FSA MODULE 38

Question 1

38.1 What are the steps in producing an income statement from a revenue forecast?

Answer 1

revenue forecast is consolidated (with a top down approach)

revenue minus operating expenses takes us to our EBIT

segments forecast approach - is a bottom up approach - when added up, should agree with the consolidated revenue forecast

tax expense forecast - looks at effective tax rate

Question 2

38.1 How should we look at the revenue forecast?

Answer 2

organic operations and M&A are kept separate - separate forecasting

Question 3

38.1 How do we consider COGS, SG&A, and other operating expenses when financial modelling?

Answer 3

Question 4

38.1 How should we consider segmental operating profit forecasts?

Answer 4

segmental forecasts are used to check the reasonableness of consolidated forecasts

problem with consolidated forecasts - is that it is harder to compare to other companies (as niche makeup of each company) - if can find segmental makeup then you can compare using this

Question 5

38.1 Name some non-operating items and describe them:

Answer 5

forecasting interest paid and received - with the idea that they will net off.

ALSO - SHARES OUTSTANDING
- potentially dilutive instruments (convertibles - bonds and preferred stock)
- Employee stock compensation plans - employee stock options/stock grants (recognise an expense in the income statement as NCCs)
- share buy backs
- secondary issues (issue of new equity)

Question 6

38.1 What do we need to consider for cash flow statement forecasts?

Answer 6

Question 7

38.1 What do we need to consider for Capex and depreciation forecasts?

Answer 7

fixed asset disclosure - used to work out average age, life, etc of PP&E

Question 8

38.1 What do we need to consider for working capital forecasts?

Answer 8

PROVIDING THE RATIOS ARE STABLE OVER TIME

normalisation - we can smooth for the business cycle (maybe we look for ratios at the midpoint of the economic cycle)

Question 9

38.1 What do we need to consider for Free cash flow to the firm forecasts?

Answer 9

Net income + non cash charges - WC investment = CFO

Once we have CFO - we add back net interest - Capex

EBIT x (1-effective tax rate) - this is a pre-levered version of net income

Question 10

38.1 Behavioural aspects: describe how overconfidence, and illusion of control can impact an analyst’s forecast:

Answer 10

All about cognitive and emotional bias

Basic idea - if bias is systematic, it can be spotted and eliminated

AND TWO MORE

Question 11

38.1 Behavioural aspects: describe how conservatism bias, and representativeness bias can impact an analyst’s forecast:

Answer 11

inside view = the specific details of the case you are analysing (company’s strategy, management quality, current financials, industry conditions, forecasts and plans)

outside view = The outside view means looking at what usually happens in similar situations, rather than focusing only on the specific details of the case you are analysing.
- You look at historical outcomes of comparable situations and use that as a benchmark.

Question 12

38.1 Behavioural aspects: describe how confirmation bias can impact an analyst’s forecast:

Answer 12

cognitive dissonance - we like to ignore data that we don’t like

Question 13

38.2 What are Porter’s 5 forces?

Answer 13

Looks at industry attractiveness- and therefore the ability to general economic profit (where the ROE > investors return (r))

competitive rivalry - how the companies compete together
- if the market is growing, everyone can grow without stealing market share
- if market is stagnant, people need to steal market share to have economic profit
- until all economic profit is eroded by cost cutting

Question 14

38.2 How can inflation and deflation impact sales projection?

Answer 14

This is really about whether we can pass on higher costs to our customer, or whether we have to accept the costs and reduce our profit margins.

NEED TO CONSIDER PRICE ELASTICITY OF DEMAND
- inelastic demand - we can pass costs on through higher prices more easily
- elastic demand - if we increase price, volume sold falls by a greater Q so we potentially cannot pass on price

Question 15

38.2 What should you consider in terms of a forecast horizon?

Answer 15

Question 16

38.2 How should we forecast with terminal values?

Answer 16

Question 17

38.2 what is an inflection point for a company?

Answer 17

inflection points are instances where the future will not be like the past, due to changes in the overall economic environment, business cycle stage, government regulations, or technology. The new export tariff is a change in government regulation—and, therefore, likely to signal an inflection point.