522 Part 6 Working Capital Management, Forecasting, and Multinational Financial Management
SEL
F^ TEST What advantages does the forecasted! nancial statement method have over
the AFN equation for forecasting! nancial requirements?
Why should a marketing or management major be interested in! nancial
forecasting? Would! nancial forecasting be relevant for such people when
they graduate and enter the work force? Explain.An interesting aspect of Part IV is the DuPont calculations. In 2008, Allied’s
pro! t margin and turnover were quite low, but its equity multiplier was relatively
high. The result was a low but risky 12.5% ROE. The forecast for 2009 shows im-
provements in the pro! t margin and turnover, which boost ROE, and a lowering
of the equity multiplier, which holds down the ROE but indicates less! nancial
risk. The result is a much better and less risky 14.9% ROE, which is very close to
the industry average.
The! nal item in Part IV is the forecasted EPS, which jumps from $2.35 in 2008
to $3.06 in 2009. The CFO calculated the following data for use in his talk but de-
cided not to include it in the table:P/E ratio 9.8% versus 11.3% for the industry
Current stock price $23.06Allied’s estimated stock price is then calculated by multiplying its forecasted EPS
by the industry average P/E ratio:$3.06 (11.3) " $34.58Percentage gain: $34.58/$23.06 $ 1 " 49.96%, or approximately 50%16-4e Using the Forecast to Improve Operations
Allied’s CFO generated Table 16-2 with a straightforward Excel model. The table
could have been worked with a calculator, but it was easier to do the work using
Excel. Moreover and very importantly, once he set up the model, he could make all
kinds of changes to see the forecasted results under alternative scenarios. It’s trivi-
ally easy to change the growth rate and the! ve key input variables in Part I. It
would be easy to change the! nancing assumptions, perhaps using more bank
debt and fewer bonds. It also would be easy to show the results of! nancing only
with debt or only with stock. With any such input changes, the model instantly
provides modi! ed results. Indeed, the CFO had the model on his laptop, took it to
the meeting, and answered a number of “what if” questions.
Of course, it’s much easier to change inputs in a spreadsheet model than it is
to change actual operations so that the forecasted results are generated. How-
ever, as we said earlier in the chapter, if you don’t know where you’re going, it’s
hard to get there. Allied’s ratio analysis in Chapter 4 pointed out the! rm’s weak-
nesses, and the model shown in Table 16-2 demonstrates how improvements in
the driver variables will affect the! rm’s ROE, its EPS, and (of course) its stock
price. Allied’s managers’ compensation is partly based on the! rm’s! nancial re-
sults, including its ROE and stock price, so they are keenly interested in the
model and its results. The threat of! ring is also a strong motivator, and getting
poor results while operating good assets makes the! ring of management a real
possibility.