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Chapter 7 FORECASTING

QUESTIONS & ANSWERS Q7.1 Accurate company sales and profit forecasting requires careful consideration of firm-specific and broader influences. Discuss some of the microeconomic and macroeconomic factors a firm must consider in its own sales and profit forecasting. ANSWER The better a company can assess future demand, the better it can plan its resources. Every corporation is exposed to three types of factors influencing demand: company, competitive and macroeconomic factors. Microeconomic company-related factors include market share trends, changes in strategy and implementation, and changes in brand value. Microeconomic industry-related factors include competitor advertising, competitor product offerings, market share. Macroeconomic factors that must be considered include income, economic growth, interest rates, and shocks. There are several methods used to assess and forecast demand. None yields demand numbers that are a 100% successful or guaranteed. However, using more than one imperfect method has proven helpful in improving forecast accuracy and confidence. Q7.2 Forecasting the success of new product introductions is notoriously difficult. Describe some of the macroeconomic and microeconomic factors that a firm might consider in forecasting sales for a new teeth whitening product. ANSWER To forecast market demand for any new product introduction, market size research must be combined with product-specific information. A useful approach would combine macroeconomic trend information with data on microeconomic and competitive performance. Customers will only buy a product if they perceive a need and are able to pay for the new good or service. Of course, ability to pay tends to be a strong determinant of demand for big-ticket items, perceived need may be more important for small-ticket items, like teeth whitening products. Advertising capability or brand name reputation is also apt to be important because consumers must be aware of new product or service offerings and perceive a given company's

Q7.1

Q7.2

Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance. - 167 -

offerings as having the best value. In practice, market size research is combined with market share research to forecast product and corporate demand. Econometric models are sometimes used for answering a wide variety of Awhat if@ questions regarding the future. This stems from the fact that econometric models reflect the causal relation between Y (the forecast value) and a series of independent X variables. When a range of X values relating to various pessimistic to optimistic scenarios concerning future events is incorporated into a given econometric model, the resulting effects on Y become readily apparent. Thus, quantifiable answers to various Awhat if@ questions can be obtained. Q7.3 Blue Chip Financial Forecasts gives the latest prevailing opinion about the future direction of the economy. Survey participants include 50 business economists from Deutsche Banc Alex Brown, Banc of America Securities, Fannie Mae, and other prominent corporations. Each prediction is published along with the average, or consensus forecast. Also published are averages of the 10 highest and 10 lowest forecasts; a median forecast; the number of forecasts raised, lowered, or left unchanged from a month ago; and a diffusion index that indicates shifts in sentiment that sometimes occur prior to changes in the consensus forecast. Explain how this approach helps limit the steamroller or bandwagon problems of the panel consensus method. ANSWER Although the panel consensus method often results in forecasts that embody the collective wisdom of consulted experts, it can be unfavorably affected by the forceful personality of one or a few key individuals. To mitigate such problems, the forecasting approach adopted by Blue Chip Financial Forecasts is similar to the Delphi method. In the Delphi method, members of a panel of experts individually receive a series of questions relating to the underlying forecasting problem. Responses are analyzed by an independent party, who then tries to elicit a consensus opinion by providing feedback to panel members in a manner that prevents direct identification of individual positions. Because the 50 business economists surveyed by Blue Chip Financial Forecasts are never collected at a single location, the steamroller or bandwagon problems of the panel consensus approach tend to be minimized. The force of personality is strongest in person, and email surveys of 50 top economic forecasters are not apt to be as affected by group pressure as would be the case if Blue Chip Financial Forecasts were derived from regular group meetings. Q7.4 "Interest rates were expected to increase by 85% of all consumers in the May 2004 survey, more than ever before," said Richard Curtin, the Director of the University of Michigan=s Surveys of Consumers. "More consumers in the May 2004 survey cited the advantage of obtaining a mortgage in advance of any additional increases in interest rates than any other time in nearly ten years,@ said Curtin. Discuss this
Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance. - 168 -

Q7.3

Forecasting statement and explain why consumer surveys are an imperfect guide to consumer expectations. Q7.4 ANSWER Survey data can be highly useful in short-term forecasting when carefully used to elicit consumer perceptions and attitudes. However, survey data are Asoft@ when they don't relate to actual market transactions and can be unreliable when consumers have incentives to misreport information. In the case of interest rate forecasting, consumers may have little tangible evidence upon which to base their expectations, and little expertise in interest rate forecasting. Moreover, even if consumers have an accurate fix on the future pattern of interest rates, they have incentives to complain about likely increases in the hope that by voicing this concern they might cause some moderation in tightening by the monetary authorities. Q7.5 Explain why revenue and profit data reported by shippers such as FedEx Corp. and United Parcel Service Inc. are apt to provide useful information about trends in the overall economy. ANSWER Revenue and profit data reported by shippers such as FedEx Corp. and United Parcel Service Inc. are apt to provide useful information about trends in the overall economy because the pace of goods shipped is a leading indicator of future sales. In a sense, FedEx and UPS find out about the sales revenues of major manufacturers before the stockholders of manufacturers whose goods are being shipped. Sales and profit numbers jump for shippers before sales and profit numbers tied to shipped goods reach the audited financial statements of manufacturers. For example, in mid-2004, FedEx Corp. reported a 47% jump in fiscal fourthquarter profit and offered an increasingly optimistic outlook as the economic rebound continued to spread throughout its customer base. The Memphis, Tenn., company saw growing signs of what Frederick W. Smith, its chairman, president and chief executive, called a "solid, broad-based economic recovery" that includes industrial, durable-goods and retail shipments. FedEx results provided strong evidence that more businesses around the world were revving up their operations and replenishing inventories depleted during the economic slump, and that the economy's improvement was "strong and sustainable."

