doughnuts, Inc.: Sales as long as 2003 in addition to 2004 will equal $657 million in addition to $819 million, respectively. Non-operating expenses in addition to income will be zero. The company’s income tax rate will be 35%. All other income statement items are expected to equal their 2002 levels as a percentage of sales.

Financial Statement Forecasts Example (contd.) Depreciation expense was $12.3 million in 2002 ($10.3 in cost of goods sold in addition to $2.0 in selling, general, in addition to administration (SG&A) in addition to $8 million in 2001 ($6.0 in cost of goods sold in addition to $2.0 in SG&A). All balance sheet items except Common stockholders’ equity are expected to equal their 2002 levels as a percentage of sales. Accumulated depreciation Was 43.9 million in addition to $50.2 million in 2001, in addition to 2002, respectively. Combine long-term investments, intangibles in addition to Other assets into a single balance sheet item (other assets). Financial Statement Forecasts Example (contd.) Debt is expected to be 15% assets, in addition to the current portion of long-term debt will be 10% of total debt each year. Interest expense will be 6% of debt at the beginning of each year. The company will issue or buy back stock during 2003 in addition to 2004 to meet its cash flow needs or to distribute excess cash. Dividends in addition to Other comprehensive income will be zero. Financial Statement Forecasts Example (contd.) Additional questions: Analysts’ as long as ecasts of net income are $50.7 million in addition to $65.9 million as long as 2003 in addition to 2004, respectively. How do your net income as long as ecasts compare with those of the analysts What does this tell you about your as long as ecasting assumptions compared to those used by the analysts

Financial Statement Forecasts Example (contd.) Why is it important to assume the company will issue or buy back stock when constructing financial statement as long as ecasts How do your sales, net income, accounts receivable, total assets in addition to operating cash flow as long as ecasts as long as 2003 in addition to 2004 compare to the amounts actually reported by the company in those two years What factors are likely to explain sizable differences between the actual figures in addition to your as long as ecasts See p9-p13 of chapter 6 homework solutions on iLearn. Equity Valuation Step 3: Valuation Determine the risk (r) or uncertainty associated with the as long as ecasted future amounts . Use the discount rate that reflects the risk to calculate the discounted present value of the expected future amounts. Learning Objective: Step 3: Valuation

Equity Valuation Step 3: Valuation Cost of capital (risk associated with the as long as ecasted future amounts). Valuation Models Discounted free cash flow model Abnormal earnings model (residual income model) (see Appendix A, P6-13). Complications Negative values Distortions from accounting reporting Equity Valuation Step 3: Valuation (contd.) Cost of equity capital (r ) Models available to estimate cost of capital include: CAPM model: cost of capital = Rf + beta risk x (Rm – Rf) Rf= risk free rate; Rm = market return Cost of Capital ( Weighted Average Cost of Capital) The WACC equation is the cost of each capital component multiplied by its proportional weight in addition to then summing: Where: R equity = cost of equity R debt = cost of debt E = market value of the firm’s equity D = market value of the firm’s debt V = E + D E/V = percentage of financing that is equity D/V = percentage of financing that is debt Tax% = corporate tax rate

Learning Objective : The Discounted Free Cash Flow Approach to Equity Valuation Corporate valuation: Discounted free cash flow approach This approach says the value per share (P0) of a company’s common stock is given by: Corporate valuation: Discounted free cash flow approach CFt is free cash flow of year t. CF equals company’s operating cash flows (be as long as e interest) minus cash needed as long as routine operating capacity replacement. This CF is cash available as long as further expansion of operation, debt reduction, etc.

Corporate valuation: Discounted free cash flow approach If the valuation is as long as common stockholders, the CF needs to subtract interest payments, debt repayments in addition to preferred dividends. r is the discount rate appropriate as long as the risk associated with the as long as ecasted free cash flows. Corporate valuation: Discounted free cash flow approach is the discount factor as long as as long as ecasted cash flows in period t. E0 is investors’ expectations (at time 0) about future free cash flows. Business valuation: Discounted Free Cash Flow illustration Estimated DCF value per share 6-

Merrett, Chelli WKXK-FM Office Manager;Traffic, Accounting, IT Manager www.phwiki.com

Discounted free cash flow approach – A simplified model Continuing to infinity Expected free cash flow in each year set equal to the free cash flow realized in Year 0 – a zero growth perpetuity. The above constant perpetuity can be simplified to : Application of Free Cash Flow Valuation in Goodwill Impairment Estimation The free cash flow approach can be used to estimate the current value of a business with goodwill from a prior acquisition . When the estimated current value of the business minus the fair value of its net assets is less than the reported goodwill, an impairment exists. Learning Objective : The Role of Earnings in Equity Valuation

The Role of Earnings in Valuation FASB’s assertion: in as long as mation about earnings measured by accrual accounting generally provides a better indication of a firm’s per as long as mance than in as long as mation of cash flows. Also, a popular belief is that accrual accounting earnings are more useful in predicting future cash flows than cash flows. The Role of Earnings in Valuation Both FASB’s assertion in addition to the common belief has been validated by academic studies: 1. Current earnings are a better as long as ecast of future cash flows than are current cash flows (Barth, Cram in addition to Nelson, 1998) 2. accrual earnings are more correlated with stock returns than operating cash flows. (Dechow, 1994) Based on FASB’s assertion, replace the CF from the equation by Earnings (denoted X) in the zero growth perpetuity setting: The role of earnings in valuation: Zero growth example

Summary You have also seen how financial reports help investors in addition to lenders assess the “amounts, timing, in addition to uncertainty of prospective net cash flows”. Knowing what numbers are used, why they are used, in addition to how they are used is crucial to underst in addition to ing the decision-usefulness of accounting in as long as mation.

Merrett, Chelli Office Manager;Traffic, Accounting, IT Manager

Merrett, Chelli is from United States and they belong to WKXK-FM and they are from  Greenville, United States got related to this Particular Journal. and Merrett, Chelli deal with the subjects like Entertainment; Music; Public Affairs/Issues; Traffic Reporting

Journal Ratings by Budapest Buddhist University

This Particular Journal got reviewed and rated by Budapest Buddhist University and short form of this particular Institution is HU and gave this Journal an Excellent Rating.