EISTI Financial Analysis (Mode de Compatibilitu00E9)

Valuation: From Theory
to Practice
EISTI
Philippe Foulquier, PhD, EFFAS

Professor of Finance and Accounting
Director of EDHEC Financial Analysis
and Accounting Research Centre
Philippe Foulquier Valuation: from Theory to Practice
Plan
Chapter I. Financial Flows and Risk Price of the main protagonists
I. Food for thought
II. Difference between the value and the price of a company
III. Financial flows and risk price of the main protagonists
Chapter II. Choice of discount rate
I. Economic Theory
II. Choice of the time period t
III. Choice of the discount rate
IV. Models measuring market risk
V. How do we choose riskrisk-free rate, risk premiums and betas?
VI. Choice of discount rate
VII. References
Plan
Chapter III. Choice of cash flows
I. Economic theory
II. Dividend Discount Models
III. Free Cash Flow to Equity Discount Models
IV. Free Cash Flow to the Firm Discount Models
V. Value creation (EVA and MVA) Dashboard and company management
Chapter IV. Peer comparison
I. Comparison based on transactions: the issues
II. Price earnings ratio
III. Price earnings growth ratio (PEG)
IV. Relative P/E ratio
V. Net Asset Value or Book Value Multiple (NAV or BV)
VI. Operating multiple (sales, EBITDA, EBIT, etc.)
Plan
Chapter V. Case Study Privatisation of ASF
I.
II.
III.
IV.
V.
Privatization of ASF
ASF: Summary financial statement
ASF: FCFF forecasts
ASF: WACC
Equity value per share
Chapter VI. Case Study AGF (Allianz Group) Valuation

I.
Asset valuation (B/S)
II. Asset valuation (B/S) / Cash flow (P&L): mix valuation
III. Case Study: AGF (Allianz Group)
Bibliography
Introduction
Pillar II
Pillar III
Modelling
and valuation
Strategys
Analysis
Pillar I
Accountings Analysis
and forecasts
Financial Analysis
Chapter I. Financial Flows & Risk Price of the main protagonists
Food for thought
An inexperienced appraiser too often clings

to the formula as if it were a lifeline and lets
himself drift on the currents without the rudder
of a critical mind to guide him
H. Mauguire, 1961
There are no absolute values, because things do

not impose values on us; it is man himself
who sets them
Viel, Bredt and Renard, 1971
EXERCISE
Difference
between PRICE
and VALUE of a
company
Difference between the value and the price of a company

In its general theory, Keynes mentioned that the companys fundamental
value corresponds to the present value of the flows of revenues du to the
ownership of the capital.
Although the price is based on the value of the Company, it depends on
subjective elements which are not always quantifiable, e.g.:
relationship between the buyers and the sellers

their determination or obligation to succeed
their respective negotiation skills
the buyers interest in the company
etc...

Misjudging the goals of the companies can lead to inconsistent valuations
and halt negotiations.
Industrial logic
Financial logic
Politico-financial logic
Raider logic
Creditor logic
Parties
BALANCE SHEET
Assets
Fixed assets
Liabilities
Shareholders Equity
Inventories
Receivables
Financial debt
Cash and bank
Suppliers
Founder / CEO
Banks
Shareholders
Clients
Employees
State
Income statement
Operating revenues
Sales
Change in inv. of finished goods
Operating charges
Purchases of raw materials
R&D
Marketing
Personnel costs
Other operating charges
EBITDA
Depreciation and amortization
EBIT
FINANCIAL PROFIT
Corporate income tax
NET INCOME
10
Year
Income statement
EBIT
20
30
Employees & suppliers
Financial charges
-5
-5
-5
Bank
Income bf. Taxes
15
25
-5
-8
State
Net Income
10
17
Shareholders
Parties
Shareholders are paid after that all other commitments of the

company are satisfied (employees, suppliers, bank, State)
=> Shareholders equity = shock absorber for other contracting parties
11
Consumption
Savings
Revenue
Consup.
interest
Risk Price
time
time
Cost of
Deposit
risk
Own
of which default
funds
risk
real insterest
cost
Interest
rate
additional eventually
Investment
inflation
Cost
Invest.
time
Nominal risk
of debt
free rate
It is important for operational choices to know the risk

relation with each party (client, bank, shareholder)!
12

Capitalisation
Exercise:
Investment in year n: EUR100,000
Sale 10y after: EUR200,000
Assumptions: in the meantime, no
income from his investment and no
invested additional funds
Question:
Return of this investment?
13

