Chapter 6 - The role of financial information in valuation and credit risk assessment. After reading the material in this chapter, you should be able to: The basic steps in business valuation using free cash flows and abnormal earnings, why current earnings are considered more useful than current cash flows for assessing future cash flows, the expanding use of fair value measurements in financial statements, what factors contribute to variation in price-earnings multiples. | The Role of Financial Information in Valuation and Credit Risk Assessment Revsine/Collins/Johnson/Mittelstaedt/Soffer: Chapter 6 Learning objectives The basic steps in business valuation using free cash flows and abnormal earnings. Why current earnings are considered more useful than current cash flows for assessing future cash flows. The expanding use of fair value measurements in financial statements. What factors contribute to variation in price-earnings multiples. 6- Learning objectives: concluded What factors influence earnings quality. How stock returns relate to “good news” and “bad news” about earnings. The importance of credit risk assessment in lending decisions, and how credit ratings are determined. How to forecast a company’s financial statements. 6- Business valuation: Overview Step 1: Forecast future amounts of the financial attribute that ultimately determines how much a company is worth. Determine the risk or uncertainty associated with the forecasted future amounts. Determine the discounted present value of the expected future amounts using a discount rate that reflects the risk from Step 2. There are three steps involved in valuing a company: Free cash flows Accounting earnings Balance sheet book values 6- Step 2: Step 3: Business valuation: Discounted free cash flow approach This approach says the value per share (P0) of a company’s common stock is given by: CFt is the future free cash flow (per share) available to common equity holders at period t. r is the discount rate appropriate for the risk and uncertainty of the forecasted free cash flows. is the discount factor for forecasted cash flows in period t. E0 is investors’ expectations (at time 0) about future free cash flows. 6- Business valuation: DCF illustration 6- Goodwill and other Intangible Assets 6- Two-step process for determining goodwill impairment Is the fair value of the reporting unit higher than the carrying amount including goodwill? Step 2 - determine . | The Role of Financial Information in Valuation and Credit Risk Assessment Revsine/Collins/Johnson/Mittelstaedt/Soffer: Chapter 6 Learning objectives The basic steps in business valuation using free cash flows and abnormal earnings. Why current earnings are considered more useful than current cash flows for assessing future cash flows. The expanding use of fair value measurements in financial statements. What factors contribute to variation in price-earnings multiples. 6- Learning objectives: concluded What factors influence earnings quality. How stock returns relate to “good news” and “bad news” about earnings. The importance of credit risk assessment in lending decisions, and how credit ratings are determined. How to forecast a company’s financial statements. 6- Business valuation: Overview Step 1: Forecast future amounts of the financial attribute that ultimately determines how much a company is worth. Determine the risk or uncertainty associated with the forecasted future .
