into the infinite horizon (the
Table only shows the first five years of forecasts). Note that year
2024 is the terminal period
(growth rate in 2024 and all years after is a constant 5%). In
addition, you should assume that
the cost of equity capital is 10 percent. Also assume there are
1,000 shares outstanding and
divide your valuation by 1,000 to get the price per share.
- Table 1 Presents The Forecasted Financial Statements That Extend Into The Infinite Horizon The Table Only Shows The Fir 1 (158.89 KiB) Viewed 52 times
1) Find the forecasted residual income for 2022 and beyond.
2) Compute the value of common equity as of December 31, 2021,
using the residual income
model. Calculate the price per share.
3) Find the forecasted free cash flow to common equity for 2022 and
beyond.
4) Compute the value of common equity as of December 31, 2021,
using the free cash flow to
common equity model. Calculate the price per share.
Accounting Distortions
Suppose that our company shifts $2,000 of noncash income from
fiscal 2023 to fiscal 2022. There are
many ways they could do this: accelerating the recognition of
revenue or deferring the recognition of an
expense. Because the shifted income is not a real cash flow, it
must necessarily increase an asset
account in 2022 by $2,000, and this account will reverse in 2023.
To make the computations
transparent, suppose the shifted income was in the line item Other
Income and the associated asset
account was Other Assets. Further, suppose that all other income
statement items, assets, and liabilities
remain the same (common shareholders’ equity will obviously
change).
5) Alter the financial statements in Table 1 to show the income
shifting just described. Based on
these new financial statements, compute the value of common equity
as of December 31, 2021,
using the residual income to common equity model.
6) The income shifting clearly moves the recognition of net income
forward in time and money has
time value, so why has this accounting distortion not changed the
value of the equity? (Hint:
Your answer to question 5 should match the value you computed in
question 2).
Table 1 Actual Forecast Forecast Forecast Forecast Forecast 12/31/2021 12/31/2022 12/31/2023 12/31/2024 12/31/2025 12/31/2026 Fiscal Year End Income Statement Sales (Net) Cost of goods sold Gross Profit EBITDA Depreciation & Amortization EBIT Interest Expense EBT Income Taxes Other Income (Loss) Net Income Before Ext. Item Net Income 20,000 (12,000) 8,000 8,000 (2,000) 6,000 (1,000) 5,000 (2,000) 24,000 (14,400) 9,600 9,600 (2,200) 7,400 (1,100) 6,300 (2,520) 25,200 (15,120) 10,080 10,080 (2,460) 7,620 (1,230) 6,390 (2,556) 26,460 (15,876) 10,584 10,584 (2,583) 8,001 (1,292) 6,710 (2,684) 27,783 (16,670) 11,113 11,113 (2,712) 8,401 (1,357) 7,046 (2,818) 29,172 (17,503) 11,669 11,669 (2,848) 8,821 (1,424) 7,398 (2,959) 3,000 3,000 3,780 3,780 3,834 3,834 4,026 4,026 4,227 4,227 4,439 4,439 Balance Sheet . Operating Cash Total Current Assets PP&E (net) Pother Assets Total Assets 1,000 1,000 20,000 1,000 1,000 24,000 25,200 26,460 27,783 29,172 21,000 25,000 25, 200 26,460 27,783 29,172 Long-term debt Total Liabilities Paid in common capital Retained earnings Total common equity Total liabilities and equity 10,000 10,000 10,000 1,000 11,000 21,000 12,000 12,000 8,220 4,780 13,000 25,000 12,600 12,600 3,986 8,614 12,600 25,200 13,230 13,230 590 12,640 13,230 26,460 13,892 13,892 620 13,272 13,892 27,783 14,586 14,586 650 13,936 14,586 29,172