tasks list
- A) Prepare forecast financial statements for your company for the next financial period based on the ‘most likely’ assumptions. Compare and contrast this scenario with one using ‘worst case’ assumptions. Discuss the limitations of your analysis and implications for investment decision making by our risk averse investors with limited knowledge.
The preparation of your forecast financial statements may be undertaken by using the Topic 6 Table 6.2 worksheet. As you did with the ratios analysis you will need to update the data for your company under review. You will need to prepare the data at least twice – once for the ‘most likely’ and once for the ‘worst case’. It may be appropriate to also prepare one for ‘best case’ as well.
- B) Perform a share price valuation for your company using the Discounted Dividends Valuation Method and the Price Multiples method. Thoroughly discuss your professional judgment in performing these evaluations and implications for investors.
The preparation of your valuation may be undertaken by using the Chapter 8 – Bega example workbook. As you did with the ratios analysis and financial statement preparation you will need to update the data for your company under review.
Answer:
Question A)
The forecasting of data has some limitation that need to be kept in mind while performing forecasting. The forecasting is done on assumptions that can be change in future and the actual result may not match with the forecasted result. The forecasting is calculated on the basis of historical data and there is no guarantee that the factors and conditions in the past will continue into the future. Therefore, it can be said that the results are based on assumptions (Elliott and Elliott, 2008). Assumptions can be dangerous as the business environment keep on changing that will affect the future results. The forecasting of financial statements shows the actual value of a company in future. The operations of the company are influenced by different factors that cannot be included as the variable. In worst scenario, the management of the company becomes slave to the historical data and they start worrying about whether the business will grow or not (Hillier, 2010). However, forecasting allows the company to plan ahead as well as evaluating future challenges and opportunities. The investors also analyses the future development of a company and analyses the forested results. Therefore, the forecasting result influences the investment decisions of the investors. If the forecasted result is positive then the decisions of the investors will be influenced in positive way and if the forecasted result is negative then the decisions of the investors will be influenced in negative way (Holton, 2012). The financial performance of Cochlear Limited has been forecasted in order to determine and evaluate the value of the company.
| Valuation summary using various methodologies under varying scenarios | |||||
| Beginning book value | Value of forecast period | Value beyond forecast horizon | Total value equity | Value per share | |
| Scenario 1 – Persistent abnormal performance | |||||
| Abnormal earnings | 302,825 | 27,212 | 59,526 | 389,563 | 2.03 |
| Abnormal ROE | 302,825 | 27,212 | 59,526 | 389,563 | 2.03 |
| Free cash flows to equity | n/a | 180,380 | 220,610 | 400,990 | 2.09 |
| Scenario 2 – Persistent abnormal performance | |||||
| Abnormal earnings | 302,825 | 38,639 | 55,032 | 396,496 | 2.07 |
| Abnormal ROE | 302,825 | 38,639 | 55,032 | 396,496 | 2.07 |
| Free cash flows to equity | n/a | 199,643 | 196,081 | 395,724 | 2.07 |
| Scenario 3 – Persistent abnormal performance | |||||
| Abnormal earnings | 302,825 | 27,212 | 59,526 | 389,563 | 2.03 |
| Abnormal ROE | 302,825 | 27,212 | 59,526 | 389,563 | 2.03 |
| Free cash flows to equity | n/a | 220,610 | 192,807 | 413,417 | 2.16 |
| Scenario 4 – Persistent abnormal performance | |||||
| Abnormal earnings | 302,825 | 27,212 | -4 | 330,033 | 1.72 |
| Abnormal ROE | 302,825 | 27,212 | -4 | 330,033 | 1.72 |
| Free cash flows to equity | n/a | 180,380 | 220,610 | 400,990 | 2.09 |
| Weighted average number of shares (Annual report Note) | 191,615 | ||||
Question B)
The share value analysis helps to estimate the value and actual performance of company during a period of time. The discount dividend valuation method is the most commonly used to method to estimate the price of share and easiest to understand. The stock of the company can be valued without taking into account the market conditions (Kieso, Weygandt and Warfield, 2007). The market value of the company can be determined with the help of this model. The investors also analyses the share price of the company in order to determine and evaluate the value of the company. The discount dividend valuation method calculates the share price of the company that helps the investors to take investment decision. The price multiple uses the share price of the firm in conjunction with specific per share method in order to evaluate the financial situation of the company (Moles, 2011). Therefore, it combines the performance of the company with the stock price of the company. The valuation techniques help to determine and evaluate the value of the company. The investors and shareholders analyses the financial performance of the company during a specific period of time. The share valuation technique has been used to determine and evaluate the market value of Cochlear Limited (Spiceland, Sepe and Nelson, 2011).
| PV of forecast period (abn earnings) | 27,212 | |
| PV of forecast period (abn ROE) | 27,212 | |
| PV of forecast period (free cash flows to equity) | 180,380 | |
| PV of forecast period (abn NOPAT) | 38,639 | |
| PV of forecast period (abn ROA) | 38,639 | |
| PV of forecast period (free cash flows to capital) | 192,807 | |
| Terminal values (abn earnings) | 59,526 | |
| Terminal values (abn ROE) | 59,526 | |
| Terminal values (free cash flows to equity) | 220,610 | |
| Terminal values (abn NOPAT) | 59,526 | |
| Terminal values (abn ROA) | 59,526 | |
| Terminal values (free cash flows to capital) | 312,809 |
| 2017 | 2018 | 2019 | 2020 | 2021 | 2022 | 2023 | 2024 | 2025 | 2026 | > 2026 (Terminal value) | |
| Capital structure | |||||||||||
| % net debt | 25.0% | 25.5% | 26.0% | 26.5% | 27.0% | 27.5% | 28.0% | 28.5% | 29.0% | 29.5% | 30.0% |
| % equity | 75.0% | 74.5% | 74.0% | 73.5% | 73.0% | 72.5% | 72.0% | 71.5% | 71.0% | 70.5% | 70.0% |
| Cost of capital | |||||||||||
| Debt % | 4.90% | 4.90% | 4.90% | 4.90% | 4.90% | 4.90% | 4.90% | 4.90% | 4.90% | 4.90% | 4.90% |
| Equity % | 8.48% | 8.48% | 8.48% | 8.48% | 8.48% | 8.48% | 8.48% | 8.48% | 8.48% | 8.48% | 8.48% |
| WACC % | 7.59% | 7.57% | 7.55% | 7.53% | 7.51% | 7.50% | 7.48% | 7.46% | 7.44% | 7.42% | 7.41% |
References
Elliott, B. and Elliott, J. (2008). Financial accounting and reporting. Harlow: Financial Times Prentice Hall.
Hillier, D. (2010). Corporate finance. London: McGraw-Hill Higher Education.
Holton, R. (2012). Global finance. Abingdon, Oxon: Routledge.
Kieso, D., Weygandt, J. and Warfield, T. (2007). Intermediate accounting. Hoboken, NJ: Wiley.
Moles, P. (2011). Corporate finance. Hoboken, N.J.: Wiley.
Spiceland, J., Sepe, J. and Nelson, M. (2011). Intermediate accounting. New York: McGraw-Hill Irwin.
Stittle, J. and Wearing, B. (2008). Financial accounting. Los Angeles: SAGE Publications.
Wild, J. (2005). Financial accounting. Boston: McGraw-Hill/Irwin.
