PROSPECTIVE ANALYSIS

Prospective Analysis
Importance
Security Valuation - free cash flow models require
estimates of future financial statements.

Management Assessment - examine the viability of

companies’ strategic plans.

Assessment of Solvency - useful to creditors to assess a

company’s ability to meet debt service requirements, both
short-term and long-term.
 The Projection Process
Projected Income Statement
Sales forecasts are a function of:
1) Historical trends

2) Expected level of macroeconomic activity

3) The competitive landscape

4) New versus old store mix (strategic

initiatives)
 The Projection Process
Projected Income Statement
Steps:
1. Project sales
2. Project cost of goods sold and gross profit margins using
historical averages as a percent of sales
3. Project SG&A expenses using historical averages as a
percent of sales
4. Project depreciation expense as an historical average
percentage of beginning-of-year depreciable assets
5. Project interest expense as a percent of beginning-of-year
interest-bearing debt using existing rates if fixed and
projected rates if variable
6. Project tax expense as an average of historical tax expense to
pre-tax income
 The Projection Process
Balance Sheet
(in millions) 2005 2004 2003
Cash ..................................................................................
$ 2,245 $ 708 $ 758
Receivables .......................................................................
5,069 4,621 5,565
Inventories .........................................................................
5,384 4,531 4,760
Other current assets ..........................................................
1,224 3,092 852
Total current assets.......................................................
13,922 12,952 11,935
Property, plant, and equipment (PP&E)..............................
22,272 19,880 20,936
Accumulated depreciation .................................................
5,412 4,727 5,629
Net property, plant, and equipment ...................................
16,860 15,153 15,307
Other assets ......................................................................
1,511 3,311 1,361
Total assets .......................................................................
$32,293 $31,416 $28,603
Accounts payable...............................................................
$ 5,779 $ 4,956 $ 4,684
Current portion of long-term debt......................................
504 863 975
Accrued expenses ..............................................................
1,633 1,288 1,545
Income taxes & other .........................................................
304 1,207 319
Total current liabilities ..................................................
8,220 8,314 7,523
Deferred income taxes and other liabilities........................
2,010 1,815 1,451
Long-term debt..................................................................
9,034 10,155 10,186
Total liabilities ..............................................................
19,264 20,284 19,160
Common stock ...................................................................
74 76 76
Additional paid-in capital..................................................
1,810 1,530 1,256
Retained earnings .............................................................
11,145 9,526 8,111
Shareholders’ equity......................................................
13,029 11,132 9,443
Total liabilities and net worth ............................................
$32,293 $31,416 $28,603
 The Projection Process
Income Statement
(in millions) 2005 2004 2003
Sales..........................................................................................
$46,839 $42,025 $37,410
Cost of goods sold .....................................................................
31,445 28,389 25,498
Gross profit................................................................................
15,394 13,636 11,912
Selling, general and administrative expense ............................. 10,534 9,379 8,134
Depreciation and amortization expense ..................................... 1,259 1,098 967
Interest expense.........................................................................
570 556 584
Income before tax ......................................................................
3,031 2,603 2,227
Income tax expense....................................................................
1,146 984 851
Income (loss) from extraordinary items
and discontinued operations................................................. 1,313 190 247
Net income.................................................................................
$ 3,198 $ 1,809 $ 1,623
Outstanding shares ...................................................................
891 912 910
 The Projection Process
Income Statement

2005 2004
Selected Ratios (in percent)
Sales growth............................................................................
11.455% 12.336%
Gross profit margin..................................................................
32.866 32.447
Selling, general and administrative expense/Sales ................. 22.49 22.318
Depreciation expense/Gross prior-year PP&E ........................... 6.333 5.245
Interest expense/Prior-year long-term debt ..............................5.173 4.982
Income tax expense/Pretax income........................................... 37.809 37.803
 The Projection Process
Income Statement

2005 2004
Selected Ratios (in percent)
Sales growth............................................................................
11.455% 12.336%
Gross profit margin..................................................................
32.866 32.447
Selling, general and administrative expense/Sales ................. 22.49 22.318
Depreciation expense/Gross prior-year PP&E ........................... 6.333 5.245
Interest expense/Prior-year long-term debt ..............................5.173 4.982
Income tax expense/Pretax income........................................... 37.809 37.803
The Projection Process
Forecasted ratios for 2006
 The Projection Process
Projected Income Statement

