# VALUATION AND FORECASTS

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```					VALUATION AND FORECASTS
Chapter 15
VALUATION AND FORECAST OBJECTIVES
Valuation
The determination of something’s worth (e.g., a business entity)
Share price is one measure of an entity’s value (on a per share basis)
Analysts often need more specific information than share price to make decisions (e.g.,
the timing of cash flows)

VALUATION AND FORECAST OBJECTIVES (CONT.)
Financial forecasts
Project an entity’s financial statements
Reflect an analyst’s assumptions about the future
Compiled on a pro forma (as if) basis

VALUATION METHODS
Investors’ assessment of the worth of an firm’s income

VALUATION METHODS (CONT.)
Price to earnings approach
Captured by the price to earning’s ratio (P-E ratio)
Reflects an investor’s expectations about the future performance of a company
A high P-E ratio means the market expects earnings to increase
A low P-E ratio signals an expected decline in earnings
Computed as: market price per share of stock / earnings per share

VALUATION METHODS (CONT.)
Price to cash flow approach
A derivative of the P-E ratio
Substitutes cash flow from operations for earnings when questions about earnings
quality exist
Computed as: market price per share of stock / operating cash flows per share

VALUATION METHODS (CONT.)
Price to equity approach
Alternative to the P-E (and cash flow to earnings ratio)
Compares market value of a share of stock to its book value at one point in time
Computed as: market price per share of stock / book value per share of stock

eSTUFF’S PRICE-EARNINGS RATIOS
FORECASTING TECHNIQUES
Statistical methods
Mathematical procedures used to help forecast financial statements
FORECASTING TECHNIQUES (CONT.)
Statistical   methods are based on characteristics exhibited in previous data or industry
conditions
Trend—general tendency or direction of events
Time series analysis—extrapolates past trends into the future

Exponential smoothing—similar to time series analysis, but places greater weight on the

more recent disclosures
Cyclical behavior—state of the economy, ranging from prosperity to recession
Seasonality—changes in activity level within reporting periods
Randomness—unforeseen events that affect financial performance

FORECASTING TECHNIQUES (CONT.)

Decompostion—specifically      accounts for trend, seasonality, cyclicality, and
randomness in projecting the future
Linear regression—uses one or more variables (e.g., time) to predict a financial
statement result (e.g., revenue)
E-stuff Regression

FORECASTING TECHNIQUES (CONT.)
Judgmental methods
Alternative to statistical methods
Based on informed opinion
Acknowledges that forecasting is as much art as science

FORECASTING TECHNIQUES (CONT.)
Economy
Industry
Entity
Entity’s previous financial statements
Competition

FORECASTING TECHNIQUES (CONT.)
Other forecasting considerations
Analysts often forecast a range of outcomes, rather than a single point estimate
They can create a best, worst, and most likely forecast
Earnings compilations
Offer a point of comparison for an analyst’s EPS forecast
Capture the range of analysts’ EPS forecasts

PRO FORMA FINANCIAL STATEMENTS
Statement construction
Requires many assumptions about future events
Does not require a forecast of every line item on the financial statements
PRO FORMA FINANCIAL STATEMENTS (CONT.)
Financial statement sequence
Income statement (Exhibit 15-3A)
Balance sheet (Exhibit 15-3B)
Statement of cash flows, including direct operating cash flows (Exhibit 15-3C and 15-
3D)

2002 PRO FORMA FINANCIAL STATEMENTS
2002 PRO FORMA FINANCIAL STATEMENTS (CONT.)
2002 PRO FORMA FINANCIAL STATEMENTS (CONT.)
2002 PRO FORMA FINANCIAL STATEMENTS (CONT.)
2002 PRO FORMA FINANCIAL STATEMENTS (CONT.)

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