Quantitative Techniques

Forecasting

Forecasting
Introduction
Forecasting is the establishment of future expectations by the analysis of past data, or the formation of opinions. Forecasting is an essential element of capital budgeting. Capital budgeting requires the commitment of significant funds today in the hope of long term benefits. The role of forecasting is the estimation of these benefits. 2

Forecasting Techniques and Routes

Techniqu es
Quantitati ve Qualitativ e

Routes
Top-down route Bottom-up route

Simple regressions Multiple regressions Time trends Moving averages

Delphi method Nominal group technique Jury of executive opinion Scenario projection

Quantitative Forecasting

Quantitative: Regression with related variable Data set of Sales as related to both time and the number of households.
H TR A DT I O I L AA S C YA ER 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1

H U E OD OSH L S
1 1 1 1 1 1 11 1 1 1 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1

SL S AE
11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1

Quantitative Forecasting
Quantitative: Sales plotted related to households.
SalesUnits Related to Number of Households
11 11 Sales Units 11 11 11 11 11 11 11 11 1 1 11 1 11 11 11 11 Sales

Number of Households
5

Quantitative Forecasting
Quantitative: Sales regressed on households.
SUMM ARY OUTPUT SALES REGRESSED AS A FUNCTION Edited output OF HOUSEHOLDS regression. from the Excel Regression Statistics M ultiple R 11 1 1 1 1 . 1111 R Square 11 1 1 1 . 1111 Adjuste d R Squa re 11 1 1 1 1 . 1 1 1 1<== "Stre ngth" of the re gre ssion Standard Error 1 11 1 1 1 1. 1 1 1 Observations 1 1

Coefficients Standard Error t Stat P-value Y Ax is Inte rce pt -1 11 1 1 1 11 1 -11 1 1 11 1 .1 1. 1 . . 1 Num be r of House holds 11 1 . 1 11 1 . 1 11 1 . 1 11 1 . 1
6

Quantitative Forecasting
Quantitative: Sales regressed on households.

Predicting with the regression output.

Regression equation is: Sales(for year) = -348.218 + ( 3.316 x households). Assuming that a separate data set forecasts the number of households at 1795 for the year 2006, then:

Sales(year 2006) = -348.218 + ( 3.316 x 1795) = 5,604 units.

7

Quantitative Forecasting
Quantitative: Multiple Regression Sales as a function of both time and the number of households.
H TR A DT I O I L AA S C YA ER 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1

H U E OD OSH L S
1 1 1 1 1 1 11 1 1 1 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1

SL S AE
11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1 11 1 1

Quantitative Forecasting:
Multiple Regression Line Information From the Excel spreadsheet.
S UM M ARY O UT P UT Regres s ion S tatis tic s M ultiple R 11 1 . 11 R S quare 11 1 . 11 A djus ted R S quare 11 1 < = = "S tre n g th " o f re g re ssio n . 11 . S tandard E rror 1 11 1 1. 1 1 O bs ervations 1 1

M UL T IP L E REG RES S IO N: S AL ES O N YEARS a n d HO US EHO L D

Y Ax is In te rce p t Ca le n d a r Ye a r Ho u se h o ld s

Coeffic ients S tandard E rror t -1 1 1 1 1 1 1 1 1 1 .1 1 1 1 1 11 1 . 1 11 1 1. 1 1 1. 1 11 1 11 1 . 11 11 1 . 1

S tat P -value Lower1 1 % -11 1 1 11 11 1 1 1 1 . . 1.1 11 1 11 1 . 1 . 1 1. 1 11 1 11 1 11 1 . 1 . 1 -11 1 .

9

Quantitative Forecasting: Using Multiple Regression

Multiple regression equation is:
Sales in year = -382643.91 +(193.33 x Year) + (0.1368 x Households) sales for the year 2005 is: Forecast of
Sales in year 2005 = -382643.91 + (193.33 x 2005) + (0.1368 x 1586) = 5200 Units (Note: the sales forecast relies upon a separate forecast of the number of households, given as 1 586, for 2005.) 10

Quantitative Forecasting
Quantitative: Time Series Regression Sales plotted as a function of time.
Plot of Past Sales Units By Year
11 11 Sales Units 11 11 11 11 11 11 11 11 1 11 11 11 11 Year
11

Sales

11 11

11 11

Quantitative Forecasting: Fitted Regression Line

Sales Regression: Line Fit Plot
11 11 11 11 Sales 11 11 11 11 11 11 1 11 11 Actual Predicted

11 11 Year

11 11

11 11
12

Quantitative Forecasting: Regression Line Information

From the Excel spreadsheet.
EDITED SUMMARY OUTPUT REGRESSION OF SALES ON YEARS Regression Statistics Multiple R 11 1 . 11 R Square 11 1 . 11 Adjusted R Square 11 1 . 1 1<== "Strength" of regression. Standard Error 1 11 1 1. 11 Observations 1 1

Y axis intercept Slope of line

Coefficients Standard Error t Stat P-value -111111 .11 1 1 11 1 1 1 . 1 1 -11111 11 1 . . 11 1 11 1. 1 1 . 1 1 11 1 11 1 . 11 11 1 . 11

13

Quantitative Forecasting: Regression Line Use

Equation for the regression line is:
Sales in year = -395541.56 + (199.87 x Year)

Forecast of sales for the year 2005 is:

Sales in 2005 = -395541.56 + (199.87 x 2005) = 5198 Units
(Note: the large negative Y axis intercept results from using the actual calendar years as the X axis scale.)

14

Quantitative Forecasting:
Regression: Auto Forecast by Excel.
Sales by Year, With Automatic Three Year Prediction
11 11 11 11 11 11 SALES

Sales

11 11 11 11 11 11 1 11 11 11 11 11 11 11 11 11 11

Simple Linear Regression, Forecast Out to Year 1111

Year
15

Quantitative Forecasting:
Moving Average- Auto Plot
Sales Units Per Year With Fitted Two Year Moving Average
11 11 Sales Units 11 11 11 11 11 11 11 11 1 11 11 11 11 Years 11 11 11 11
16

SALES 1per. Mov. Avg. (SALES)

Quantitative Forecasting:
Notes on Excel Auto Plot.
Excel will plot, and automatically forecast, a data series which has a functional relationship. For example, a regression trend line. The auto plot is driven through the Chart menu as Add Trendline. A particular forecast is specified via the dialog box. Future point data values cannot be read from the automated trendline. Non-functional relationships, such as a moving average, can be plotted, but cannot be automatically forecast.

17

Forecasting Routes
Top-Down
where international and national events affect the future behaviour of local variables.

18

Forecasting Routes

Where local events affect the future behaviour of local variables.

Bottom-Up
19

Forecasting: Summary
Sophisticated forecasting is essential for

capital budgeting decisions Quantitative forecasting uses historical data to establish relationships and trends which can be projected into the future Qualitative forecasting uses experience and judgment to establish future behaviours Forecasts can be made by either thetop down or bottom up routes.
20