Forecasting 2006
(in millions) Step Estimate
Income statement
Total revenues......................................................................................... 1
Cost of goods sold .................................................................................. 3
Gross profit............................................................................................. 2
Selling, general, and administrative expense ............................................ 4
Depreciation and amortization expense .................................................. 5
Interest expense...................................................................................... 6
Income before tax ................................................................................... 7
Income tax expense................................................................................. 8
Income (loss) from extraordinary items and discontinued operations ...... 9 0
Net income.............................................................................................. 10
Outstanding shares ......................................................................... 891
 The Projection Process
Projected Income Statement
1. Sales: $52,204 = $46,839 x 1.11455
2. Gross profit: $17,157 = $52,204 x 32.866%
3. Cost of goods sold: $35,047 = $52,204 - $17,157
4. Selling, general, and administrative: $11,741 = $52,204 x 22.49%
5. Depreciation and amortization: $1,410 =
$22,272 (beginning-period PP&E gross) x 6.333%
6. Interest: $493 = $9,538 (beginning-period interest-bearing debt) x 5.173%
7. Income before tax: $3,513 = $17,157 - $11,741 - $1,410 - $493
8. Tax expense: $1,328 = $3,513 x 37.809%
9. Extraordinary and discontinued items: none
10. Net income: $2,185 = $3,513 - $1,328
 The Projection Process
Projected Balance Sheet
Steps:
1. Project current assets other than cash, using projected
sales or cost of goods sold and appropriate turnover ratios
(using ending balance).
2. Project PP&E increases with capital expenditures
estimate derived from historical trends or information
obtained in the annual report.
 The Projection Process
Projected Balance Sheet
Steps:
3. Project current liabilities other than debt, using projected
sales or cost of goods sold and appropriate turnover ratios
(using ending balance)
4. Obtain current maturities of long-term debt from the
long-term debt footnote.
5. Assume other short-term indebtedness is unchanged from
prior year balance unless they have exhibited noticeable
trends.
 The Projection Process
Projected Balance Sheet
Steps:
6. Assume initial long-term debt balance is equal to the
prior period long-term debt less current maturities from
Step 4.
7. Assume other long-term obligations are equal to the prior
year’s balance unless they have exhibited noticeable
trends.
 The Projection Process
Projected Balance Sheet

Steps:
8. Assume initial estimate of common stock is equal to the
prior year’s balance
9. Assume retained earnings are equal to the prior year’s
balance plus (minus) net profit (loss) and less expected
dividends.
10. Assume other equity accounts are equal to the prior
year’s balance unless they have exhibited noticeable
trends.
 The Projection Process

