Business and Financial Analysis

1
Business and Financial Analysis

• Analysis of companies for possible investments
  and valuation involves many components.
• The entire business must be considered.

2
Components of analysis

• Business strategy analysis
• Accounting analysis
• Financial analysis (ratios etc.)
• Prospective analysis

3
Business strategy analysis

• Generate Performance expectations through
  industry analysis and competitive strategy
  analysis

4
Accounting analysis

• Evaluate accounting quality by assessing
  accounting policies and estimates

5
Financial analysis

• Evaluate performance ratios using ratios and cash
  flow analysis

6
Fundamental Analysis
7
Prospective analysis

• Forecast future events and value the business

8
Strategic analyses (Porter)

• Industry analysis
• Competitive strategy analysis
• Corporate strategy analysis

9
Structural Analysis of Industries

• Determines the ultimate profit potential of the
  industry
• Mix of economic factors and technology
• Level of competition and long-run ROI
• Firm will respond with unique competitive strategy

10
Forces Driving Industry Competition and profit

• Threat of entry
• Rivalry among current competitors
• Threat of substitution
• Bargaining power of buyers
• Bargaining power of suppliers

11
Competitive Strategies

• Overall Cost Leadership
• Differentiation
• Focus (unique products/ market niche)

12
Impact of strategy on financial statements

• A companys competitive strategy will affect the
  look of its financial statements.
• In a competitive industry, gross profits will
  tend to equalize.
• In a monopoly we will see very high profits

13
Quality of Accounting

• We are looking here at the way in which the firm
  applies the rules of accounting
• The quality of accounting relates to the extent
  to which the financial statements reflect the
  true economic picture of the company

14
Accounting quality?
15
Factors Influencing Accounting Quality

• Accounting Rules
• Uniformity of Accounting rules do not reflect the
  economic situation of all firm equally well
• Forecast Errors
• Management must make estimates in preparing
  financial statements
• Some of the estimates are less accurate than
  others
• Firms differ in the materiality of the effect of
  estimates on inferences made from information in
  the financial statements

16
Factors Influencing Accounting Quality and
Managers Choices

• Managerial Compensation
• Corporate Control Contests
• Tax Considerations
• Regulatory Considerations
• Capital Market Considerations (international vs.
  US)
• Stakeholder Considerations
• Competition Within the Industry

17
Accounting Analysis

• Identify Key Accounting Policies
• Assess Accounting Flexibility
• Evaluate Accounting Strategy
• Evaluate Quality of Disclosure
• Identify Potential Red Flags
• Undo Accounting Distortions

18
Identify Key Accounting Policies

• We will be learning about how to do this
  throughout the course
• First footnote to financial statements
• Differ somewhat by industry

19
Assess Accounting Flexibility

• Some of the policies that have a substantial
  effect on one industry are governed by rigid
  rules, while others allow managerial discretion
• Need to evaluate both situations carefully
• These differ by industry

20
Evaluate Accounting Strategy

• Does manager use flexibility to reveal true
  economic situation of the firm or to hide it?
  Questions to ask
• How do accounting policies compare to industry
  norms
• Does manager have strong incentive to use
  discretion to manage earnings
• Have accounting policies or estimates changed
  recently
• Have policies been realistic in the past

21
Evaluate Quality of Disclosure

• Does firm provide adequate disclosure to allow an
  assessment of its business strategy ?
• Do footnote adequately explain accounting
  policies ?
• Does management explain current performance
  adequately?
• If rigid accounting rules do not allow the firm
  the flexibility to reveal relevant information in
  the financial statements, do they do so in other
  sections of the financial statements?
• Is segment disclosure adequate?
• How is bad news revealed ?
• Investor relations program?

22
Identify Potential Red Flags (Shenanigans)

• Unexpected changes in accounting policies
• Unexpected sale of assets or other actions that
  boost profits
• Unusual increases in Accounts Receivable relative
  to sales
• Unusual increases in Inventory relative to sales
• Increasing gap between reported income and CFO

23
Red flags (continued)

• Increasing gap between reported income and tax
  income
• Sale of receivables and other off balance sheet
  financing
• Large asset write-offs
• Qualified audit opinion or change in opinion

24
Accounting Analysis

• Nature of Accounting policies
• Aggressive
• Income increasing
• Conservative
• Income decreasing

25
Receivables

• Are they collectible?
• Is the allowance for uncollectible accounts
  reasonable?

