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Accounting Analysis  Identifying accounting distortions –caused by estimation error, bad GAAP, or management manipulation  From a valuation perspective,

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Presentation on theme: "Accounting Analysis  Identifying accounting distortions –caused by estimation error, bad GAAP, or management manipulation  From a valuation perspective,"— Presentation transcript:

1 Accounting Analysis  Identifying accounting distortions –caused by estimation error, bad GAAP, or management manipulation  From a valuation perspective, –Correcting the distortion = Forecasting the distortion’s reversal  But you have to know the distortion exists!

2 the RI model and accounting distortions  suppose firm has 100 in SE, but you believe that 8 of their assets are worthless.  you forecast 12 of NI next year, but only 4 in NI the year after when they will write off the worthless assets.  now suppose that you restate accounting so that SE = 92.

3 the RI model may be immune to accounting manipulation but are you? … beg. bkv earning FCF beg. bkv earning FCF beg. bkv earning FCF beg. bkv earning FCF beg. bkv earning FCF beg. bkv earning FCF beg. bkv earning FCF

4 Salton, Inc.  Who are they? –makers of the George Foreman Grill (1/3 of sales) and other small appliances.  What is their strategy? –manufacture in Asia –sell to K-Mart, Wal-Mart etc.  Can they sustain a competitive advantage?

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6 load Salton into eVal  close any open eVal files  browse to CD, “Salton” folder  open file “Salton Benchmark Valuation”  with students we simply pass them a raw data file to import under the “Input Historical Data” step on the User’s Guide.

7 Salton’s Past Performance

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9 The Deal with George Foreman  the old deal with George: 60% of gross profit –approximately $64 million in 1999  the new deal with George: $122 million pmt, amortized over 15 years (after 8.1 amortization as of yr end)  How will the deal change the financial statements going forward?  Is this an accounting distortion?  correcting the balance sheet today versus forecasting the correction in the future?

10 accounting distortions Suppose Foreman Trademark has a 3 year life. Adjusted amounts based on amortization over 3 years = 40.5M/yr or 32.4M more than As Reported

11 removing the 113.9M asset  benchmark price is $ ( with 9/30/2000 valuation date ). –move $113,900K from Intangibles to Other Assets  method 1: write off in year 1 –put -8.5% for Other Income in 2001, 0 thereafter –set Other Assets/Sales = 0% in 2001 and beyond –results in value = $ –note that debt/asset ratios are 19.9 and 38.1  method 2: remove asset in year 0 –set Other Asset = $0 in 2000 –lower Retained Earnings by $113,900K in 2000 –note the debt/asset ratios (19.9 current and 38.1 LT) –reset debt/asset ratios to 19.9 and 38.1 each year –results in value = $  So value is the same in either case, BUT WHY DOES VALUE INCREASE?

12 Salton Redux  what was the point again? –accounting distortions influence on valuation  when we correct doesn’t matter –the asset writeoff in year 0 or year 1  but don’t let a distorted past influence your forecasted future –margins were artificially improved by the long amortization period –what does it mean to say the asset is “worthless”? –extreme valuation caused by  naïve extrapolation of past sales growth  overstatement of profitability

13 what happened? (so far)

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15 sales growth mean reverts quickly


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