Q7.5

Presented by Suong Jian & Liu Yan, MGMT Panel , Guangdong University of Finance. - 169 -

ANSWER No..6 Q7. founded by Nobel Prize winner Lawrence Klein.6 AThe economy is on the verge of faster growth. seasonal variation. a linear model of the advertising-sales relation is not appropriate for estimating the advertising levels where Athreshold@ or Asaturation@ effects become prevalent. A basic shortcoming of trend projection is that the method is incapable of forecasting the magnitude or duration of divergences from trend and is not helpful for indicating fundamental changes in trend (i.@ What makes forecasting turning points difficult? What methods do economists use to forecast turning points in the overall economy? ANSWER All economic data have a strong trend elements. MGMT Panel . Describe the data requirements that must be met if econometric analysis is to provide a useful forecasting tool. To forecast the magnitude of such deviations from trend.170 - Q7. Q7. or logistic models are often employed for this purpose.7 Would a linear regression model of the advertising/sales relation be appropriate for forecasting the advertising levels at which threshold or saturation effects become prevalent? Explain. turning points). by definition. . simple trend projection methods are incapable of forecasting the magnitude of cyclical fluctuations. Our best judgment is that things will be improving after sluggish growth and a fitful recovery from recession. Q7. and irregular or random influences. "We believe we are at a turning point. changes in trend. Therefore. log-linear. A nonlinear method of estimation is appropriate when advertising by a firm or an industry is subject to such influences. A spinoff of the Wharton School of the University of Pennsylvania. managers often employ the barometric approach to forecasting.e.7 Q7. Quadratic. ANSWER Presented by Suong Jian & Liu Yan. and turning points are.@ Federal Reserve Chairman Alan Greenspan testified . WEFA was merged with Data Resources Inc.8 . Guangdong University of Finance. where Klein taught. in 2001 to form Global Insight.8 Perhaps the most famous early econometric forecasting firm was Wharton Economic Forecasting Associates (WEFA).Chapter 7 Q7.

between actual and forecast values and a high correlation between the actual and forecast series. Q7. When these two criteria are met. Larger samples are needed for larger populations and when particularly difficult forecasting problems suggest the use of highly sophisticated econometric models. It is most useful when indirect linkages between sectors are few in number and can be estimated with a great deal of precision. is to provide a fruitful tool for forecasting. all relevant variables must be properly incorporated in the analysis.10 What are the main characteristics of accurate forecasts? ANSWER The main characteristics of accurate forecasts are a close correspondence. or firms. a number of important conditions must be met.9 Cite some examples of forecasting problems that might be addressed using regression analysis of complex multiple-equation systems of economic relations. At the national level. actual and forecast data will be closely related. some of which entail many different structural relations (equations). Similarly. as few as 30 or 40 observations may be sufficient. . interest rates. firms might use a system method of analysis to measure the effects of changing energy. Presented by Suong Jian & Liu Yan. ANSWER Econometric analysis of multiple-equation systems of economic relations is a forecasting technique that is useful for reflecting the effects of important economic changes on related sectors. Second. for example. and water requirements. MGMT Panel . or capital costs on demand conditions for related products. and a desirable low level of average forecast error (root mean squared forecast error) will be apparent. For small populations and simple linear regression models. this type of econometric analysis has been used extensively to analyze changes in GDP. industries. And third. Guangdong University of Finance.Forecasting If the statistical analysis of economic relations. or econometrics. First. energy. on average. labor.10 Q7. This involves data measurement and model specification issues that must be addressed. Q7. a sufficient number of sample observations must be available for analysis. there must be a high degree of stability over time between the dependent and independent variables under consideration.9 .171 - Q7.

the regression line minimizes the sum of squared deviations over the estimation period. In the absence of GDP data for future periods. This is called a constant growth model because it is based on the assumption of a constant percentage growth in economic activity per year. . T1951 = 2. the reliability of alternative forecast techniques can be illustrated by arbitrarily dividing historical GDP data into two subsamples: a 1950-99 50-year test period. it is necessary to test the predictive capability of a given regression model over data that was not used to generate that very model. In other words. regression results generated over the entire 1950-2004 period cannot be used to forecast GDP over any subpart of that period. estimation results over the 1950-99 subperiod provide a forecast model that can be used to evaluate the predictive reliability of the constant growth model over the 2000-04 forecast period. Then.. A. Guangdong University of Finance. by definition. . It is defined as the value at the final point of sale of all goods and services produced during a given period by both domestic and foreign-owned enterprises. Use the regression model approach to estimate the simple linear relation between the natural logarithm of GDP and time (T) over the 1950-99 subperiod. subtract forecast values Presented by Suong Jian & Liu Yan. and u is a residual term. .3 offer the basis to test the abilities of simple constant change and constant growth models to describe the trend in GDP over time. and a 2000-04 5-year forecast period. GDP data for the 1950-2004 period shown in Figure 7.Chapter 7 SELF-TEST PROBLEMS & SOLUTIONS ST7. T1952 = 3. say 2005-2010. To test forecast reliability. However. . MGMT Panel . How well does the constant growth model fit actual GDP data over this period? B.1 Gross Domestic Product (GDP) is a measure of overall activity in the economy. and T1999 = 50). To do so would be to overstate the forecast capability of the regression model because. Create a spreadsheet that shows constant growth model GDP forecasts over the 2000-04 period alongside actual figures. and T is a time trend variable (where T1950 = 1. where ln GDPt = b0 + b1Tt + ut and ln GDPt is the natural logarithm of GDP in year t. Regression models estimated over the 1950-99 test period can be used to Aforecast@ actual GDP over the 2000-04 period.172 - .