Capitalisation
Capitalising income means foregoing receipt of it. It then become
capital and begins itself to produce interest during the following
periods
Year
N
N+1
N+2
N+3
N+4
N+5
N+6
N+7
N+8
N+9
Capital at the beginning

of the period (EUR)
100000.00
105000.00
110250.00
115762.50
121550.63
127628.16
134009.56
140710.04
147745.54
155132.82
Income
(EUR)
5000.00
5250.00
5512.50
5788.13
6077.53
6381.41
6700.48
7035.50
7387.28
7756.64
Capital at the end

of the period (EUR)
105000.00
110250.00
115762.50
121550.63
127628.16
134009.56
140710.04
147745.54
155132.82
162889.46
V(t+1) = V(t) + 5% V(t) = V(t) (1+5%)

Compound interest : V(t+1) = V(t) * (1+i)
V(T) = V(0) * (1+i)T
14

Capitalisation
Exercise:
Compare the three following investment rate of return:
- Tripling ones capital in 16 years
- Doubling ones capital in 10 years
- Asking for a 7,177% annual return
Conclusion regarding the previous exercise
15

Discounting
To discount means to calculate the present
value of a future cash flow
Discounting converts a future values into a
present value while capitalisation converts
values into future ones.
Having discounted the future value to a
present value, we can then compare it with
other values.
Discounting is based on the time value of
money (time is money!)
V(0) = V(T) * [1/(1+i)T]
where 1/(1+i)T discounting factor
V(T) = V(0) * (1+i)T where (1+i)T capitalisation factor
16

Present Value (PV) and Net Present Value (NPV)
PV = t=1
(1+i)t
NPV = t=1
(1+i)t V0
t=1,n Ft / (1
t=1,n Ft / (1
where
Ft cash flows generated by the security or project,
i
applied discounting rate
n
number of years for which the security or project is discounted
V0 invested capital (project) or market value (security)
The NPV decision rule says to invest in projects when NPV > 0
Exercise
Comment: in efficient fairly valued market, NPV are zero
17
IRR Internal Rate of Return (or yield to maturity)

The discounting rate that makes NPV equal to zero is called the IRR or yield to
maturity.
If an investments IRR is higher than the investor-required
return, you will make the investment or buy the security.
Yield to maturity => financial security
Internal Rate of Return => other capital expenditure
An investment is worth making when its internal rate of return is equal to or
greater than the investors required return.
18

Exercise
Take the following example of an asset (e.g. a financial security or a capital
investment) whose market value is
Year
Cash flow
1
1
2
1,1
3
1,2
4
1,3
5
1,4
1. Based on a 10% discount rate, determinate the discounting factors and

the present value
2. Based on a market value of 4, calculate the NPV
3. Based on different discount rates, calculate the NPV
4. Investment decision
19

Solution: IRR=14.3%
Year
Cash flow
1
1
2
1,1
3
1,2
4
1,3
A 10% discount rate produce the following discounting factors

Year
Discount factor
Present value
Sum PV
1
0,909
0,909
4,477
2
0,826
0,909
5
1,4
10%
3
0,751
0,902
4
0,683
0,888
5
0,621
0,869
As a result, the present value of this investment is about 4,5. As its market value is 4,
its net present value is approximately 0,5
If discount rate changes, the following values are obtained
Discounted rate
PV of the investment
Market Value
NPV
0%
6,000
4
2,000
5%
5,153
4
1,153
10%
4,477
4
0,477
15%
3,930
4
-0,070
20
The Limits of the IRR

Exercise: Reinvestment rate
Consider two investments A and B with the following cash flows.
Investments market value is 10 and 15 respectively for A and B.
Year
Investment A
Investment B
1
12
4
2
1
6
10
Based on a 5% discount rate:

