Introduction

The report is designed to assess the financial performance of Harvey Norman Holdings Limited, Australia’s largest publicly traded international corporation with a wide variety of items, such as appliances, bedding, laptops, electronics and electrical consumer items, etc. This report is based on prospective analysis which is split into four sections in this report. First, we use the estimated data to forecast future financial results and measure its present value by appropriate valuation methods that can be correlated with the current value. In the second section, there are four valuations models used to estimate the value of the equity. Then, there is sensitivity analysis followed by management consultation advice. In the prospective section, to forecast its potential periodic results, we use the perception of Harvey Norman’s operations in historical details and then estimate the approximate valuation of this business for potential investors.

Forecasting future is very common in business world. Similarly, we are analyzing and estimating the forecasting parameters of the chosen company i.e. “Harvey Norman Holdings Limited” in order to check its competitiveness in today’s world. The projection of Harvey Normans is based on the potential growth for coming 5 years, i.e. 2020 to 2024 in terms of revenue growth rate assumption, asset turnover (ATO) and profit margin (PM) is mentioned in this report. In order to assess Harvey Norman’s intrinsic worth, multiple predictions were made to predict the company’s projected accomplishment and financial position over the five-year forecast horizon and to forecast perpetuity. These assumptions are calculated based on the projected demand with Harvey Norman’s approach and is entirely based on historical data with personal understandings and assumption over the forecast period of five years.

1.     Forecasting

For the past several years, Harvey Norman Holdings Limited has been running its company and its key strategic advantage is the product’s band name and consistency. In a third party franchise arrangement, Harvey Norman Holdings Limited is a holding firm for businesses and trusts. The franchises run stores that offer home appliances and electrical items under the label “Harvey Norman Discounts.” The business offers the franchises with advisory and marketing services. All this allows Harvey Norman Holdings Limited to project their long-term market growth by actually investing their revenues, growing their business areas, expanding their product portfolio diversity and purchasing new companies to stabilize their growth.

Initial forecast assumptions

Sales growth

Owners of companies are often reluctant to estimate sales revenue. Each year is unusual, so businesses need to understand some shifting conditions, such as the present case of COVID 19, that might dramatically impact their revenues. These variables are known as the assumptions of the sales forecast that provides the framework for the forecasting.

The method of predicting what the profits of the firm would be in the future is Sales Forecasting. The prediction period for revenue can be weekly, quarterly , half-yearly, or annually. An important part of market strategy is revenue forecasting. Without a solid understanding of what the potential revenues will be, the inventory or the cash flow or growth plan will not be handled. The aim of sales forecasting is to have details that people can use to take good financial decisions.

The basis for Sales Forecast

A sales forecast is an estimation of the amount of products and services that will probably sell, the expense of the products and services, and the expected benefit over the forecast timeframe.

This is usually carried out by:

• Having a list of the products and services to be sold
• Predicting the amount of sales to be made for each item
• Multiplying the unit price by the amount of products or services to be sold projected
• Determination of the cost of each product or service
• Multiplying the cost of each product or service by the volume expected to be sold
• Subtracting net costs from total revenue

It could be appropriate to compress unit sales /costs into divisions if an organization has a huge number of items in stock.

Sales Forecast Assumptions

There are several parameters that can theoretically impact sales that can form the foundation for the prediction of sales, such as:

• The economy and the specific industry: is the economy losing momentum? Is the products and services demand rising or steadily decreasing? Is more rivalry going into the global market? Are you planning to grow or lose any big clients? An expectation of percentage growth or shrinkage in the sector should be included in the sales forecast.
• Regulatory changes: New rules or legislation may also have a positive or negative effect on the sales prospects.
• Company goods or services: Are you introducing any new products or services that could boost revenue, or are decreasing revenue of your current products / services due to improved products / services or lower competitive market prices? Due to higher material , labor, or other expenses, would you be pressured to boost rates and how will this effect sales?
• Company promotion efforts: Are you getting a head start on or investing more or less on ads on your new advertising campaigns? Maybe putting online a new business platform, improving your email campaigns, or expanding into social media to improve sales? Are you adding extra sales workers or lose the best sales assistant?