SOLUTION The constant growth model estimated using the simple regression model technique illustrates the linear relation between the natural logarithm of GDP and time.3357 9.6 10.66) (75.5026 + 0.0 ln GDP 9.1919 Forecast ln GDP 9.561. . how well does the constant growth model generated over the 1950-99 period forecast actual GDP data over the 2000-04 period? ST7.9 Presented by Suong Jian & Liu Yan. Each constant growth GDP forecast is derived using the constant growth model coefficients estimated in part A. simply take the exponent (antilog) of each predicted ln GDPt variable.817.4109 Forecast GDP $9. . and T2004 = 55 and that the constant growth model provides predicted. Nevertheless.1 51 -431.Forecasting from actual figures to obtain annual estimates of forecast error. . Guangdong University of Finance.2% and a highly significant t statistic for the time trend variable indicate that the constant growth model closely describes the change in GDP over the 195099 time frame. along with values for each respective time trend variable over the 2000-04 period. used to forecast GDP over the 2000-04 5-year period.50) The R2 = 99. for each year over the 2000-04 period.441. values for ln GDPt. A constant growth regression model estimated over the 1950-99 50-year period (t-statistic in parentheses). B.2 $29. or forecast.2% (188.9 186. .1 A.1344 9. even modest changes in the intercept term and slope coefficient over the 2000-04 time frame can lead to large forecast errors. Finally.0752t. R2 = 99.. MGMT Panel . The following spreadsheet shows actual and constant growth model GDP forecasts for the 2000-04 forecast period: Forecast Error (GDP -Forecast GDP) Squared Forecast Time Error Period (GDP .8 52 Year 2000 2001 GDP $9.Forecast GDP)2 -$173.173 - .248. Based upon these findings. Also compute the sample average (or root mean squared) forecast error.4 9. T2001 = 52.994.268. and squared forecast error. compute the correlation coefficient between actual and forecast values over the 2000-04 period. To obtain forecast values for GDPt. is: ln GDPt = 5. Remember that T2000 = 51.

FGDP = 99.298. Branded Products.024.8 10.069.480.799 1. Px Ad 1 1.3 -$1.7 $1. At the time of the introduction. Market Cases.305 51.7 $1.2204 9. forecast error is also very high.208 37.206 49. Branded Products rolled out its new Super Detergent in 30 regional markets following its success in test markets. California. ST7.565 1.4860 9.5 4.7). This isn't just a Ame too@ product in a commodity market.463.2 Multiple Regression.3 Mean squared error 1.4 billion (= $1.177 147 81 896 3 1. Q $53.595. are used to forecast economic growth.200.3045 9. The following spreadsheet shows weekly demand data and regression model estimation results for Super Detergent in these 30 regional markets: Branded Products Demand Forecasting Problem Regional Demand in Price per Competitor Advertising.100.109.9 $10.6364 9.499.3 12.7 -2.657.290 $137 $94 $814 2 1.289.2217 9.4 53 54 55 Correlation 99.049.4860 11.2 $11. About a year ago.299 117 92 854 5 1.191. despite the fact that the correlation between actual and constant growth forecast model values is relatively high.749 1.125. MGMT Panel .076.166 135 86 810 6 1. a successful laundry product in its own right. like the 1950-99 period. The sample root mean squared forecast error is $1.3 -1.589 1.7% of average actual GDP over the 200004 period.333 Presented by Suong Jian & Liu Yan. Inc.881 1.185 55.155 149 89 852 4 1.662.123 1.546.326 42.186 143 79 768 7 1.50%.0 9. Thus.913.6 2. 463.. 662. is a leading producer and marketer of household laundry detergent and bleach products.204 43. P Price. I Demand.50% The correlation coefficient between actual and constant growth model forecast GDP is rGDP. Q Case.174 - .5 -1. Unusually modest economic growth at the start of the new millennium leads to large forecast errors when GDP data from more rapidly growing periods. Branded Products' detergent contains Branded 2 bleach.293 113 91 978 Household Estimated Income.Chapter 7 2002 2003 2004 Average 10.5612 9. Guangdong University of Finance.2573 9.121.8 10.959 1. management wondered whether the company could successfully crack this market dominated by Procter & Gamble and other big players.131. .987. or 12.5 13. based in Oakland.

467 1.328 0.413 1.338 1.839 1. .176 1.249 50.066 44.216 1.366 1.38432E-08 Intercept Price.83 3.220 1.000 951 848 891 870 768 1.86 -11.160 1.034 4.938 -5.328 1. P Competitor Price.473 51.264 1.322 1.433 1.99 P-value 4.199 1.02 4.663 55.085 46.501 37.846 0.348 45.809 55.343 39.515 1.449 1.293 1.089 Maximum 1. Px Advertising.438 54.004293208 2.839 47.104 0.163 39.310 1.476 1.293 1. MGMT Panel .089 1.09301E-06 4.97 Observations 30 Coefficients 807. Guangdong University of Finance.380 38.331 1.006 0.235 1.314 1.304 1.478 Regression Statistics R Square 90.286 Minimum 1.Forecasting 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 Average 1.328 1.478 1.215 111 109 129 124 117 106 135 117 147 124 103 140 115 119 138 122 105 145 138 116 148 134 127 127 103 149 82 81 82 91 76 90 88 99 76 83 98 78 83 76 100 90 86 96 97 97 84 88 87 87 76 100 821 843 849 797 988 914 913 867 785 817 846 768 856 771 947 831 905 996 929 1.080 43.291 1.326 1.367 1. Ad Household Income.175 - .471 46.293 1.809 41.14 7.345 1.457 1.165 1.166 55.001 t Stat 5. I Presented by Suong Jian & Liu Yan.299 1.788 37.34134E-11 5.084 52.288 1.546 38.226 1.855 54.208 1.302 1.73825E-05 0.223 1.656 46.196 50.437 1.286 1.860 0.263 51.359 1.515 1.4% Standard Error 34.009 Standard Error 137.238 1.474 1.203 1.024 1.291 38.000 47.024 1.215 1.

I 41.176 - .845 47. Interpret the coefficient estimate for each respective independent variable. MGMT Panel . C.560 39.543 53. Use the regression model estimation results to forecast weekly demand in five new markets with the following characteristics: Regional Forecast Market A B C D E Average Price per Case.410 Presented by Suong Jian & Liu Yan. . B.234 39.870 44.Chapter 7 A. Characterize the overall explanatory power of this multiple regression model in light of R2 and the following plot of actual and estimated demand per week. P 115 122 116 140 133 125 Competitor Price. Advertising. Px Ad 90 790 101 812 87 905 82 778 79 996 88 856 Household Income. Guangdong University of Finance.