1.
Calculate discount factors, present value and net present value for each
two investments
2.
Determinate the IRR of each two investments
3.
Conclusion
21
Exercise: Reinvestment rate - Solutions
Discount rate
Year
Discount factor
PV(A)
PV(B)
Total PV(A)
Total PV(B)
NPV(A)
NPV(B)
5%
1
0,952
11,429
3,810
12,336
19,493
2,336
4,493
Discount rate
Year
Discount factor
PV(A)
Total PV(A)
NPV(A)
27,8%
1
0,782
9,390
10,002
0,002
Discount rate
Year
Discount factor
PV(B)
Total PV(B)
NPV(B)
12,3%
1
0,890
3,562
14,999
-0,001
2
0,907
0,907
5,442
3
0,864
4
0,823
5
0,784
6
0,746
7
0,711
0,000
0,000
3,134
0,000
7,107
Synthesis
NPV at 5%
investment A 2.336
investment B 4.493
contradictory conclusions
2
0,612
0,612
2
0,793
4,758
3
0,706
0,000
4
0,629
0,000
5
0,560
2,240
6
0,499
0,000
IRR (%)
27.8
12.7
7
0,444
4,440
22
Exercise: Multiple IRR or no IRR

Consider the following investment and calculate IRR. What is your
conclusion?
Year
Cash flow
0
-2
1
14,4
2
-14,4
Consider the following investment and calculate IRR. What is your

conclusion?
Year
Cash flow
0
6,4
1
-14,2
2
8
23
Plan
24
Plan
I. Economic Theory
III.1. What does it mean to discount a sum?
III.2. Diversifiable and non diversifiable risk?
III.3. Market risk premium
IV.1. CAPM
IV.2. APT
IV.3. Regression or proxy models

V.1. Risk-free rate choice
V.2. Risk premium choice
V.3. Beta choice: 2 approaches
VI.1. Cost of equity
VI.2. Cost of capital
25
Chapter 2: Choice of discount rate

I. Economic theory
The value of a financial asset is equal to the present value of future flows
generated by the asset
t
V0 = t=1
F
/
(1
(
1
+i)
t=1,n t
where
Ft are the flows generated by the asset,

i is the applied discounting rate
t is the number of years for which the asset is discounted
26

I. Economic theory
V0 = t=
(11+i)t
t=1
1,n Ft / (
where
? ?

27

II. Choice of a time period t
a) n : life of the asset
b) In accordance with the kind of investment (financial or
industrial), the nature of the company
c) V0 = [[
t=
1+i)t ] + [Vm / (1+i)m ]
t=1
1,m Ft / ((1
i) Liquidation value
ii) Multiple approach
iii) Stable growth model
28

V0 = t=
(11+i)t
t=1
1,n Ft / (
where

29

III. 1. What does it mean to discount a sum?
Two components in the discount rate:
Time
Risk
The distribution of returns on an investment
Variance or standard deviation
Skewness
Kurtosis
30

III. 2. Diversifiable and Nondiversifiable Risk
Components of risk: firm-specific and market
Diversification reduces or eliminates firm-specific
An intuitive explanation: 2 reasons
A statistical analysis:
2P =A 2A+(1-A)2 2B +2 A(1- A)AB A B
Limits: assets can be traded easily

and at low cost
31

III. 3. Market risk premium
The discount rate is a function of:
interest rate
Inflation rate
Market risk premium (RM -Ro)

32

The required rate of return of an asset i is a linear function of the risk,

measured by the beta of the asset
E(ri) = rF + i (E(rM) rF)
E(rM) rF is the premium required by investor for investing in the market
portfolio instead of investing in a risk-free asset
33

Cost of equity = risk free rate + [ * ((market
market risk premium) ]
MARKET RISK PREMIUM IN EUROPE

14%
13%
12%
11%
10%
9%
8%
7%
6%
01
0
12
/2
01
0
09
/2
01
0
06
/2
01
0
03
/2
00
9
11
/2
00
9
08
/2
00
9
05
/2
00
9
01
/2
00
8
10
/2
07
/2
00
8
5%
34
Plan
I. Economic Theory
IV.1. CAPM
IV.2. APT
IV.3. Regression or proxy models

V.1. Risk-free rate choice
VI.1. Cost of equity
35

IV.1. Capital Asset Pricing Model
Assumptions
No transaction costs, assets infinitely divisible (diversification)

Efficient portfolios (higher return for a given level of risk)
Homogeneous expectations among investors (all relevant information)
=> market portfolio
Introduction of the risk-free asset (risk preference)
CAPM: E(ri) = rF + i (E(rM) rF)

36

IV.2. Arbitrage Pricing Theory (APT)
Firm-specific and market risk components (like the CAPM)

