276  Forecasting Performance
using revenues. Working cash is estimated at 7.6 days’ sales, inventory at 182.5 
days’ COGS, and accounts payable at 81.1 days’ COGS. We forecast in days for 
the added benefit of tying forecasts more closely to the velocity of operating 
activities. For instance, if management announces its intention to reduce its 
inventory holding period from 180 days to 120 days, it is possible to compute 
changes in value by adjusting the forecast directly.
Property, Plant, and Equipment  Consistent with our earlier argument 
concerning stocks and flows, net PP&E should be forecast as a percentage 
of revenues.11 A common alternative is to forecast capital expenditures as a 
percentage of revenues. However, this method too easily leads to unintended 
increases or decreases in capital turnover (the ratio of PP&E to revenues). 
Over long periods, companies’ ratios of net PP&E to revenues tend to be quite 
stable, so we favor the following three-step approach for PP&E:
1. Forecast net PP&E as a percentage of revenues.
2. Forecast depreciation, typically as a percentage of gross or net PP&E.
3. Calculate capital expenditures by summing the projected increase in net 
PP&E plus depreciation.
To continue our example, we use the forecasts presented in Exhibit 13.11 to 
estimate expected capital expenditures. In 2019, net PP&E equaled 104.2 per-
cent of revenues. If this ratio is held constant for 2020, the forecast of net PP&E 
equals $300 million. To estimate capital expenditures, compute the increase 
in net PP&E from 2019 to 2020, and add 2020 depreciation from Exhibit 13.6.
Capital Expenditures = Net PP&E2020 − Net PP&E2019 + Depreciation2020
= $300.0 million − $250.0 million + $23.8 million
= $73.8 million
For companies with low growth rates and projected improvements in cap-
ital efficiency, this methodology may lead to negative capital expenditures 
(implying asset sales). Although positive cash flows generated by equipment 
sales are possible, they are unlikely. In these cases, make sure to assess the 
resulting cash flow carefully.
Goodwill and Acquired Intangibles  A company records goodwill and ac-
quired intangibles when the price it pays for an acquisition exceeds the tar-
get’s book value.12 For most companies, we choose not to model potential 
12 This section refers to acquired intangibles only. Forecast internal investments in intangibles, such as 
capitalized software and purchased sales contracts, with the methodology used for capital expendi-
tures and PP&E.
11 Some companies, such as oil refiners, will report number of units. In these cases, consider using 
number of units instead of revenue to forecast equipment purchases.

Mechanics of Forecasting  277
acquisitions explicitly, so we set revenue growth from new acquisitions equal 
to zero and hold goodwill and acquired intangibles constant at their current 
level. We prefer this approach because of the empirical literature documenting 
how the typical acquisition fails to create value (any synergies are transferred 
to the target through high premiums). Since adding a zero-NPV investment 
will not increase the company’s value, forecasting acquisitions is unnecessary. 
In fact, by forecasting acquired growth in combination with the company’s 
current financial results, you make implicit (and often hidden) assumptions 
about the present value of acquisitions. For instance, if the forecast ratio of 
goodwill to acquired revenues implies positive NPV for acquired growth, in-
creasing the growth rate from acquired revenues can dramatically increase the 
resulting valuation, even when good deals are hard to find.
If you decide to forecast acquisitions, first assess what proportion of future 
revenue growth they are likely to provide. For example, consider a company 
that generates $100 million in revenues and has announced an intention to 
grow by 10 percent annually—5 percent organically and 5 percent through 
acquisitions. In this case, measure historical ratios of goodwill and acquired 
intangibles to acquired revenues, and apply those ratios to acquired revenues. 
For instance, assume the company historically adds $3 in goodwill and intan-
gibles for every $1 of acquired revenues. Multiplying the expected $5 million 
of acquired growth by 3, you obtain an expected increase of $15 million in 
goodwill and acquired intangibles. Make sure, however, to perform a reality 
check on your results by varying acquired growth and observing the result-
ing changes in company value. Confirm that your results are consistent with 
the company’s past performance related to acquisitions and the challenges of 
creating value through acquisition.
Nonoperating Assets, Unfunded Pensions, and Deferred Taxes  Next, 
forecast nonoperating assets (such as nonconsolidated subsidiaries), debt 
equivalents (such as pension liabilities), and equity equivalents (such as 
deferred taxes). Because many nonoperating items are valued using meth-
ods other than discounted cash flow (see Chapter 16), any forecasts of these 
items are primarily for the purpose of financial planning and cash manage-
ment, not enterprise valuation. For instance, consider unfunded pension li-
abilities. Assume management announces its intention to reduce unfunded 
pensions by 50 percent over the next five years. To value unfunded pen-
sions, do not discount the projected outflows over the next five years. In-
stead, use the current actuarial assessments of the shortfall, which appear 
in the note on pensions. The rate of reduction will have no valuation im-
plications but will affect the ability to pay dividends or may require addi-
tional financing. To this end, model a reasonable time frame for eliminating 
pension shortfalls.
We are extremely cautious about forecasting (and valuing) nonconsoli-
dated subsidiaries and other equity investments. Valuations should be based