Px 90 101 87 82 79 88 Advertising.358 1. the multiple regression model closely tracks week-by-week changes in demand with no worrisome divergences between actual and estimated demand over time. SOLUTION Coefficient estimates for the P. I 41.285 1.845 47. in fact.Forecasting ST7.223 1. Moreover.. as shown in the graph of actual and fitted (estimated) demand. Presented by Suong Jian & Liu Yan.1 Constant Growth Model.4% of demand variation is explained by the underlying variation in all four independent variables.234 39. Guangdong University of Finance.410 Forecast Demand.177 - . advertising (AD) and household disposable income (I)are positive as expected. Thus. the regression model estimated previously can be used to forecast demand in each regional market.560 39. C. Bureau of the Census publishes employment statistics and demand forecasts for various occupations. whereas the effects of competitor price (Px).4% obtained by the model means that 90.870 44. The U. This is a relatively high level of explained variation and implies an attractive level of explanatory power. The R2 = 90. The chance of finding such large t-statistics is less than 1% if. MGMT Panel . Ad and I independent X-variables are statistically significant at the 99% confidence level. P 115 122 116 140 133 125 Competitor Price. Price of the product itself (P) has the predictably negative influence on the quantity demanded.2 A. Forecast results are as follows: Regional Forecast Market A B C D E Average Price per Case.196 1. Px.S. This means that this regression model can be used to forecast demand in similar markets under similar conditions. Notice that each prospective market displays characteristics similar to those of markets used to estimate the regression model described above. .543 53.298 1. Q 1. PROBLEMS & SOLUTIONS P7.272 B. there were no relation between each variable and quantity. Ad 790 812 905 778 996 856 Household Income.

MGMT Panel . . Et 420 1.031 or 3.031 .Chapter 7 Employment (1. Presented by Suong Jian & Liu Yan. SOLUTION Using the assumption of annual compounding. Guangdong University of Finance.35) 0. P7.35 ln(1.1 A.030 1.000) Occupation 1998 2008 Bill collectors 311 420 Computer engineers 299 622 Physicians assistants 66 98 Respiratory therapists 86 123 Systems analysts 617 1.178 - . B. Compare your answers and discuss any differences. calculate the ten-year growth rate forecast using the constant growth model with annual compounding.1 g = E0(1 + g)t = 311(1 + g)10 = (1 + g)10 = 10 Η ln(1 + g) = ln(1 + g) = 1+g = g = 0. and the constant growth model with continuous compounding for each occupation.1% Using the continuous compounding assumption.194 A.300/10 e0. Using a spreadsheet or hand-held calculator.

3000/10 = 0.194 Continuous Growth Model Annual Continuous Compounding Compounding 3.2 .05% 3. With continuous compounding.57% 6. MGMT Panel .82% 6. Almost 2 million persons per year visit wondrous Glacier National Park. Growth Rate Estimation. if the number of jobs jumps to 420. this small difference is due to the amount of Ainterest-on-interest.35) g = E0egt = 311e10g = e10g = 10g = 0.64% 3.35 ln(1. but managers must make growth comparisons using a consistent basis.00% Using the same methods.00% 7.000 over a ten-year period. monthly park attendance figures varied widely during a recent year: Presented by Suong Jian & Liu Yan.00% rate of growth leads to a similar growth in jobs over a ten-year period. then a 3. Guangdong University of Finance.03% 3. 1998 2008 311 420 299 622 66 98 86 123 617 1.000 from 311.@ Either method can be employed to measure the rate of growth.32% 4.95% 3. a 3.60% 7. .000) Occupation Bill collectors Computer engineers Physicians assistants Respiratory therapists Systems analysts B. Of course. Due to the weather. continuous growth model estimates for various occupations are: Employment (1.Forecasting Et 420 1.179 - P7.03 or 3.60% For example.05% rate of job growth is indicated when annual compounding is assumed.

1% -79.0% -42.237 540. managers rely Presented by Suong Jian & Liu Yan.029 6. and July (111. despite a 42. When compound growth rates are considered. This simple example documents the difficulty involved with measuring growth using arithmetic averages.5% 37. . December park attendance is lower than January attendance despite a 42.8% -80.5% 42.602 57.488 528. June (186.166 89. How is that possible? Suppose the data described in the table measured park attendance over a number of years rather than during a single year.4% average rate of growth in monthly attendance. Guangdong University of Finance. Big attendance gains in May (269. Explain how the arithmetic average annual rate of growth gives a misleading picture of the growth in park attendance. SOLUTION The arithmetic average presents a distorted view of the rate of growth over time because upside growth is theoretically unlimited.180 - B. B.5% 269. but declines are limited to no more than 100%.716 286. . Notice that park attendance is lower in December than in January.85%) simply overwhelm smaller positive increases or declines in other months when arithmetic averages are taken.8% -2.5% 81.166 255.913 152.580 Percent change 29.686 13.2%). MGMT Panel .0%).Chapter 7 Month January February March April May June July August September October November December Average Visitors 7.2% 111.481 9. In this case.4% average monthly gain in park attendance.4% A. P7.2% -45.316 24.0% 186.2 A.164 12.

1 g = S0(1 + g)t = $25.6) 0. sales revenue has increased from $25 million to $65 million. produces and installs energyefficient window systems in commercial buildings..50%)/2) despite the fact that no net growth has occurred.100 or 10. Notice that when sales increase from $250. MGMT Panel .000 (a 100% gain).000 2. . but declines are limited to no more than 100%. P7. when attendance falls from January to December levels. Calculate the company's growth rate in sales using the constant growth model with annual compounding.000(1 + g)10 = (1 + g)10 = 10 Η ln(1 + g) = ln(1 + g) = g = 0. SOLUTION St $65.6 ln(2.000 to $500.0956) . Inc. Guangdong University of Finance.000. Environmental Designs.181 - . Five-Year Sales Forecast St = S0 (1 + g)t Presented by Suong Jian & Liu Yan. A. but then fall back to $250.956/10 e(0.Forecasting on the geometric average rather than the arithmetic average rate of return. Similarly. Derive a five-year and a ten-year sales forecast.000. The arithmetic average presents a distorted view of the rate of growth over time because upside growth is theoretically unlimited.3 A. this decline in attendance is not captured by the 42.3 Sales Trend Analysis.0% B. B.4% arithmetic average rate of growth in monthly attendance. During the past ten years. P7. the arithmetic average growth is 25% (= (100% .000 (a 50% loss).

