FSACV/Q3 2007
Assumptions for Holmes’ Proforma Financial Statements
We’re using case 11.1 (Holmes Corporation) to illustrate each step in the valuation process (see Notes on the Valuation of Holmes). The use of a spreadsheet is required because one important aspect of a sound valuation model is the ease at which the impact of changing assumptions can be assessed. Below is more clarifying detail regarding the assumptions found in the case template used to construct a base case of Holmes’ projected financial statements. You should project five years of income statements, balance sheets, and statements of cash flow from these assumptions.
· Sales grow at 5 percent (later we can examine the impact of alternative assumptions (e.g., 10 percent, or the five-year compounded growth rate of 25.5 percent).
· Cost of Goods and SG&A are each estimated using the variable/fixed cost structure implied by years Y15 and Y14 (i.e., two-period estimation). For SG&A, you will find there are no fixed costs apparent in this estimation.
· The provision for tax is determined using the average marginal tax rate over the last three years. Any tax rate used for the averaging calculation should not be outside the range of 25% to 40%.
· Inventory grows at the compound annual growth rate of forecasted cost of goods sold.
· Accounts receivable, accounts payable, and other current liabilities grow at their three-year average historical growth rates. For these turnover rates ending balances of accounts are used.
· Investments and other non-current assets do not change.
· Property plant and equipment (PPE) grow at the three-year average rate of capital expenditures to gross PPE. Depreciation expense is estimated using the 3-year average depreciation rate (depreciation ¸ gross PPE).
· Deferred charges (deferred tax) grow at $200,000 per year.
· Highly liquid assets, cash plus marketable securities, are treated as one account. The account will remain steady at the rate of the Y15 balance over all remaining assets.
· Retained earnings (with dividends) is a balancing plug.
· Proforma financial statements are prepared before the assumption of additional debt to purchase assets under the LBO.