26
Inventory

• FIFO Or LIFO?
• Turnover?
• Read the Footnotes!

27
Accounting changes

• Discretionary or required
• income increasing or decreasing
• Do they seem justified?

28
Unusual gains/losses

• What is their impact?
• How are they reported?

29
Disclosures

• VERY IMPORTANT
• Are they consistent with what you think?
• Are footnotes adequate?

30
Disclosures (cont)

• Are there hidden liabilities?
• Operating leases
• Contingent liabilities
• Unfunded pension liabilities
• Purchase commitments

31
Financial Analysis

• Separate from accounting analysis
• Use ratios and other information to make
  inferences about a companys prospects and
  performance.

32
Sources of InformationAbout Companies

• Information about publicly traded companies comes
  in many forms and may be found in many places.
• Annual reports
• SEC filings and databases
• Company press releases
• Articles that appear in the financial press
• Web sites

33
Sources of InformationAbout Companies

• Annual report
• The annual report is important to investors
  because of its completeness and its reliability
  due to the audit performed by an independent
  auditor.

34
Annual report components

• Financial statements
• Footnotes to the financial statements
• A summary of accounting principles used
• Managements discussion and analysis of the
  financial results
• The auditors report
• Comparative financial data for a series of years
• Narrative information about the company

35
Sources of InformationAbout Companies

• Publicly traded companies must also prepare
  reports for the Securities and Exchange
  Commission (SEC).
• Form 10-K - presents financial statement data in
  greater detail than the financial statements in
  annual reports
• Form 10-Q - includes quarterly financial
  statements that provide more timely but less
  complete information than annual reports

36
Sources of InformationAbout Companies

• Company press releases provide the basis for
  articles in the financial press such as The Wall
  Street Journal and Business Week.
• Services such as Standard and Poors Industrial
  Surveys and Dun Bradstreet provide useful
  information to investors.

37
Sources of InformationAbout Companies

• Large investors often require pro forma
  statements which are carefully formulated
  expression of predicted results.
• Any investor should take the time to gather as
  much information about potential investments as
  possible.
• There are many sources of information for
  investors to use.

38
WEB SITES

• http//www.hoovers.com
• http//www.fool.com
• http//www.wsj.com
• http//quote.yahoo.com

39
Objectives of FinancialStatement Analysis

• Although different investors demand different
  returns, they all use financial statement
  analysis to
• predict their expected returns
• assess the risks associated with those returns
• Past performance is only important if it can be
  used to predict future performance

40
Objectives of FinancialStatement Analysis

• Creditors want to know about short-term liquidity
  and long-term solvency.
• Short-term liquidity - an organizations ability
  to meet current payments as they become due
• Long-term solvency - an organizations ability to
  generate enough cash to repay long-term debts as
  they mature

41
Objectives of FinancialStatement Analysis

• Equity investors look for returns in the form of
  dividends and increased market price of the
  stock.
• These investors are naturally more interested in
  profitability.
• Profits spur both dividends and increased stock
  prices.

42
Evaluating Trends and Components of the Business

• Evaluating trends and components of a business
  are two ways of looking at financial information.
• Trend analysis involves comparing financial
  trends from one year to another.
• Evaluating components of a business can be done
  in more than one way.
• Relationships among elements of the financial
  statements may be examined.
• Components may also be thought of as separate
  business units or segments. These components may
  be examined.

43
Trend Analysis

• Trends are predictable patterns that have been
  observed in the past and are expected to continue
  into the future.
• A pattern must be identified, and expectations of
  whether the trend will continue must be formed.
• Trends can be shown as changes in amounts from
  year to year or as percentage changes from year
  to year.

44
Trend Analysis change

• Use of percentages helps to control for scale
  differences
• Percentage change Amount of change/ Base year
  amount x 100
• Trends require more that two years

45
Common-Size Statements

• Common-size statements - financial statements
  expressed in component percentages
• The income statement is expressed as a percentage
  of sales.
• This makes it easy to compare percentages to
  those of other companies because percentages are
  a common index.
• The balance sheet is expressed as a percentage of
  total assets.
• This is often referred to as component
  percentages because they measure each component
  as a percentage of the total.