Calculate the company's unit labor cost growth rate using the constant rate of change model with continuous compounding.000.Chapter 7 = $65.4 A.000 (1.25) = 3g Presented by Suong Jian & Liu Yan. P7.610.25 = e3g ln(1.10)10 = $65. is concerned about unit labor cost increases for the assembly of electrical snapaction switches. A. a quality-control supervisor for Wizard Products. Guangdong University of Finance.000. Costs have increased from $80 to $100 per unit over the previous three years. Inc. Gale thinks that importing switches from foreign suppliers at a cost of $115.715. SOLUTION Ct = C0egt $100 = $80e3g 1.182 - .000 Ten-Year Sales Forecast St = S0 (1 + g)t = $65. MGMT Panel .611) = $104. Forecast when unit labor costs will equal the current cost of importing.000 (1 + 0.4 Cost Forecasting.000 (1 + 0. . Dorothy Gale..000.000 P7.000.594) = $168.10)5 = $65. B.90 per unit may soon be desirable.000 (2.

What would you predict the sales of A to be this week? B. using the variables A = sales of Product A.148/0. 75 units of B were sold.074t t = 0. B = sales of Product B. SOLUTION At = At-1 + ΔAt-1 ⎛ ⎞ At = At-1 .159) = 0.1⎟ A t-1 ⎝ B t-2 ⎠ Presented by Suong Jian & Liu Yan. A. if sales of B rose by X% last week.5 Unit Sales Forecasting. Boris Badenov has discovered that the change in Product A demand in any given week is inversely proportional to the change in sales of Product B in the previous week. Assume that there will be no shortages of either product.4% B. That is. Last week. sales of A can be expected to fall by X% this week.Forecasting g = 0. Write the equation for next week's sales of A. P7. Guangdong University of Finance.5 A.074)t 1.074 or 7.074 = 2 years P7. Import Cost = C0egt $115. MGMT Panel .90 = $100e(0.074)t ln(1. Two weeks ago.183 - . 100 units of A and 90 units of B were sold. . and t = time.223/3 = 0.⎜ B t-1 .159 = e(0.

Write an equation for predicting sales if Grissom assumes that the percentage change in sales is twice as large as the percentage changes in income and advertising but that it is only one-half as large as. $25. ⎛ ⎞ At = At-1 .000 (advertising). SOLUTION ⎛ ⎞ ⎛ ⎞ St+1 = St + 2 ⎜ Y t . MGMT Panel . and CA = competitor advertising. advertising is $20.400.184 - .5 ⎜ ⎝ CA t-1 ⎠ ⎛ ⎞ ⎛ ⎞ = St + 2St ⎜ Y t ⎟ .6 A. Previous period levels were $70.2St + 2St ⎜ A t ⎟ . and $60.Chapter 7 B. Gil Grissom must generate a sales forecast to convince the loan officer at a local bank of the viability of Marina Del Rey. sales total $500. a trendy west-coast restaurant.1⎟ St ⎝ Y t-1 ⎠ ⎝ A t-1 ⎠ ⎛ CA t ⎞ .1⎟ 100 ⎝ 75 ⎠ = 80. Use the variables S = sales. and advertising by a competing restaurant. the percentage change in competitor advertising.000 (competitor advertising).2St ⎝ Y t-1 ⎠ ⎝ A t-1 ⎠ Presented by Suong Jian & Liu Yan.1⎟ S t .⎜ B t-1 . Guangdong University of Finance.000 (income). Forecast next-period sales.⎜ . and competitor advertising is $66.000.1⎟ St + 2 ⎜ A t . Grissom assumes that next-period sales are a function of current income.000. A = advertising.000. and the opposite sign of. P7.6 Revenue Forecasting.0. median income per capita in the local market is $71. P7. B. Y = income. During the current period. A. advertising. .1⎟ A t-1 ⎝ B t-2 ⎠ ⎛ 90 ⎞ = 100 .

2. and a1 = regression slope coefficien.5 ($500.5St ⎜ ⎟ + St ⎝ CA t-1 ⎠ 2 ⎛ ⎞ ⎛ ⎞ 1 ⎛ CA t ⎞ = 2St ⎜ Y t ⎟ + 2St ⎜ A t ⎟ .St ⎜ ⎟ ⎝ Y t-1 ⎠ ⎝ A t-1 ⎠ 2 ⎝ CA t-1 ⎠ . Clint Cassidy is supervising physician at the Westbury HMO.000 + $800. and believes that monthly downtime on the packaging line caused by equipment breakdown is related to the hours spent each month on preventive maintenance. If 40 hours were spent last month on preventive maintenance and this month's downtime was 500 hours.80) . Cassidy is evaluating the cost effectiveness of a preventive maintenance program. St+1 = 2($500. Assume that downtime in the forecast (next) month decreases by the same percentage as preventive maintenance increased during the month preceding the current one.Forecasting ⎛ CA t ⎞ 1 .000) = $1.000)(1. P7.5St B. A. Guangdong University of Finance.000)(1. .$1.02) + 2($500. M = preventive maintenance.2.000)(0. SOLUTION Dt+1 = a0 + a1 M Presented by Suong Jian & Liu Yan.000 = $295.000 P7. a0 = constant term.0.000 .250.185 - .10) .7 A.5 ($500.7 Cost Forecasting. Write an equation to predict next month's downtime using the variables D = downtime. t = time.0.$275. MGMT Panel . what should downtime be next month if preventive maintenance this month is 50 hours? Use the equation developed in part A. Dr.000 . B. a New York City-based medical facility serving the poor and indigent.020.