Diversification eliminates firm-specific risk
Market risk measured to unspecified macroeconomic variables
APT: E(ri) = rF + i1 (E(r1) rF) ++ iK (E(rK) rF)

Where
ik beta on factor k (called factor beta )

E(rK) rF risk premium for each of the factors in the model
called factor risk premium
CAPM: E(ri) = rF + i (E(rM) rF) special case of APT

37

IV.3. Regression or Proxy models
Fama and French model (1992) increasingly used

E(ri) = rF + i1 (E(rM) rF) + i2 (E(rsmall) E(rbig) + i3 (E(rhigh) E(rlow)
3 factors: market return (CAPM)
size (gap between small and large caps: liquidity)
book value/market capitalization
Over 1963-1990, high-return investments tended to be investments in
companies with low market cap and high book-to-price ratio
Other factors: P/E, market capitalization, liquidity (through size, free float,
transaction volume, bid-ask spread), etc.
38

Economic theory
V0 = t=1
(11+i)t
t=1,n Ft / (
where

i is the discount rate, the required rate of return of an asset j, a linear
function of the risk, measured by the beta of the asset:
E(rj) = rF + j (E(rM) rF)
?? ?
39

V.1
V.1. Risk
Risk--free rate choice
Expected return known with certainty
There can be no default risk (at least on local borrowing).

(adjustment when default-free entity exists)
There can be no reinvestment risk

=> different risk-free rates for each period? Zero coupon rate?
Horizon
40

V.2
Historical premium earned by stocks over default-free securities over long

time periods
Three reasons for the divergence in historical risk premium

i) Time period used (risk aversion issue)
ii) Choice of risk-free securities
iii) Choice of market index
Alternative approach: the implied equity premium

41

V.3.1. Historical market betas

Rj = a + b RM where a: intercept from the regression
b: slope of the regression = cov(Rj, RM)/M2
CAPM: Rj = RF + (RM RF) = RF (1- ) + RM
a - RF (1- ) is called Jensens alpha and provides a measure of performance
of the investment during the period of the regression
42

EXERCICE : COCACOCA-COLA
State your view of the situation (, annualised excess return, R2, Sdt Error)
Linear Relationship : E(ri) = rF + i (E(rM) rF)
Y = Coca Cola return
X = S&P return
Points = 520
(10Y weekly)
Y = 0,528 X + 0,042
R2 = 0,257
Std Error of beta = 0,112
43

EXERCICE : COCACOCA-COLA
State your view of the situation (, annualised excess return, R2, Sdt Error)
Linear Relationship : E(ri) = rF + i (E(rM) rF)
Y = Coca Cola return
X = S&P return
Points = 520
(10Y weekly)
Y = 0,528 X + 0,042
R2 = 0,257
Std Error of beta = 0,112
44

V.3
V.3.1 Historical market betas
In practise: using a service beta (Bloomberg, Datastream, Value Line,
Brokers) but beta estimates are very different between the providers and
they do not reveal their estimation procedures (except Bloomberg)
Four reasons for the divergence in historical beta
i) Time period used (risk characteristic change)
ii) Choice of return interval
iii) Choice of market index
iv) Estimation procedure (e.g. adjusted beta for Bloomberg)
45

V.3
V.3.2. Fundamental betas: the bottom
bottom--up betas process
Less reliant on historical betas and more cognizant of the fundamental

determinants:
i) Type of businesses (sensitivity to market conditions)
ii) Operating leverage (costs)
iii) Financial leverage

46

V.3.2. Fundamental betas: the bottombottom-up betas process
Less reliant on historical betas and more cognizant of the fundamental

determinants:
i) Type of businesses (sensitivity to market conditions)
ii) Operating leverage (costs)
iii) Financial leverage

47

V.3
iii) Financial leverage (Proposition I of Modigliani Miller)
Scenario
without debt
1000
Scenario
with debt
1000
-300
Profit before tax (EBIT - rD D)
1000
700
Tax (TC =35%)

Profit after tax
Total cash flows for shareholders and lenders
-350
650
650
-245
455
755
EBIT
Net Financial expenses (rD D)
Total cash flow for shareholders and lenders = (EBIT rD D) (1 - TC ) + rD D