46
Common-Size Statements

• For the income statement, sales is set at 100
  percent and each other element is expressed as a
  percentage of the sales figure.
• For the balance sheet, the total assets amount is
  set at 100 percent, and each other element is
  expressed as a percentage of the total assets
  figure.

47
Common-Size Statements

• WASHINGTON COMPANY
• Income Statements
• For the Years Ended December 31, 1997 and 1996

48
Managements Discussionand Analysis

• Managements discussion and analysis - a required
  section of the annual report that concentrates on
  explaining the major changes in the income
  statement and the major changes in liquidity and
  capital resources

49
Segment Reporting

• Many large companies are involved in more than
  one type of business activity or market.
• Each individual type of business activity or
  market may be considered a segment.
• The FASB requires that information on each
  business segment be disclosed in the financial
  statements.
• Segments can be stated in terms of industry
  segments, geographic segments, major customers,
  etc.

50
Financial Ratios

• The major component of financial statement
  analysis is the use of ratios.
• Financial ratios are sometimes grouped into four
  categories
• Short-term liquidity ratios
• Long-term solvency ratios
• Profitability ratios
• Market price and dividends ratios

51
Financial Ratios

• Short-term liquidity ratios

52
Financial Ratios

• Long-term solvency ratios

53
Financial Ratios

• Profitability ratios

54
Financial Ratios

• Market price and dividend ratios

55
Evaluating Financial Ratios

• Financial ratios are evaluated using three types
  of comparisons.
• Time-series comparisons - comparisons of
  financial ratios with a companys own historical
  ratios
• Bench marks - general rules of thumb specifying
  appropriate levels for financial ratios
• Cross-sectional comparisons - comparisons of
  financial ratios with the ratios of other
  companies or with industry averages

56
Ratios

• Financial analysis using ratios is useful to
  investors because the ratios capture critical
  dimensions of the economic performance of the
  company.
• Managers use ratios to guide, measure, and reward
  workers.
• Often companies base employee bonuses on a
  specific financial ratio or a combination of some
  other performance measure and a financial ratio.

57
Ratios

• Ratios mean different things to different groups.
• A creditor might think that a high current ratio
  is good because it means that the company has the
  cash to pay the debt.
• However, a manager might think that a high
  current ratio is undesirable because it could
  mean that the company is carrying too much
  inventory or is allowing its receivables to get
  too high.

58
Operating Performance

• Rate of return on investment - evaluates the
  overall success of an investment by comparing
  what the investment returns with the amount of
  investment initially made
• ROI Income/Invested Capital

59
Operating Performance

• Income may be defined differently for alternative
  purposes.
• Net earnings
• Pretax income from operations
• Earnings before interest and taxes (EBIT)
• Invested capital may also be defined differently.
• Stockholders equity
• Total capital provided by both debt and equity
  sources

60
Operating Performance

• Operating performance is best measured by pretax
  operating rate of return on total assets.
• This eliminates any affect related to how assets
  are financed
• Pretax operating rate of return on total assets
  Operating income/ average total assets

61
Operating Performance

• Operating income/average total assets
• Operating income/Sales
• X
• Sales/average total assets

62
Operating Performance

• The expanded expression of pretax operating rate
  of return on total assets highlights that
  operating income percentage and asset turnover
  will each increase the rate of return on assets.
• Using these two ratios allows manipulation of
  either one to determine what happens to the rate
  of return under different scenarios.

63
DuPont formula

• ROE Return on sales X Asset Turnover X Leverage
• Net Income/sales X Sales/Average Total Assets X
  Average Total Assets/ Average stockholders Equity

64
Use of the Dupont Formula

• Allows a breakdown of the effects of the asset
  base, sales growth and financing on ROE

65
Operating Performance

Operating Income
Operating Income on Sales

Sales
Pretax Return on Total Assets
x
Sales

Total Asset Turnover
Average Total Assets
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67
Financial Performance

• Debt and equity financing must be balanced in
  order to achieve good financial performance.
• Firms must choose how much debt is appropriate.
• The firms must also choose how to split their
  debt between short-term debt and long-term debt.
• The prudent use of debt is a major part of
  intelligent financial management.

68
Financial Performance

• Short-term debt must be repaid or refinanced in a
  short period of time.
• If a company has trouble repaying the debt, it
  will also generally have trouble refinancing the
  debt.
• Naturally, lenders like healthy borrowers, not
  troubled borrowers.