In percentage terms.. St+1 =-2(16. A. . Write an equation for estimating the Christmas season sales. and t = time. P7.ΔD ⎛ ⎞ = Dt . Furthermore. SOLUTION St+1 = St + ΔS = St . and customer traffic is expected to rise by 15% over previous levels.⎜ ⎟ 500 ⎝ 40 ⎠ = 375 hours of downtime P7. B. this season's price is anticipated to be $16.000 Presented by Suong Jian & Liu Yan.8 Sales Forecast Modeling.000 + 3(1.40 ⎞ =500 .2(Pt+1/Pt .1)St + 3(Tt+1/Tt .Chapter 7 = Dt .⎜ M t M t-1 ⎟ D t ⎝ M t-1 ⎠ B. using the variables S = sales. Forecast this season's sales if Toys Unlimited sold 10.50. these effects seem to be independent.ΔSP + ΔST = St .186 - .000 games last season at $15 each. MGMT Panel . must forecast sales for a popular adult computer game to avoid stockouts or excessive inventory charges during the upcoming Christmas season. T = traffic. Toys Unlimited Ltd. Guangdong University of Finance. Dt+1 ⎛ 50 . the company estimates that game sales fall at double the rate of price increases and that they grow at triple the rate of customer traffic increases.15)10.8 A.1)St = -2(Pt+1/Pt)St + 3(Tt+1/Tt)St B. P = price.5/15)10.

average nightly attendance has risen from 500 to 1. plus 40% of the moviegoers that do not buy popcorn..8(0.50Q Other Concession Revenue = $4 (Popcorn buyers + Other buyers) = $4[0. .500 games P7. SOLUTION If Q is the number of moviegoers. Eighty percent of these popcorn buyers. Popcorn and other concession revenues tied to attendance have also risen dramatically. Mid-Atlantic has found that 50% of all moviegoers buy a $5 cup of buttered popcorn.9 Simultaneous Equations.4(0.000 + 34. P7. Historically. Forecast total revenues for both regular and special Tuesday night pricing.187 - . C. By offering half off its regular $9 admission price. Mid-Atlantic Cinema. A. MGMT Panel . Write an expression describing total revenue from tickets plus popcorn plus other concessions. runs a chain of movie theaters in the east-central states and has enjoyed great success with a Tuesday Night at the Movies promotion. B.5Q) + 0. Inc.500 persons. each spend an average of $4 on soda and other concessions.500 = 12.Forecasting = -22. then: Ticket Revenue = P Η Q Popcorn Revenue = $5(0.9 A.5Q)] Presented by Suong Jian & Liu Yan.5Q) = $2. Guangdong University of Finance. Forecast the total profit contribution earned for the regular and special Tuesday night pricing strategies if the profit contribution is 30% on movie ticket revenues and 80% on popcorn and other concession revenues.

950 Special Price Total Revenue = $4.50(1.50Q + $2.90(500) = $6.50)(1.310 Special Price Profit Contribution = 0.905 Presented by Suong Jian & Liu Yan. Guangdong University of Finance. MGMT Panel .500) + $4.8($4. Profit Contribution Regular Price = 0. Concession Total Revenue = Ticket Revenue Revenue Revenue + Popcorn + Other = P Η Q + $2.100 C.500) = $14.90Q B.8($4.90(1.500) = $7. Regular Price Total Revenue = $9(500) + $4.3($9)(500) + 0.40Q Therefore.188 - .40Q = P Η Q + $4.500) + 0.90)(500) = $3. .Chapter 7 = $2.90)(1.3($4.

X Forecast each of the preceding variables through the simultaneous relations expressed in the multiple equation system. the ATuesday Night Special@ results in a $4. The alternatives to expansion are to use additional overtime.16GDP Net Exports X National income Y = 0.310) increase in profit contribution. Washington.$3. The company will add new capacity only if the economy appears to be expanding. forecasting the general pace of economic activity for the United States is an important input to the decision-making process.200) Presented by Suong Jian & Liu Yan.905 . P7.200 billion This year's government expenditures G Annual consumption expenditures C Annual investment expenditures I = $2. to reduce other production.03GDP = GDP .500 billion = $900 billion + 0. .10 A.189 - . based in Seattle. economy: Last year's total profits (all corporations) Pt-1 = $1.S.595 = ($7. The firm has collected data and estimated the following relations for the U.T Gross domestic product (GDP) = C + I + G . SOLUTION Investment I = $920 + 0.10 Simultaneous Equations. or both. Supersonic Industries. manufactures a wide range of parts for aircraft manufacturers. MGMT Panel .9Pt-1 = $920 + 0. Guangdong University of Finance.Forecasting Based on these figures.75Y = $920 billion + 0. P7.9Pt-1 Annual tax receipts T = 0.9($1. Assume that all random disturbances average out to zero. Therefore. The company is currently evaluating the merits of building a new plant to fulfill a new contract with the federal government.

000 billion Gross Domestic Product GDP = C + I + G .84GDP) = $900 + 0.75(GDP .400 GDP = $13.T) + $2.75(GDP .T) = $900 + 0.000 + $2.405 billion Taxes T = 0.000 + $2.75(0.500 .4GDP = $5.16GDP) + $2.000 + $2.75(GDP .6GDP + $2.500 .03GDP = $900 + 0.500 .0.75Y + $2.500) = $9. MGMT Panel .190 - .0. Guangdong University of Finance.03GDP = $900 + 0.500 billion ($13.500) = $2.0.000 + $2.75Y = $900 + 0.0.03GDP = $900 + 0.16($13. .16GDP = 0.5 trillion) Consumption C = $900 + 0.500 0.63($13.X = $900 + 0.160 billion Presented by Suong Jian & Liu Yan.Chapter 7 = $2.