Projected Balance Sheet

• Cash is computed as total assets less (1) and
(2)
• At this point, cash will be either be too high
or too low. Long-term debt and equity stock
are then adjusted for issuances (repurchases
as) as appropriate to yield the desired level
of cash and to maintain historical financial
leverage.
 The Projection Process
Balance Sheet
(in millions) 2005 2004 2003
Cash ..................................................................................
$ 2,245 $ 708 $ 758
Receivables .......................................................................
5,069 4,621 5,565
Inventories .........................................................................
5,384 4,531 4,760
Other current assets ..........................................................
1,224 3,092 852
Total current assets.......................................................
13,922 12,952 11,935
Property, plant, and equipment (PP&E)..............................
22,272 19,880 20,936
Accumulated depreciation .................................................
5,412 4,727 5,629
Net property, plant, and equipment ...................................
16,860 15,153 15,307
Other assets ......................................................................
1,511 3,311 1,361
Total assets .......................................................................
$32,293 $31,416 $28,603
Accounts payable...............................................................
$ 5,779 $ 4,956 $ 4,684
Current portion of long-term debt......................................
504 863 975
Accrued expenses ..............................................................
1,633 1,288 1,545
Income taxes & other .........................................................
304 1,207 319
Total current liabilities ..................................................
8,220 8,314 7,523
Deferred income taxes and other liabilities........................
2,010 1,815 1,451
Long-term debt..................................................................
9,034 10,155 10,186
Total liabilities ..............................................................
19,264 20,284 19,160
Common stock ...................................................................
74 76 76
Additional paid-in capital..................................................
1,810 1,530 1,256
Retained earnings .............................................................
11,145 9,526 8,111
Shareholders’ equity......................................................
13,029 11,132 9,443
Total liabilities and net worth ............................................
$32,293 $31,416 $28,603
 The Projection Process
Income Statement
(in millions) 2005 2004 2003
Sales..........................................................................................
$46,839 $42,025 $37,410
Cost of goods sold .....................................................................
31,445 28,389 25,498
Gross profit................................................................................
15,394 13,636 11,912
Selling, general and administrative expense ............................. 10,534 9,379 8,134
Depreciation and amortization expense ..................................... 1,259 1,098 967
Interest expense.........................................................................
570 556 584
Income before tax ......................................................................
3,031 2,603 2,227
Income tax expense....................................................................
1,146 984 851
Income (loss) from extraordinary items
and discontinued operations................................................. 1,313 190 247
Net income.................................................................................
$ 3,198 $ 1,809 $ 1,623
Outstanding shares ...................................................................
891 912 910
5.682
5.588 5.682
 The Projection Process
Target Corporation Balance Sheet
(in millions) Step Estimate
Cash ..........................................................................
17 $ 2,245
Receivables ...............................................................
1 5,069
Inventories.................................................................
2 5,384
Other current assets ..................................................
3 1,224
Total current assets ..................................... 13,922
Property, plant, and equipment.................................. 4 22,272
Accumulated depreciation ......................................... 5 5,412
Net property, plant, and equipment ........................... 6 16,860
Other assets ..............................................................
7 1,511
Total assets ................................................ $32,293
Accounts payable.......................................................
8 $ 5,779
Current portion of long-term debt.............................. 9 751 504
Accrued expenses ......................................................
10 1,633
Income taxes & other .................................................
11 304
Total current liabilities.................................... 8,220
Deferred income taxes and other liabilities................ 12 2,010
Long-term debt..........................................................
13 9,034
Total liabilities ............................................. 19,264
Common stock ...........................................................
14 74
Additional paid-in capital..........................................15 1,810
Retained earnings .....................................................
16 11,145
Shareholders’ equity ...................................... 13,029
Total liabilities and net worth......................... $32,293
Selected Ratios
 The Projection Process
Steps in Projection (Target)
1 Receivables: $5,650 = $52,204 (Sales)/9.24 (Receivable turnover).
2 Inventories: $6,001 = $35,047 (Cost of goods sold)/5.84 (Inventory turnover).
3 Other current assets: no change.
4 PP&E: $25,629 = $22,272 (Prior year’s balance) + $3,357 (Capital expenditure
estimate = estimated sales of $52,204 x 6.431% (CAPEX/sales percentage).
5 Accumulated depreciation: $6,822 = $5,412 (Prior balance) + $1,410 (Depreciation
estimate).
6 Net PP&E: $18,807 = $25,629 - $6,822.
7 Other long-term assets: no change.
8 Accounts payable: $6,382 = $35,664 (Purchase)/5.588 (Payable turnover)
turnover).
9 Current portion of long-term debt: amount reported in long-term debt footnote
as the current maturity for 2006.
10 Accrued expenses: $1,820 = $52,204 (Sales)/28.683 (Accrued expense turnover).
11 Taxes payable: $352 = $1,328 (Tax expense) x 26.527% (Tax payable/Tax
expense).
12 Deferred income taxes and other liabilities: no change.
13 Long-term debt: $8,283 = $9,034 (Prior year’s long-term debt) - $751 (Scheduled
current maturities from step 9).
14 Common stock: no change.
15 Additional paid-in capital: no change.
16 Retained earnings: $13,054 = $11,145 (Prior year’s retained earnings) + $2,185
(Projected net income) - $276 (Estimated dividends of $0.31 per share x 891
million shares).
17 Cash: amount needed to balance total liabilities and equity less steps (1)–(7).
 The Projection Process
Target Corporation Balance Sheet
(in millions) Step Estimate
Cash ..........................................................................
17 $ 1,343 $ 2,245
Receivables ...............................................................
1 5,650 5,069
Inventories.................................................................
2 6,001 5,384
Other current assets ..................................................
3 1,224 1,224
Total current assets ..................................... 14,218 13,922
Property, plant, and equipment.................................. 4 25,629 22,272
Accumulated depreciation ......................................... 5 6,822 5,412
Net property, plant, and equipment ........................... 6 18,807 16,860
Other assets ..............................................................
7 1,511 1,511
Total assets ................................................ $ 34,536 $32,293
Accounts payable.......................................................
8 $ 6,382 $ 5,779
Current portion of long-term debt.............................. 9 751 504
Accrued expenses ......................................................
10 1,820 1,633
Income taxes & other .................................................
11 352 304
Total current liabilities.................................... 9,305 8,220
Deferred income taxes and other liabilities................ 12 2,010 2,010
Long-term debt..........................................................
13 8,283 9,034
Total liabilities ............................................. 19,598 19,264
Common stock ...........................................................
14 74 74
Additional paid-in capital..........................................15 1,810 1,810
Retained earnings .....................................................
16 13,054 11,145
Shareholders’ equity ...................................... 14,938 13,029
Total liabilities and net worth......................... 34,536 $32,293
Selected Ratios
 The Projection Process