69
Financial Performance

• Long-term debt or equity are generally used to
  finance long-term investments.
• Debt financing is more attractive than equity
  financing.
• Interest payments are deductible for income tax
  purposes, but dividends are not deductible.
• The ownership rights to voting and profits are
  kept by the present shareholders.

70
Trading on the Equity

• Trading on the equity (leveraging) - using
  borrowed money at fixed interest rates with the
  objective of enhancing the rate of return on
  common equity
• Capitalization (capital structure) - the total of
  a companys long-term financing

71
Trading on the Equity

• There are costs and benefits to the shareholders
  from leveraging.
• Costs
• Interest payments
• Increased risk
• Benefits
• Larger returns to the common shareholders, as
  long as overall income is large enough to cover
  the increased interest payments

72
Trading on the Equity

• General comments about leveraging
• A debt-free, or unleveraged, company has
  identical return on assets (ROA) and return on
  equity (ROE).
• When a company has an ROA greater than the
  interest rate it is paying its lenders, ROE
  exceeds ROA. (This is called favorable financial
  leverage.)
• When a company is unable to earn at least the
  interest rate on the money borrowed, the return
  on equity will be lower than it would be for a
  debt-free company.

73
Economic Value Added (EVA)

• Firm must earn more than the capital invested to
  increase value
• Requires a measure of Cost of Capital
• The intuition is that the cost of capital is that
  this is the cost that must be paid to attract
  funds

74
Example

• Assume that the cost of capital is 12
• Invested capital is 5,000,000
• Investments must earn more than 600,000 to
  increase firms value

75
Income Tax Effects

• If all things are equal, debt financing is less
  costly to a corporation than equity financing
  because interest payments are deductible for
  income tax purposes.
• Dividends paid on stock are not deductible.
• Also, dividend rates on stock are generally
  higher than interest rates on debt because of the
  increased risk associated with stock.

76
Income Tax Effects

• General comments on debt financing versus equity
  financing
• Because interest is deductible for income tax
  purposes, net income attributable to common
  shareholders can be higher if debt is used
  because taxes are lower.
• Book net income is higher if equity financing is
  used because there are no interest payments to be
  deducted.
• Failure to pay interest is an act of bankruptcy,
  which gives creditors the right to control the
  company. Failure to pay dividends has less
  severe consequences.

77
Measuring Safety

• Investors in debt securities want assurance that
  the company in which they have invested will be
  able to make the scheduled interest and principal
  payments.
• These investors want to avoid the trouble of
  recovering their investments through bankruptcy
  of the company.
• They would much rather a steady stream of income
  from a healthy company.

78
Measuring Safety

• Interest coverage (times interest earned) - a
  ratio that focuses on the interest-paying ability
  of a company
• Interest coverage
• Income before interest and taxes/
• Interest expense

79
Measuring Safety

• A rule of thumb for debt investors is that the
  interest coverage should be at least five times
  even in the poorest year in a span of 7 to 10
  years.
• The tax deductibility feature of interest is a
  major reason why debt financing is used more than
  equity financing using preferred stock.

80
Prominence of Earnings Per Share

• Earnings per share is a basic reporting element
  in the financial statements.
• Some issues tend to complicate the calculation of
  earnings per share.
• Preferred stock
• Stock issues and redemptions
• Possibility of exercise of options or various
  convertible securities

81
Prominence of Earnings Per Share

• The formula for Earnings per Share is
• (Net income-preferred dividends)/weighted average
  shares outstanding during the period

82
Weighted-Average Sharesand Preferred Stock

• Earnings per share is calculated as net income
  divided by weighted-average number of shares
  outstanding during the period.
• The weighted-average number of shares is based on
  the number of months that the shares were
  outstanding during the year.

83
Weighted-Average Sharesand Preferred Stock

• Home, Inc., has 450,000 shares of common stock
  outstanding at the beginning of the calendar
  year, and 150,000 additional shares were issued
  on August 30. What is the weighted-average
  number of shares outstanding during the year?

84
Weighted-Average Sharesand Preferred Stock

• The weighted-average number of shares is
  computed as follows
• 450,000 x weighting of 12/12 450,000
• 150,000 x weighting of 4/12 50,000
• 500,000

85
Weighted-Average Sharesand Preferred Stock

• Another complication arises if there are shares
  of nonconvertible preferred stock outstanding.
• The dividends on preferred stock for the current
  period, whether or not paid, should be deducted
  in calculating EPS.

