Earnings Estimation (g):

Question: How do analysts actually estimate earnings per share?

For EPS estimates, analysts typically use the company guidance.  In particular, they try to talk to the CFO once per quarter and pick their brains.  They also look at what other analysts are doing and what they see in the industry.  For example, an analyst for a large investment bank who follows the software industry stated " for Baan N.V. (currently at a 4H (Underperform, High Risk), we believe the company estimates are a little high so we reduce them.  For other companies, like Microsoft, we usually go higher than managment estimates, given their very conservative outlooks.  We also may look at industry growth patterns or what we hear from their competition (why you also need to read the competitors 10Ks)."

Weighted Average Cost of Capital (WACC):

Question: My firm has no long term debt but it does have a line of credit.  Can I use this revolver as my cost of debt?

No.  The interest on lines of credit should not be used as the pre-tax cost of debt in general.  (There are some exceptions to this however).  Revolvers are short term financing designed to meet unexpected/seasonal working capital needs.

Question: What if my firm reports this revolver in their balance sheet as long term debt?

In this case, since we are dealing with a variable interest rate, you will probably need to look at the cost of a swap for the appropriate time period over which this swap will occur.

Spring 2004 questions

(1) What is the value of non-operating assets that you want us to use (for Lowe's it could be INVEST & ADV TO SUBS, DEPOSITS & OTH ASSET, or both)?

Use INVEST & ADV TO SUBS only since it is unclear in the case of Lowe's that DEPOSITS & OTH ASSET is operating assets or non-operating assets based on the footnotes to their financial statements.

(2) What is the "Market Value of Options Outstanding?"  The assumption for that value is not given.  Values for exercisable options can be pulled from either the 10-K or the PROXY, but they wouldn't be market values, though.

Input 17,268 in that cell. I pulled the numbers from the PROXY; recognize that they aren't market values since it is beyond the scope of this class to value these options although it is easily doable using the Black-Scholes option pricing model.

(3) In the case description, it says to convert all numbers to millions.  I don't understand why we need to do it because apparently all the data is in (000s).  The supplemental data at the bottom of the worksheets say that the numbers are in millions, but when you try to verify the data to the balance sheet (i.e. the deferred income tax number) it is shown that the numbers are indeed in 000s.

In constructing the cases, I sometimes am in such a rush that I forget to convert millions to thousands and vice versa. In the current case, all numbers were converted to thousands. It's a good thing that you did verify the data because you're absolutely correct, the numbers are indeed in 000s.

(4) In the class notes you gave a definition for the market value of debt.  In the case, you did not specifically say that we are supposed to use the market value of debt when calculation "debt & debt equivalents" in the market value section.  Should I be using the market value definition for "debt & debt equivalents"?  If so, is this the correct definition?:

long-term debt+current liabilities+other long-term liabilities+total liabilities+notes payable+(total liabilities*pretax cost of debt)

No, it's not. We use the following definition which is from cell row 37 through cell row 44:

Current Long Term Debt + Current Portion of Capital Leases + Mortgages + Convertible Debt + Long Term Debt
+ Non-Current Capital Leases + PV of Operating Leases

Old questions
Question: I find discrepancies when calculating EVA using NOPAT, WACC, and Capital and calculating EVA by partitioning my firm's numbers to sales.

According to Igor Sokolovsky, a former student at Stern Stewart, his reponse to this question is as follows:

100%-(COGS/Sales + SGA/Sales) supposedly represents the NOPAT margin on sales.  However, if you have other operating expenses in your NOPAT statement that are not captured by COGS and SG&A you are not going to get the right margin.  The formula is not wrong, it is rather too general.  I would put it in the following way:

100%-(COGS/Sales + SGA/Sales + All Other (Income)Expense/Sales + Taxes/Sales)

The second part has the same problem, it does not include all parts of your capital.

C*(WC/Sales + Fixed PPE/Sales)  This is supposedly capital charge as a percent of sales.  However, the definition of capital probably includes other parts besides NWC and PPE, like Goodwill, capitalized R&D, other assets, cumulative unusual (gain) loss after-tax etc.  You should include all of those capital components in your calculation.  So the formula will look more like the following:

C*(WC/Sales + Fixed PPE/Sales + Other Assets/Sales + Capitalized R&D/Sales + Cum. Unusual AT/Sales +
Etc./Sales)

Again, make sure that the formula includes all NOPAT and capital components.
 

Relative Valuation:

Question: In doing relative valuation analysis, should I use the current year's or the expected EBIT, (EBITDA, FCFE, etc)?

Answer: Do it both ways since this is done on the Wall Street.  However, you should definitely put more emphasis on the expected multiples.