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Financial Statement Analysis Exam 2
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Terms in this set (25)
Forecasting the Income Statement
▪ We forecast the Income Statement first.
▪ Sales estimate―for P&G we use 3.5% (from company guidance)
▪ Expense estimate
▪ COGS―as a % of sales
▪ SG&A―as a % of sales
▪ Nonoperating expenses―assume no change and adjust later
▪ One-time items―assume the items will not recur
▪ Income tax―as a % of pre-tax income (from company guidance)
▪ Noncontrolling interest―no change in historic ratio
Transitory Items
Transactions or events that are not likely to recur.
Revenue Forecasting
Requires understanding of past, an object view of future & intuitive feel of future.
Calculating growth rate
(Current year - Previous year)/ Previous year
Projecting Receivable off of sales
project as a percentage of revenues from prior year unless information suggests otherwise.
Projecting/Forecasted Depreciation Expense
(Current year depreciation expense/Prior year PPE, gross) x Current year PPE gross
Projecting/Forecasted dividends
(Current year Dividends/Current year net income) x Forecasted net income
Projecting NOPAT when Given sales and NOPM
NOPM = (NOPAT/Sales), multiply NOPM and Sales to get NOPAT
Projecting NOA when given NOAT
NOAT = (Sales/Average NOA), Divide Sales by NOAT
Capital Asset Pricing Model (CAPM)
Equates the expected return on a particular asset as the sum of three components: Risk-free rate, the beta risk, and the stock-specific risk. The first two components are use in estimating the cost of equity capital. The third component, the stock-specific risk, is the risk that diversified away in large portfolios
CAPM or Cost of equity capital (re) Equation
Re = Rf + [B x (Rm - Rf)]
Market risk Premium
The difference between the expected market return (Rm) and the expected risk-free rate (Rf)
Cost of debt Capital (rd)
is the market rate on debt instruments, calculated as: rd = Pretax borrowing rate × (1 - tax rate)
pretax borrowing rate for debt
(Interest Expense) / (Average amount of interest-bearing debt)
Interest-Bearing debt
Include items from banks and other lenders, bonds payable, and mortgage obligations.
Weighted Average Cost of Capital (WACC)
▪ The nature of the future payoffs dictates the discount rate we use to compute their present value.
▪ When valuing a debt instrument we use the cost of debt capital and when valuing equity instruments we use the cost of equity capital.
▪ Some valuation models, such as the discounted free cash flow and the residual operating income models, assume the payoffs are distributed to both equity holders and debt holders.
▪ For these models, the appropriate discount rate is a weighted average of the cost of debt capital and the cost of equity capital.
WACC formula (Rw)
[Rd x (IV debt / IV Frim)] + [Re x (IV Equity / IV Firm)]
Dividend Discount Model (DDM)
The value of a security today is equal to the present value of the security expected dividends, discounted at eh weighted average cost of capital.
DDM formula
IV 0 = (D1 + IV1) / (1+ Re)
D1 = Dividends received
IV1 = value of equity at end of period
Re = cost of equity capital
Constant Growth DDM
a form of the dividend discount model that assumes dividends will grow at a constant rate
Free Cash Flows to firm (FCFF)
= NOPAT - Increase in NOA
= Net cash flow from operating activities − CAPEX
Discount Factor Formula
1/(1+rw)^t
Ways to increase FCFF
-Restructuring debt to lower interest rates and optimize repayment schedules.
-Reducing, limiting or delaying capital expenditures.
-Hiring a CFO, or fractional CFO to improve financial strategy and business operations with management accounting.
Residual Operating Income (ROPI) Model
An equity valuation approach equates the firm's value to the sum of its met operating assets (NOA) and the present value of its residual operating income (ROPI).
Market Multiple
Ratios of market cap to a selected summary performance measure (such as PE ratio or book value) calculated for a comparable firm(s) and used for equity valuation.
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