= EBIT (1 - TC ) + rD D TC
VL = [EBIT (1 - TC ) / rU] + [rD D TC / rD]
= VU + TC VD (Proposition I of Modigliani Miller)
48

V.33.2. Fundamental betas: the bottomV.
bottom-up betas process
iii) Financial leverage (Hamada 1972)
1972)
EV = VU + TC VD = VE + VD (1)
EV = UVU/(VU+TCVD)]+[DTCVD/(VU+TCVD)]
= [EVE/(VE+VD)]+[DVD/(VE+VD)] (2)
E = U + [(1 TC) (
U - D) (VD/VE)
where:
E = Levered beta in the company, determined both by the riskiness of the

business and financial leverage
U = Unlevered beta of the company (without any debt)
TC = Corporate tax rate
VD/VE = Debt-to-equity ratio (market value)
When D -> 0 and
E = U [1 + ((1
1 TC) (VD/VE)]
49

V.3
bottom--up betas process (in 5 steps)
i)
ii)
iii)
iv)
Identify the business(es) (sector)

Determinate the for the sector (average for comparable companies)
Calculate the average debt to equity ratio of the sector and estimate the
average unlevered for the sector:
Unlevered sector = sector / [[1
1 + ((1
1 TC) (VD/VE)sector]
Estimate the unlevered for the company, thanks to a weighted average of
the unlevered for the businesses it operates in:
Unlevered company = j=1
j=1,K Unlevered j x Value weightj
v)
where the company is assumed to be operating in K different businesses

Estimate the current market values of debt and equity at the company and use
this debt to equity ratio to estimate a levered .
1 TC) (VD/VE)company]
Levered company = Unlevered company [1 + ((1
50

V.3
What are the advantages of the bottombottom-up betas process?
i) Adapted to reflect actual changes in a companys business mix and
expected changes in the future
ii) Idem for the debt ratios over time
iii) Adapted to deal with private firms, division of business, and stock with
insufficient historical data.
iv) Much lower standard error
51

V.3.2. Fundamental betas: the bottombottom-up betas process
What are the weaknesses of the bottombottom-up betas process?
i) Define how narrowly we want to define a business
ii) and after comparable companies
iii) Estimating betas
iv) Averaging method (market-weighted average or arithmetic average)
52

V.1
V.1. Cost of equity
CAPM: Expected return = Risk-free rate + ( * expected risk premium)
Multifactor models:
Expected return = Risk-free rate + j=1,K(j * expected risk premiumj)
What are the implications for equity investors and managers?
53

VI.2
VI.
2. Cost of capital
Weighted average of the costs of the different components of financing,
(equity, debt, and hybrid securities)
The cost of debt measures the current cost to the company of borrowing
funds to finance projects, function of:
i) The risk-free rate
ii) The default risk (default spreads, rating, alternative if no rating available)
iii) Tax benefit associated with debt
54

Year
1
2
3
Operating lease
expense
1000
800
600
Present
Value @ 5%
952
726
518
450
370
5
320
6
220
PV of operating lease expenses
251
164
2981
Debt
Equity
Components (leases),
Market value
Components (management options)

Market value
Cost of capital
Cost of capital rEV = rE (VE/(VD+VE)) + rD (VD/(VD+VE))
55

VII. References
Fama, E.F. and K.R. French. 1988. Permanent and temporary components of stock prices.
Journal of Political Economy, 96, 246-273
Fama, E.F. and K.R. French. 1992. The cross-section of expected returns. Journal of
Finance, 47, 427-466
Hamada, R.S. 1972. The effect of the firms capital structure on the systematic risk of
common stocks. Journal of Finance, 27, 435-452
Markowitz, H.M. 1952. Portfolio selection. Journal of Finance, 7, 77-91
Markowitz, H.M. 1991. Foundations of portfolio theory. Journal of Finance, 46, 469-478
Modigliani F. and M. Miller. 1958. The cost of capital, corporation finance and the theory
of investment. American Economic Review, 48, 261-297
Ross, S.A. 1976. The arbitrage theory of capital asset pricing. Journal of Economic Theory,
13, 341-360
Sharpe, W.F. 1964, Capital asset prices: A theory of market equilibrium under conditions of
risk. Journal of Finance, 19, 425-442
56
Plan
57
Plan
I. Economic theory
V. Value creation (EVA and MVA)
58
Chapter 3: Choice of cash flows

