VALUATION MEASURING AND MANAGING THE VALUE OF COMPANIES FORECASTING PERFORMANCE PREPARED BY DAVID DAI

Determine Length and Detail of the Forecast All continuing value approaches are based on an assumption of steady state performance. Constant Rate of Return on all new capital invested during the continuing value period The company earn a constant return on its base level of invested capital The company grows at a constant rate and reinvests a constant proportion of its operating profits in the business each year.

- Continued Recommend using a forecast period of 10 to 15 years A detailed forecast for 3 to 5 years. In addition to simplifying the forecast, this approach also forces you to focus on the long-term economics of the business, not just the individual line items of the forecast.

Develop Strategic Perspective - Means crafting a plausible story about the company’s future performance. What ultimately drives the value of the company is the assessment of whether and for how long a company can earn returns in excess of its opportunity cost of capital. superior value to customer through a combination of price and product Achieve lower costs than competitors Using capital more productively than competitors.

Industry Structure Analysis Five Force Model Suppliers - Substitute products - Buyers Entry of new competitors Entry of existing competitors

Customer Segmentation Analysis External Shock Structure Conduct Performance Feedback Macroeconomics Technology Regulation Customer Preference/Demographics

Competitive Business System Analysis Product design and development Procurement Manufacturing Marketing Sales and Distribution Product attributes; quality; Time to market; Technology Pricing; Advertising Promotion Packaging Brands Access to Sources cost Outsourcing Sales Effective Costs Channels Costs Cycle Time; Quality

Translate the Strategic Perspective into Financial Forecast Build the revenue forecast Forecast operational items, such as operating cost. Project non-operating items. Project the equity accounts. Use the cash and/or debt accounts to balance the cash flows and balance sheet. Calculate the ROIC tree and key ratios to pull the elements together and check for consistency. Such as operating cost, working capital, property, Plant, and equipment, by linking them to revenues or volume Equity should equal last year’s equity plus net income And new share issues less dividends and share repurchases.

Inflation Expected inflation = (1+Nominal rate)/(1+ Real rate) - 1 Forecast and cost of capital could be estimated in nominal rather than real currency uits. For consistency, both the financial forecast and the cost of capital must be based on the same expected general inflation rate. This means inflation rate built into the forecast must be derived from an inflation rate implicit in the cost cost of capital.

Develop Performance Scenarios 1228 Once the scenarios are developed, an overall value of the Company can be estimated. This will involve a weighted Average of the values of the independent scenarios, Assigning probabilities to each scenario.

Checking for Consistency and Alignment Is performance on the value drivers consistent with the company’s economics and the industry competitive dynamics? Is revenue growth consistent with industry growth? Is the return on capital consistent with the industry’s competitive structure? How will technology changes affect returns? Will they affect risk? Can the company manage all the investment it is undertaking?

Some Data to Guide your forecast Companies rarely outperform their peers for long periods of time. Company performance varies from industry averages. Industry average ROICs and growth rate are linked to economic fundamentals.

CASE STUDY