Module 8: Valuation Using the Abnormal Enterprise Income Growth Model Andrew DePalma

1. Module 8: Valuation Using the Abnormal Enterprise Income Growth Model Andrew DePalma March 17, 2014

2. ANF 1-Year Chart

3. ANF Retail Fundamentals

4. ANF Inventories

5. ANF Margins

6. ANF Earnings Surprises

7. AEIG Model Overview • AEIG model focuses on readily available accounting information • Primary difference between abnormal enterprise income growth model and residual enterprise model is the accounting anchor employed • Abnormal Enterprise Growth is Equal to the Change in Residual Enterprise Income

8. AEIG Model Overview • Abnormal enterprise income growth model anchors the valuation on the capitalized forecast of next-year’s EPAT • Residual income model anchors the forecast on current NEA • Driven by free cash flow being equal to EPAT adjusted for the change in net enterprise assets

9. AEIG Model Overview • Changes in depreciation have no effect on value calculated • Income shifted between periods also has no effect on the value calculated • E.g. LIFO vs. FIFO, capital vs. operating leases, US GAAP vs. IFRS • Model could not be used if accounting changes caused a change in the the value estimate

10. Derivation of the AEIG Model • Derivation begins with the discounted free cash flow valuation model • Next step is the introduction valuation anchor • Capitalized next period enterprise profit after tax • The present value of each future period’s capitalized EPAT is added and, at the same time, subtracted in the right hand side of the discounted free cash flow model equation

11. Effect of Accounting Choices on AEIG Model • Accounting choices should not affect the valuation of the project • Underlying economic transactions have not changed • For example, excess or too little deprecation is taken care of in the gain or loss on sale. Thus, future earnings are affected by an offsetting amount

12. Continuing Value • Value is calculated using the same method as the free cash flow model and residual income model • First period is a finite-horizon period for which explicit forecasts of agr have been formed • The second period, continuing value, is beyond this horizon • Represents something different than what is captured in the free cash flow model or residual income model

13. Continuing Value • Abnormal enterprise income growth valuation model continuing value equals the expected difference between intrinsic value and capitalized earnings of the enterprise operations at the horizon • Need to capture excess of intrinsic value over capitalized earnings (the anchor) • Could be equal to zero

14. Choosing a Valuation Model • Mathematically the models are equivalent • Need to consider how much of the value is captured within the forecasting horizon • Abnormal enterprise income growth model, when compared to the free cash flow model and the residual enterprise income model, is the least reliant on continuing value

15. Forecasting Assumption

19. Questions?