Sales Forecasting for Existing Businesses

Sales forecasting for an existing company is simpler than sales forecasting for a new company; the established business also has a prior sales prediction benchmark. Integrated with information of general business and financial patterns, a company’s sales revenues from the very same month in the previous year function well to forecast the earnings of a firm in a given potential month.

Develop a Range of Forecasts

It is a smart practice , particularly for new companies, to generate several revenue estimates using a variety of projections. The forecast leads to positive numbers and another focus on the negative ones is created after making an initial forecast utilizing the current estimates. When time passes, review the projection with the real values.

The sales outlook of a business dependent on the quantity of items it will offer in the future and the price they will charge on the market for the price. Harvey Norman Holdings Limited has an increasing annual sale rate over the period 2020 to 2024 and in that time their operating revenue will expect to increases from $2,397,353,000 to $3,638,460,000. Similarly, the growth rate is predicted to sow the growing trend.

Asset Turnover Ratio

Asset turnover calculates the capacity of the company to produce profits from its investments, whereas profit margin calculates the ability of the company to manage the expenses incurred to earn income. The level of asset turnover, indicating the asset usage of the company, and the profit margin, indicating the operational performance of the company, are partially products of the policy of the company. Efficiency is a company’s ability to function efficiently and use its products to produce sales and is demonstrated by the inventory turnover ratio in the financial forecasts framework. The ratio is an measure of how efficiently a company can derive profits from its investment portfolio. For the asset turnover ratio, there is no correct value, consideration must be undertaken if the ratio becomes too high, as while it may mean a very productive company, it may mean that the company is attempting to over-trade; producing too much revenue with very little asset investment. It appears to be reliable, partially because it’s a feature of the industry’s innovation. There is also an anomaly where it begins to decrease and then stabilize, like with the very high ATO businesses.

As asset turnover (ATO) illustrates how productive Harvey Norman utilizes its assets and how efficiently it generates sales, ATO can then be used to estimate the potential net operating asset (NOA), which calculates the value-added asset of the firm digitally. Refer to the ATO ratios in Appendix 1 , it is clear that the ATO ratios have been higher than 1 for the past few years and are almost compatible with 2.12, indicating that Harvey Norman has an important potential to earn profit from its operating properties. In comparison, in the last two years, its cash and account receivables, which are the dominant source of revenue profits, have risen dramatically. In addition, because of the increased trade and payables in the last two years, the company’s operating liabilities have gradually increased. The potential ATO ratio is expected to be 2.12 on average on the basis of this analysis, so the estimated net operating assets (NOA) will grow marginally from $1,130,827,000 to $1,716,255,000, as shown in Appendix 1.

Profit Margin

Profit margin is considered as the more variable part of ROE which tend to be driven towards “normal” by competition. A variation of the expected sales and profit margin (PM) has been used after modification of the projected sales to forecast the potential net operating profit after tax (NOPAT) for the next five years, extending from 2020 to 2024. The profit margin reflects the potential of the company to profit from each transaction. In the last year, the profit margin was 2.72% which is estimated to be same for the coming next five years. Nevertheless, sensitivity analysis is undertake for profit margin’s estimation based on the last year’s sales revenue which in turn will affect the net operating profit finally. So, the average number of profit margins is 2.72% as shown in Appendix 1 and this is used as the estimated profit margin to calculate future NOPAT (NOPAT = Sales x PM). Then the estimated periodic NOPAT is $65,208,010 in 2020 and will ascend to $98,966.100 in 2024.