Guangdong University of Finance. television animation programs. and Discovery) and radio networks. Epcot Center.T = GDP . show promoters and publishers. cable/satellite and international broadcast operations. France. ESPN. The studio entertainment segment produces live-action and animated motion pictures. and Walt Disney World. retailers.84GDP = 0. located just outside of Paris. Hong Kong Disneyland. MGMT Panel . During recent years. Disney was able to entice foreign investors to put up 100% of the financing required for both the Tokyo and Presented by Suong Jian & Liu Yan. California. production and distribution of television programming. and Disney-MGM Studios.16GDP = 0. Work is underway on a fifth resort.191 - . Through the parks and resorts segment. Magic Kingdom. Disney's foreign operations provide an interesting example of the company's shrewd combination of marketing and financial skills. The consumer products segment licenses the company's characters and other intellectual property to manufacturers. the company has extended its amusement park business to foreign soil with Tokyo Disneyland and Euro Disneyland. To conserve scarce capital resources. Disney parks and resorts are at the cornerstone of a carefully integrated entertainment marketing strategy. . Japan and France. studio entertainment and consumer products. musical recordings and live stage plays. scheduled to open in late 2005 or early 2006. kids flock to Disneyland. Walt Disney owns and operates four destination resorts in the United States. and Internet operations. In the United States.0. Florida--an immense entertainment center that includes the Animal Kingdom.340 billion CASE STUDY FOR CHAPTER 7 Forecasting Global Performance for a Mickey Mouse Organization The Walt Disney Company is a diversified worldwide entertainment company with operations in four business segments: media networks. The media networks segment consists of the company's television (ABC. parks and resorts.84($13.Forecasting National Income Y = GDP .500) = $11.

33. a chain of retail specialty shops. These performance measures exceed industry and economy-wide norms. Snow White. the Walt Disney Company is one firm that doesn't mind being called a AMickey Mouse Organization. capital spending. in addition to a film library including hundreds of movie classics like Fantasia. Will the company be able to reassert itself and once again enjoy enviable growth. During this time frame. Touchstone. Pirates of the Caribbean: The Curse of the Black Pearl. Disney is also a major force in the movie picture production business with Buena Vista. The company's family entertainment marketing strategy is so broad in its reach that Disney characters such as Mickey Mouse. Over the 1980-2003 period. will Disney find it impossible to maintain above-average performance? Disney=s new amusement parks and the growing popularity of ESPN sports programming promise significant future revenues and profits from previously untapped global markets. retains an important equity interest. The Disney Store. Given its ability to turn whimsy into outstanding operating performance. The Lion King.3% annual rate of return. All data are expressed in dollars per share to illustrate how individual shareholders have benefitted from the company's growth. or. and recorded music. books. Anyone with young children who has visited Disneyland or Disney World has seen their delight and Presented by Suong Jian & Liu Yan. Also making a significant contribution to the bottom line are earnings from Disney=s television operations which include ABC. The company is famous for recent hit movies such as Finding Nemo. in addition to the renowned Walt Disney Studios. like many companies. . after adjusting for stock splits. and year-end share prices for the Walt Disney Company during the 1980-2003 period. CEO Michael D. the Discovery Channel. but have grown frustrated by stagnant results during recent years.@ Table 7. revenue per share grew at an annual rate of 14.0% per year. and enjoys significant royalties on all gross revenues.7 shows a variety of accounting operating statistics. and Mary Poppins.192 - . Investors now want to know how the company will fare during coming years. Disney employs an aggressive and highly successful video marketing strategy for new films and re-releases from the company's extensive film library. This represents a 14. profits from the sale of movie tie-in merchandise. cash flow.7 here Table 7. In turn. book value. Eisner.5% per year. MGMT Panel . Disney employees. among others. and The Sixth Sense.Chapter 7 Paris facilities. and earnings per share grew by 9. the Entertainment and Sports Programming Network. Disney is responsible for the design and management of both operations.07 per share to $23. and stockholders are getting restless. and Hollywood Pictures. The Disney Channel. Guangdong University of Finance. However. and sports juggernaut ESPN. including revenues. dividends. and Goofy have become an integral part of the American culture. earnings. and all stockholders profited greatly from the company's outstanding stock-price performance during the 1980's and 1990's. and illustrates how Disney has been an above-average stock-market performer. the stock price has grown stagnant since 1996. Disney common stock exploded in price from $1. Donald Duck.

or the former Soviet Union also hold the potential for rapid growth into the next century.000 by the year 2009. Actual results will vary. It is also impossible not to notice how much foreign travelers to the United States seem to enjoy the Disney experience.55. earnings of $1. The Value Line Investment Survey. discounted at an appropriate risk-adjusted rate of return.45. Fidelity's legendary mutual fund investor Peter Lynch argues that stock prices are largely determined by future earnings per share. it will prove interesting to employ the data provided in Table 7.Forecasting fascination with Disney characters. Both Lynch and Templeton have built a large following among investors who have profited mightily using their stock-market selection techniques. In economic terms. say 2007-09. focuses on a three. the father of global stock market investing.to fiveyear time horizon. On the other hand.25.10. A simple regression model over the 1980-2003 period where the Y-variable is the Disney year-end stock price and the X-variable is Disney=s earnings per share reads as follows (t-statistics in parentheses): Presented by Suong Jian & Liu Yan.21. Future expansion possibilities in Malaysia. Given the many uncertainties faced by Disney and most major corporations. but these assumptions offer a fruitful basis for measuring the relative growth potential of Disney. Maintaining control with such a rapidly growing workforce would be challenging. the 112. At that pace. focuses on book value per share.7.7 to estimate regression models that can be used to forecast the average common stock price for The Walt Disney Company over the 2007-09 period. MGMT Panel . Templeton contends that future earnings are closely related to the book value of the firm. Historical numbers for a recent period. represent a useful context for projecting future stock prices. The most interesting economic statistic for Disney stockholders is the stock price during some future period. . For example. As an experiment.193 - . growth of 10% per year is exceedingly hard to maintain for any length of time.65. For the 2007-09 period. A. maintaining Disney's high level of creative energy might not be possible. Sir John Templeton. and book value per share of $17. Value Line forecasts Disney revenues of $18. China. Stock prices rise following an increase in earnings per share and plunge when earnings per share plummet. one might use any or all of the data in Table 7. ABargains@ can be found when stock can be purchased in companies that sell in the marketplace at a significant discount to book value. or accounting net worth.000 workers employed by Disney in 2004 would grow to over 180. capital spending of $0. like 1980-2003. cash flow of $2. dividends of $0. one of the most widely respected forecast services. or when book value per share is expected to rise dramatically. Donald Duck and Mickey Mouse will do a lot of business abroad. Guangdong University of Finance. forecasts of operating performance are usually restricted to a fairly short time perspective. To forecast Disney's stock price during the 2007-09 period. stock prices represent the net present value of future cash flows.