86
Basic and Diluted EPS

• When a company has convertible securities or
  stock options outstanding, the calculation of EPS
  becomes even more complicated.
• When convertible securities exist, EPS is
  calculated using the assumption that any and all
  convertible shares are turned into common stock.

87
Basic and Diluted EPS

• The presence of convertible securities increases
  the number of common shares to the highest
  possible number considering the convertible
  securities and stock options outstanding.
• If the number or shares outstanding is increased,
  earnings per share is decreased.
• These convertible securities are said to dilute
  (reduce) earnings per share.

88
Disclosure of Nonrecurring Items

• Financial statement analysis focuses on normal
  recurring items of the financial statements, not
  nonrecurring items.
• Four major categories of nonrecurring items
• special items
• extraordinary items
• discontinued operations
• accounting changes

89
Special Items

• Special items - expenses that are large enough
  and unusual enough to warrant separate disclosure
• Special items appear as separate line items among
  operating expenses on the income statement.
• Any necessary discussion must be included in the
  footnotes to the financial statements.
• Companies generally have flexibility in deciding
  when to treat something as a special item.

90
Extraordinary Items

• Extraordinary items - items that are unusual in
  nature and infrequent in occurrence that are
  shown separately, net of tax, in the income
  statement
• Unusual in nature means that an item is different
  from the typical or normal operating activities
  of a business.
• Infrequent in occurrence means that an event
  should not be expected to recur often.

91
Extraordinary Items

• Examples of extraordinary items are the financial
  effects of natural disasters such as earthquakes
  or hurricanes and government expropriations.
• Whether an item is extraordinary sometimes
  depends on where the event occurs.
• For example, losses from damage resulting from a
  hurricane on the coast of Louisiana would not be
  considered extraordinary, but losses from damage
  resulting from a hurricane in South Dakota would
  be extraordinary.

92
Extraordinary Items

• Extraordinary items must be shown separately on
  the income statement.
• They must also be shown net of tax, which means
  that the amount on the income statement includes
  any tax effect the item might have.

93
Discontinued Operations

• Discontinued operations - the termination
  (closing or sale) of a business segment reported
  separately, net of tax, in the income statement
• Any gain or loss from the actual disposal of the
  segment must be disclosed along with the results
  of operations (income or loss) for that segment
  during the period before the disposal.

94
Accounting Changes

• Accounting changes occur when the FASB requires a
  new way of accounting for a particular item.
• When the FASB changes its rules, it often
  requires a major one-time recognition (revenue or
  expense).
• Accounting changes are shown separately and are
  shown net of tax.

95
Accounting Changes

• The presentation of nonrecurring items on the
  income statement is as follows
• Income from continuing operations before income
  taxes
• Deduct income taxes
• Income from continuing operations
• Discontinued operations, net of tax
• Income before extraordinary items
• Extraordinary items, net of tax
• Income before cumulative effect of an
  accounting change
• Cumulative effect of an accounting change,
  net of tax
• Net income

96
International Considerations

• Financial statement analysis may be complicated
  by several factors when companies carry on
  operations in different countries.
• Language in which the results are reported
• Currency in which results are reported
• Different securities markets, tax structures,
  and local customs

97
Basics of Valuation using financial data
98
Goal of Valuation

• Search for undervalued or overvalued securities
• To what extent is a companys stock price
  supported by evidence?

99
Methods

• Present value of dividends
• Asset based Price multiples
• Abnormal earnings based
• Free cash flows

100
Dividend based

• Value present value of future dividends
• Dividends /(cost of equity capital- growth in
  dividends)
• Estimate market value of net assets (equity) by
  adjusting the balance sheet
• compare market value of equity to adjusted book
  value

101
Asset based (price multiples)
102
Reasons market differs from adjusted book value

• future earning prospects
• missing assets/ liabilities
• asset in place synergies

103
Growth in PB ratio- determinants

• PB PE ROE
• How much greater than expected is ROE?
• How quickly will book value grow ?
• Dividend policy
• acquisitions

104
How to evaluate multiples

• Low PB - Low PE - dog little or no future
  prospects
• high PB- High PE rising star with strong
  prospects
• high P B- Low PE- falling star- mature firm
  with low growth
• Low PB- High PE recovering firm has had damage
  but is in the early stage of rising star

