Accounting: Module 7

common stock forecasting

Common stock reflects the amount of funding raised by issuing shares of stock to individuals that will hold a stake in the company. We would generally expect common stock to stay the same from year to year, unless the business is planning on issuing more stock or buying back its own outstanding shares. In our example below, we'll assume it is going to stay constant from one year to the next

which of the following statements are true? Select all that apply.

EBIAT re-applies the tax rate to a pretax amount that excludes the cost of interest.

free cash flow calculation

FCF = (1-t) x EBIT + Dep - Capx - Δ NWC EBIAT = (1-t) x EBIT > t is tax rate > Dep is depreciation & amortization > Capx is Capital Expenditures > Δ NWC is change in Net Working Capital

IRR

IRR is the discount rate at which the NPV of an investment equals zero. - ex. Because NPV at 11% is positive while NPV at 12% is negative, IRR must fall between 11% and 12%

which of the following statements is NOT true regarding Payback Period?

Payback Period is impacted by cash flows that occur after the initial cost is recovered

A project has a negative Net Present Value. Which of the following statements is true regarding this project?

The IRR of the project is less than the WACC. IRR is the discount rate at which the net present value of an investment equals zero. Therefore: When NPV < 0, IRR < WACC. When NPV = 0, IRR = WACC. When NPV > 0, IRR > WACC.

pro-forma financial statements

- a depiction of financial statements over time if the assumptions that were made when they were created hold true

the Gordon Growth Model

- a way to estimate the value of a seemingly endless stream of cash flows; assuming growth remains steady forever PV of infinite cash flow = Cash flows in final year of our projection ÷ (discount rate - growth rate) > find the first period of stabilization > first, multiply that last cash flow by 1 + growth rate > then, plug that into the equation > if asked to get the PV, discount all of them including the first period of stabilization and add together - this gives us present value of cash flows at the END of our forecast, meaning we STILL have to discount the value back to the beginning of our forecast

free cash flow

- intended to show the company's normal ability to generate cash

Net working capital

- refers to the business having cash tied up in operations. As the business grows, it will typically need more cash to fund day to day operations. This is cash that will be dedicated to the business and won't be available for other purposes - current assets less current liabilities

retained earning forecasting

- retained earnings reflects the earnings that have been retained in the business to finance growth or future operations. For any given year, we can forecast retained earnings by adding the amount of prior year retained earnings plus current year net income, excluding amounts to be distributed to shareholders - prior year retained earnings + current year retained earnings

forecasts for businesses that do not finance their operations

- you will solve for another variable, such as cash, as the plug - Note: in the case of a startup, it may be most appropriate to use equity as a plug, so the company can determine how much equity financing they will need to fund their operations

present value

excel: =PV(rate, nper, pmt) > Rate is the interest rate > Nper is the number of payment period for the given cash flow > Pmt is the payment, or cash flow, to be discounted - a negative PV represents the amount you would be willing to pay today to receive the given cash flows; it is equivalent to the amount you will receive, so the net amount you would pay and receive would be zero

circularity problem in forecasting

occurs when a company is relying on borrowings to finance the business activities. However, some companies have no borrowings and, hence, no interest expense. Some other companies do have some amount of borrowings but they are not relying on those borrowings to finance their operations

forecasts for businesses that finance their operations with borrowings

you will solve for borrowings as the plug