R2 = 86.194 - .182BVt.8% (-1.46) (0.75) (1.822CFt + $13. A multiple regression model over the 1980-2003 period where the y-variable is the Disney year-end stock price and x-variables include the accounting operating statistics shown in Table 7.377REVt + $0.$1.88) (5. A simple regression model over the 1980-2003 period where the Y-variable is the Disney year-end stock price and the X-variable is Disney=s book value per share reads as follows (t-statistics in parentheses): Pt = $3.03) Use this model to forecast Disney=s average stock price for the 2007-09 period using the Value Line estimate of Disney=s average earnings per share for 2007-09. A multiple regression model over the 1980-2003 period where the Y-variable is the Disney year-end stock price and the X-variables are Disney=s earnings per share and book value per share reads as follows (t-statistics in parentheses): Pt = -$1.57) Use this model to forecast Disney=s average stock price for the 2007-09 period using the Value Line estimate of Disney=s average book value per share for 2007-09.869BVt.3% (-1.24) (0. Pt = -$2.Chapter 7 Pt = -$1.603CAPXt + $17.84) (0.7 reads as follows (t-statistics in parentheses): D.9% (1.66) (3. MGMT Panel .437EPSt .453 + $2. R2 = 76.13) (12. Discuss this share-price forecast. Discuss this share-price forecast.665BVt. R2 = 90.06) Use this model to forecast Disney=s average stock price for the 2007-09 period using the Value Line estimate of Disney=s average earnings per share and book value per share for 2007-09.99) (8. C.661 + $31.03) (-0.388EPSt. B.94) Presented by Suong Jian & Liu Yan. R2 = 94.161 + $2.09) (2.777EPSt + $0.9% (-0.706DIVt + $0. Discuss this share-price forecast.112 + $21. . Guangdong University of Finance.

gives a forecast of $50. From a 2003 year-end base of $23. Discuss this share-price forecast. . this would represent a five-year average annual rate of capital appreciation of roughly 12. Using this simple model of stock prices and book values. along with Value Line estimates of Disney=s average earnings per share and book value per share for 2007-09. along with Value Line estimates of Disney=s average book value per share for 2007-09.46. this forecast means that if stock market investors accord Disney=s 2007-09 earnings per share a price-earnings ratio typical of the 1980-2003 period. this would represent a five-year average annual rate of capital appreciation of roughly 16.161 + $2.55) = $41.13 for Disney=s average stock price for the 2007-09 period: Pt = -$1. and if the Value Line forecast of 2007-09 earnings per share is accurate. and if the Value Line forecast of 2007-09 book value per share is accurate.195 - .13 In other words.46 In words.Forecasting Use this model and Value Line estimates to forecast Disney=s average stock price for the 2007-09 period.182(17. Guangdong University of Finance. From a 2003 year-end base of $23. earnings per share and book values. this forecast means that if stock-market investors accord Disney=s 2007-09 book value per share a price-book ratio typical of the 1980-2003 period. Disney=s stock price should grow to $41. Using this simple regression model of stock prices and earnings per share.33.08 for Disney=s average stock price for the 2007-09 period: Presented by Suong Jian & Liu Yan. MGMT Panel . Disney=s stock price should grow to $50.46 for Disney=s average stock price for the 2007-09 period: Pt = $3.388(1. C.661 + $31. gives a forecast of $41.2% per year. B. CASE STUDY SOLUTION A.5% per year.33.13.65) = $50. along with Value Line estimates of Disney=s earnings per share for 2007-09. gives a forecast of $50. Using a multiple regression model of stock prices.

377(18.706(0.55) = $23.33.665(17. and insignificant t statistics.65) .Chapter 7 Pt = -$1.437(1.822(2.4% per year.08 In other words.$1.21) + $0. gives a forecast of only $23. this forecast means that if stock market investors accord Disney=s 2007-09 accounting operating statistics a valuation typical of the 1980-2003 period.08.603(0. From a 2003 yearend base of $23. From a 2003 yearend base of $23. Using an extended multiple regression model.65) + $0. Disney=s stock price should grow to roughly $50.77 for Disney=s average stock price over the 2007-09 period: Pt = -$2.112 + $21.453 + $2. this would represent a five-year average annual rate of capital appreciation of roughly 16. and if the Value Line forecasts for accounting performance over the 2007-09 period are accurate.33. this forecast means that if stock market investors accord Disney=s 2007-09 earnings per share and book value per share a valuation typical of the 19802003 period.25) + $13.) Presented by Suong Jian & Liu Yan.869(17. and if the Value Line forecasts of these numbers for 2007-09 are accurate.77.45) + $17..777(1. . Disney=s stock price should grow to only $23.10) + $0. along with Value Line estimates for 2007-09. This is despite the fact that many individual variables have the anticipated signs and statistical significance when individually considered in simple regression models. MGMT Panel . this would represent a five-year average annual rate of capital appreciation of only 0.196 - .5% per year.77 In other words. Guangdong University of Finance. D. (Note: High multicollinearity among the independent variables results in high standard errors for the coefficient estimates. This example give a good basis for discussing estimation and forecasting problems encountered when using financial data.55) = $50.