Professional Documents
Culture Documents
Stephen H. Penman
Prepared by Peter D. Easton and Gregory A. Sommers
Fisher College of Business The Ohio State University
With contributions by Stephen H. Penman Columbia University Luis Palencia University of Navarra, IESE Business School
McGraw-Hill/Irwin The McGraw-Hill Companies, Inc., 2001 All rights reserved.
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Part III
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Chapter 14
Creating simple forecasts
Chapter 16
Analyzing price-to-earnings ratios
Chapter 15
Creating pro-forma financial statements to get forecasts for valuation
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What a perfect balance sheet is How a perfect balance sheet implies a zero residual earnings forecast What a normal P/B is Why forecasted residual income on financial assets and liabilities is usually zero How one values firms based on forecasts of operating activities What residual operating income is The drivers of residual operating income The difference between the cost of capital for equity and the cost of capital for operations How financial leverage effects both ROCE and the required return for equity The difference between levered and unlevered P/B ratios and how they are calculated
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Review Chapter 6
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3.
R E 1 = earn 1 ( E 1 )CSE
(1) (1) (2) (2)
Forecast of comprehensive earnings for next year Benchmark forecast of comprehensive earnings: CSE will earn at the cost of capital
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15.7 23.4
13.3 20.3
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MS, Inc. Income Statement, Year 0 Operating income Dividends from equity securities Unrealized gains from equity securities Interest expense: 0.10 x 7.0 Net income
MS, Inc. Statement of Cash Flows, Year 0 Cash flow from operations (cash dividends) Cash flow - investment activities Free cash flows Cash-financing activities 1.2 (1.2) 0.0 0.0
(Borrowing cost is 10%; equity cost of capital is 12%) Chapter 13 Page 419
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V 0E = CSE 0
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P r ior Y ear 7 .0 6 2 .9 6 9 .9
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P P E , Inc. I n c o m e S ta te m e n t, Y e a r 0 O p e r a t i n g in c o m e S a le s o f p r o d u c t s C o s t o f g o o d s s o ld ( in c l u d e d d e p . o f 2 1 .4 ) O t h e r o p e r a t in g e x p e n s e s 1 2 4 .9 (1 1 4 .6 ) 1 0 .3 ( 0 .5 ) 9 .8 ( 0 .7 ) 9 .1 P P E , Inc. S t a t e m e n t o f C a s h F lo w s , y e a r 0 C a s h f l o w f r o m o p e r a t io n s O p e r a t in g i n c o m e D e p r e c ia t i o n C a s h f l o w f r o m in v e s t in g a c t iv it ie s I n v e s t m e n t s in P P E ( 2 1 . 4 + 4 . 5 ) F r e e c a s h f lo w s F in a n c i n g f lo w s D iv id e n d s p a i d
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I n t e r e s t e x p e n s e : 0 .1 0 x 7 . 0 N e t in c o m e
9 .8 2 1 .4 3 1 .2 2 5 .9 5 .3 5 .3
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RE Model:
V 0E = CSE 0 + PV of RE
Some assets and liabilities have zero expected RE because they are measured at market value Modified Model:
V0E = CSE 0 + PV of RE of net assets not at market val ue
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Net Income Component Operating Income (OI) Net Financial Expense (NFE) Earnings (earn)
Book Value Component Net Operating Assets (NOA) Net Financial Obligations (NFO) Common Stockholders Equity (CSE)
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NFO are usually at market value on the balance sheet (or close to it). So residual earnings from NFO are expected to be zero NOA are not usually at market value in the balance sheet
V 0E = NOA +
(OI
t =1 t F
( F 1 ) NOA
t 1
) NFO
(2)
The Residual Operating Income Model: (1) Value of the firm (value of the operations) (2) Value of the net debt
(1)
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CSE 0
t =1
t E
(earn
( E 1) CSE t 1 )
= NOA 0 NFO 0 + E t t =1
[OI
(
NFE t
( E 1) NOA t 1 NFO t 1
)] )
Nike Base Data for 1996: Net operating assets (NOA) Net financial obligations (NFO) Total equity Minority interest Common stockholders equity (CSE) Analysts earning forecast for 1997 Earnings forecast Less NFE forecast (NFO x Core NBC) Less minority interest in earnings Analysts implicit OI forecast 2,659 228 2,431 2,431
Calculation of residual earnings components: Residual operating income (ReOI) forecast Nike: 656 (0.110 x 2,659) 364 Reebok: 187 (0.101 x 1,135) Residual net financial expense (ReNFE) forecast Nike: 8 (0.035 x 228) 0 Reebok: 29 (0.040 x 720)
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0
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Case 1:
CV
= 0 Re OI T +1 F 1
Re OI T +1 F g
Case 2:
CV T =
Case 3:
CV T =
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1,135
= (89.0 x 1.07)/(1.101 1.07) = 3071.9 value of the minority interest depends on the value of the NOA in the relevant subsidiaries. It has been calculated here as 14 times minority interest earnings. The McGraw-Hill Companies, Inc., 2001 All rights reserved.
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(2)
Operations have their own risk, referred to as operational risk This risk determines the required return (or cost of capital) to invest in the operations The required return is called the cost of capital for operations or the cost of capital for the firm: F It is also called the weighted average cost of capital because For MS, Inc.: F
= V 0E V 0 NOA E + V 0D V 0 NOA D
15 .7 7 .7 11 .34 % = 12 % + 10 % 23 .4 23 .4
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market leverage
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ReOI Valuation of Firm with 9% cost of capital for operations & 5% after-tax cost of debt 0 1 2 3 Net operating assets 1,300 Net financial obligations 300 Common shareholders equity 1,000 Operating income 135 135 135--- Net Financial expense (300 x 0.05) 15 15 15--- 120 120--- Earnings 120 Residual operating income, ReOI (0.09) 18 18 18--- PV of ReOI 200 Value of common equity 1,200 Value per share (on 600 shares) 2.00
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300 x [9 .0 % 5 .0 % ] = 10 .0 % 1,200
120 12% 20
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Unlevered
Levered P/B =
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6.0
VNOA/NOA = 2.5
5.0
4.0
VNOA/NOA = 2
3.0
VNOA/NOA = 1.5
2.0
1.0
VNOA/NOA = 1
0.0 0.0 -1.0 0.3 0.5 0.8 1.0 1.3 1.5 1.8 2.0 2.3
VNOA/NOA = 0.5
V E CSE
V NOA NOA
+ FLEV
V NOA NOA
1
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2.5
2.0
FLEV = 0.75
1.5
1.0
FLEV = 0
0.5
-1.0
/NOA )
V V V = + FLEV 1 CSE The McGraw-Hill NOA NOA Companies, Inc., 2001 All rights reserved.
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Median Levered and Unlevered P/B Ratios, 1963-96 for NYSE & AMEX Firms
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Concept
Profitability
Unlevered Measure
RNOA
Relationship
ROCE=RNOA+FLEV[RNOA-NBC]
Cost of Capital
E = F +
V 0D [ F D V 0E
P/B Ratio
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