Net dividend payout ratio

Since 2020, the dividend payout level has been exaggerated, ranging from $16,302,000 to $24,741,525 over the duration from 2020 to 2024. Therefore, as seen in Appendix 1, the projected future payoff ratio measured for the average historical ratio from 2020 to 2024 is 25 percent. Afterwards, the payment that Harvey Norman will pay to its debt holders in the future was projected, with a rising pattern varying from $16,302,000 to $24,741,525. The above calculation should be reasonable and should be expected in Appendix 1, as Harvey Norman’s net finance commitments (or net debt) have continued to rise in recent years due to the growing in long-term funding liabilities. Ultimately, from the aforementioned calculation, the estimated debt expense (NFEat) can be determined and should be used to forecast projected detailed incomes (NOPAT-NFEat), as referred to in Appendix 1. After checking by the estimated equity results, the comprehensive income for Harvey Norman in future five years are estimated from $62,534,420 to $92,075,123 as indicated in Appendix

2.     Valuation

Valuation is especially responsive to growth. It is an essential part of operating businesses in the long run as valuation provides clear picture of the performance of the company’s operations.

       i.            Dividend Discount Model

The Dividend Discount Model (DDM) is a mathematical way of assessing the stock price of a company founded on the notion that a stock’s current fair price constitutes the amount of all possible dividends of the firm discounted down to their current value (Setia, 2018).

Further division of the Dividend Discount Model

The Dividend Discount model was built under the assumption that the valuation of the stock represents the present value of all potential cash flows produced by the defence (Neumann, 2017). At the same time, dividends are basically positive cash flows created by the company and paid to its owners. Usually, with minimal input variables needed, the dividend discount model offers a simple way to measure a realistic stock price from a mathematical viewpoint. The structure, though, depends on certain assumptions that can not simply be anticipated. An analyst has to predict potential dividend payments, the growth in dividend payments, and the cost in equity capital, based on the variance of the dividend discount model (Neumann, 2017). It is very difficult to accurately predict all the factors. In certain ways, the ideal fair stock price so far has been from practice.

In the case of Harvey Norman Holding Limited, the value of equity under dividend discount model will be $2,482,192,000 as indicated in Appendix 3.

     ii.            Residual Income Model

The valuation of residual income (also regarded as the residual income model or the method of residual income) is a method of equity valuation built on the notion that the value of the shares of an organization equals the current value of potential residual income discounted at the required equity rate (Cziglerné Erb, 2020). A formula that calculates the value added from residual earnings projections are as follows.

Further Analysis of Residual Income Valuation

The basic assumption driving the valuation of residual income is that the actual cost of capital (i.e., all debt and equity costs) must be paid for by the income earned by the firm. While net income reporting takes into consideration the cost of debt (interest payments are included in the measurement of net income), the cost of equity is not taken into consideration, as dividends and other transfers of equity are not included in the calculation of net income.

For the aforementioned factors, the net benefit does not reflect the economic profitability and success of the company. Besides that, in some situations, even though accounting profits are announced by a corporation, those profits may turn out to be financially unviable after taking equity costs into account.

Residual income, on the other hand, is the amount of income accounted for equity expenses. Keep in mind that equity costs are simply the appropriate return rate demanded by investors as reimbursement for the cost of opportunity and the resulting amount of risk. In general, however, the worth of a company measured using the residual income valuation is more reliable since it is dependent on the company’s financial earnings.

Benefits of Residual Income Valuation

Normally, the valuation of residual income is appropriate for large firms that do not pay out dividends or pursue volatile dividend payout trends. In this respect, a suitable solution to the dividend discount model (DDM) is the residual income model (Romeiro, 2016). In addition, it fits well for industries who also do not produce positive cash flows. An expert must be mindful, though, that such a strategy is often focused forward in-looking hypotheses that can be distorted or are vulnerable to different biases. Residual income valuation is among the most known valuation methods in the business, alongside the discounted cash flow (DCF) model. The residual income model is commonly used in capital management, although the methodology is quite well-known. An absolute valuation model that attempts to assess the inherent value of a business is residual income valuation).

In the case of Harvey Norman Holding Limited, the value of equity under residual income model will be $652,006,560 as indicated in Appendix 4. The valuation with Residual income model in the case of Harvey Norman uses case 2 as a terminal value assumption because this is used for the sustainable competitive advantage where after certain time period, there will be zero residual income growth patterns.

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