Chapter 3: Long-term financial planning Corporate

Transcript:Chapter 3: Long-term financial planning Corporate:
Chapter 3: Long-term financial planning Corporate Finance An overall picture Among all the financial ratios, return on equity (ROE = net income / equity) is probably the most scrutinized one among practitioners. Some practitioners view ROE as the bottom-line ratio. Thus, it is important to understand the sources (determinants) of ROE. The Du Pont Identity is popular among practitioners because it shows the determinants of ROE. The Du Pont Identity ROE = (NI / sales) × (sales / total assets) × (total assets / equity) = profit margin × total asset turnover × equity multiplier. The Du Pont Identity is the decomposition of ROE. ROE is a function of profitability, as measured by profit margin. ROE is a function of asset use efficiency, as measured by total asset turnover. ROE is a function of financial leverage. An example (Intel), I An example (Intel), II Intel’s ROEs seem to trend downward. Can you say something about what might have happen based on the ROE decomposition? It is also sometimes useful to compare the financial ratios (profit margin, total asset turnover, equity multiplier, etc.) of Intel with those of its peers. Pro forma analysis It is important for corporate insiders, and outside investors as well, to project future financial conditions of a firm. The process of projecting future financial conditions is call pro forma analysis. Pro forma analysis is used to generate after-tax cash flows estimates. This is the reason why we are studying Chapter 3 after we talked about those capital budgeting decision rules in Chapter 6. The default method that we use in this course is the percentage of sales approach. The percentage of sales approach The logic of the percentage of sales method is to assume that many items on the income statement and balance sheet increase (decrease) proportionally with sales. You should not be afraid to refine the estimates from this method if you have better information. Starting with sales forecasts Pro forma analysis starts with a sales forecast. For outside investors, there are at least 2 methods for obtaining sales forecasts: Use analysts’ forecasts. I/B/E/S regularly surveys analysts about their expectations on publicly held companies. See finance.yahoo.com. Use companies’ forecasts. Many companies provide sales estimates in their 10-Ks. Usually, better (worse) companies provide conservative (aggressive) estimates. These forecasts serve as starting points. Pro forma income statement, I For income statement, except for depreciation, interest expense, other income,