Projected Balance Sheet

• Cash is computed as total assets less (1) and (2)

• If the estimated cash balance is much higher or
lower, further adjustments can be made to:
1. invest excess cash in marketable securities
2. reduce long-term debt and/or equity proportionately
so as to keep the degree of financial leverage
consistent with prior years.
 The Projection Process
Projected Statement of Cash Flows
(in millions) 2006 Estimate
Cash flows from operating activities
Net Income
Adjusting for:
Depreciation & Amortization
Change in Acc. receivables
Change in inventories
Change in Acc. payable
Change in Accrued exp.
Change in Income tax & other
Net cash flows from operating activities
Cash flows from investing activities
Capital expenditures
Net cash flows from investing activities
Cash flows from financing activities
Long term debt payment
Dividend payment
Net cash flows from financing activities
Net change in cash
Beginning cash
Ending cash
Projected statement of cash flows

603

3,235

(902)

1,343
 The Projection Process
Sensitivity Analysis
• What will happen if we assume increase in
capital expenditures to 7.5% of sales in place of
6.431%?
• Changes in assumptions in order to analyse
their impact on financing requirements, return
on assets and equity, and so on.
• Analysts often prepare several projections to
examine best (worst) case scenarios in addition
to the most likely case.
Project Income Statement
Steps:
1. Project sales
2. Project cost of goods sold and gross profit margins using
historical averages as a percent of sales
3. Project SG&A expenses using historical averages as a percent of
sales
4. Project depreciation expense as an historical average percentage
of beginning-of-year depreciable assets
5. Project interest expense as a percent of beginning-of-year
interest-bearing debt using existing rates if fixed and projected
rates if variable
6. Project tax expense as an average of historical tax expense to pre-
tax income
 Projected Balance Sheet
Steps:
1. Project current assets other than cash, using projected
sales or cost of goods sold and appropriate turnover ratios
(using ending balance).
2. Project PP&E increases with capital expenditures
estimate derived from historical trends or information
obtained in the annual report.
 Projected Balance Sheet
Steps:
3. Project current liabilities other than debt, using projected
sales or cost of goods sold and appropriate turnover ratios
(using ending balance)
4. Obtain current maturities of long-term debt from the
long-term debt footnote.
5. Assume other short-term indebtedness is unchanged from
prior year balance unless they have exhibited noticeable
trends.
 Projected Balance Sheet
Steps:
6. Assume initial long-term debt balance is equal to the
prior period long-term debt less current maturities from
Step 4.
7. Assume other long-term obligations are equal to the prior
year’s balance unless they have exhibited noticeable
trends.
 Projected Balance Sheet

Steps:
8. Assume initial estimate of common stock is equal to the
prior year’s balance
9. Assume retained earnings are equal to the prior year’s
balance plus (minus) net profit (loss) and less expected
dividends.
10. Assume other equity accounts are equal to the prior
year’s balance unless they have exhibited noticeable
trends.
 Project The Statement of Cashflows
 Sensitivity Analysis