105
Use of asset based methods

• Look at PE/PB and try to determine why the
  company differs from the market
• consider earnings prospects
• management quality
• accounting methods
• Contingencies

106
Earnings and cash flow models

• Both earnings and cash flow models require
  forecasts

107
Free Cash flow

• Amount of cash available for growth
• Various definitions but means cash from
  operations minus replacement investment

108
Free cash flow debt and equity

• Cash from operations
• Interest expense (net of tax)
• - capital expenditures
• -increases in working capital

109
Free cash flow to equity

• Cash from operations
• - capital expenditures
• - debt repayment
• -Change in cash balance needed to maintain
  operations

110
How do we forecast earnings and free cash flows?

• Starting point is usually sales forecast
• This serves as the basis for a forecast of the
  remaining income statement and balance sheet
  components
• The earnings forecast is used to derive the
  forecast of FCF

111
Forecast of financial statements

• Income statement
• Balance sheet
• Statement of cash flows

112
Income forecast

• Sales
• Expenses (separate into fixed and variable)

113
Balance sheet

• Forecast assets individually
• Usually tie to sales
• Working capital
• Long term assets
• Some accounts you may assume constant ratios

114
Cash flows

• Need forecasted net income
• Depreciation
• Expected interest
• Changes in balance sheet accounts
• Planned investments
• Planned dividends and debt repayments

115
Free cash flow model

• Value sum of discounted free cash flows the
  present value of the terminal value

116
Shareholder value

• Basic idea value to shareholders is the present
  value of future cash flows to owners.

117
Earnings based model

• ValueCurrent book value plus the discounted sum
  of abnormal earnings
• Abnormal earnings earnings- cost of capital
  (book value (t-1))
• May use abnormal earnings over a forecast horizon
  terminal value

118
Cost of capitalall equity firm

• RE RF ? E (RM )- RF
• RE return to equity
• RF risk free rate
• ? systematic risk (you can find estimates of
  this)
• E (RM )- RF market risk premium

119
Estimation of cost of capital

• risk free rate- intermediate term t bill rate-
  avg. around 6, presently about 4.5
• Market risk premium- 7.6 average from
  1923-1993
• ? systematic risk- firm specific can obtain
  beta from PC compustat

120
Cost of capital with debt-

• use Weighted average cost of capital
• WACC
• (value of debt/total firm value) int. rate
  (1-t)
• Value of equity/(total firm value) RE

121
Short cut valuation method

• V(t) estimated value of equity at time tb(t)
  book value at time tr(e) cost of equity
  capitalg(t n) growth in book value in year
  t n (b(tn)- b(tn-1))/(b(tn-1))

122
Short cut valuation method-cont

• V(t)/b(t) 1 E(t) (ROE (t1) -
  r(e))/(1r(e)) E(t) (ROE (t2) -
  r(e))(1g(t1))/(1r(e))2 E(t) (ROE (t3)
  -r(e))(1g(t2))/(1r(e))3 .... Terminal
  value

123
Terminal value

• Usually assume that growth in book value stops or
  reduces at some point.

124
Example

• Assume the following
• Cost of capital 14
• goals for ROE are 34.
• Assume growth in book value 10 for three years
  then dropping to 3

125
Example continued

• V/b 1 (.34-.14)/(1.14) (.34-.14)(1.1)/(1.14)2
  (.34-.14)(1.10)2/(1.14)3 terminal value
  1.1754.1692.1633 terminal value
• 1.5079 .10/(.14-.03)/(1.14)3 1.5079 .6135
  2.1214

126
Example, continued

• book value is 677,788,000 on 1/1/92
• and the number of shares are 142,139,577
• The model above implies that firm value should be
  10.10 per share.

127
Short cut earnings method

• Stock value BVE0 AE/ cost of equity capital
• BVE0 book value of equity
• AE BV (actual return cost of capital)
• 677,788,000 (.34-.14) 135,557,600 (abnormal
  earnings)
• equity value 677,788,000 135,557,600/.141,646,
  056,571
• price/share11.58

128
Free cash flow model

• value present value of free cash flows to
  equity
• forecast free cash flows to equity
• NI capital outlays /- net cash flows from/to
  debt holders
• discount free cash flows at cost of equity capital

129
Steps in valuation

• Forecast sales and financial statements
• Forecast earnings and or free cash flow
• Determine discount rate
• Determine forecast horizon
• Apply model