I. Economic theory
t
V0 = t=
F
/
(
(1
1
+i)
t=1
1,n t
where
? ?

59

V0 = t=1, Ft / (1+i)t = t=1, Dt / (1+rE)t
where Dt expected dividends and rE cost of equity (levered beta)
Flexible enough to allow for time-varying discount rates

(CAPM or multifactor models)
Several versions of DDM based on different assumptions about future

growth
i)
Stable growth (Gordon Shapiro)
V0 = D1 / rE- g where g perpetual growth in dividend Dt+1 = Dt (1+g)

Particular case: g=0
=> V0 = D / rE (Irving Fisher)
60

ii) Two stage DDM
V0 = t=1,n Dt / (1+rE)t + Vn / (1+rE)n

where Vn is the terminal value. If we assume
a growth rate forever after year n
Vn = Dn / rE- gn
iii) Modolovski: three stage DDM
Initial period: growth period based on the fundamentals of the company
Transitional period: linear declining growth (Fuller and Hsia 1984)
Final period: stable growth phase
iv) Strengths and weaknesses

61

FCFE: variants on the DDM

Cash flows to equity left over after meeting all financial obligations vs.
dividends => after the impact of financing
2 approaches: from the bottom up or from the top down

FCFE =
net profit + depreciation and provisions capital expenditure

- change in working capital + new debt issue debt repayment
- exceptional items + asset disposal
FCFE =
EBITDA change in WC
+ financial profit - tax capital expenditure
62

The company value is V0 = t=1,inf FCFEt /(1 +rrE)t

- if FCFE growth is equal to zero => then V0 = FCFE / rE
- if FCFE growth is equal to the rate g => V0 = FCFE1 / (rE - g)
- if FCFE growth is variable:
V0 = t=1,n FCFEt /(1 + rE)t + Vn /(1 + rE)n
= t=1,n FCFEt /(1 + rE)t + FCFEn [(1+g)/(rE - g)] /(1 + rE)n
Given the weight of the terminal value (especially as the forecast period short),
a sensitivity study with different rE and g is recommended
63

FCFF: sum of the cash flows to all claim holders in the firm
including stockholders and bondholders.
The company is valued the same way as in the FCFE method, but before the
impact of financing, i.e. before financial profit.
FCFF = EBIT (tax + (tax rate * interests)) + depreciation capital expenditure

- change in WC
The value of capital employed to finance productions process is the present

value of future FCFF discounted at weighted average cost of capital
WACC)t
VCE = t=1,inf FCFFt /(1 + WACC
64

The company value is V0 = t=1,inf FCFFt /(1 + WACC)t
- if FCFF growth is equal to zero => then V0 = FCFF / WACC
- if FCFF growth is equal to the rate g => V0 = FCFF1 / (WACC - g)
- if FCFF growth is variable:
V0 = t=1,n FCFFt /(1 + WACC)t + Vn /(1 + WACC)n
= t=1,n FCFFt /(1 + WACC)t + FCFFn [(1+g)/(WACC - g)] /(1 + WACC)n
Given the weight of the terminal value (especially as the forecast period short),
a sensitivity study with different WACC and g is recommended
65

OPERATIONAL
DECISIONS
Assets
Fixed assets
Inventory
Receivables
Cash and bank
FINANCIAL
DECISIONS
Sales
Change in inv. of finished goods
Purchases of raw materials
R&D
Marketing
Personnel costs
Other charges, depr. amort.
EBIT
ROCE
Economic
Profitability
=
Net EBIT
Net Fix. Assets + WC
Liabilities
Shareholders
Equity
Financial debt
VALUE
CREATION
ROCE > WACC
WACC
Return required
by fund
providers
Suppliers
1) OPERATIONAL DECISIONS define financial needs

2) VALUE CREATION => ROCE > WACC
66
66

From accounting to an economic approach

ACCOUNTING BIASES
Provisioning and amortization policy

Inventory valuation policy
Policy to manage costs over several financial years
Classification of assets under IFRS (fair value and financial crisis)
Tax optimisation
Communication policy (for example: smoothing )
Exceptional items management
Etc.
67

From accounting to an economic approach

. to CASH FLOWS:
- Independent from accounting choices and rules,
- Reflect the companys financial flows (4 categories)
Economic activity: Cash flow from operating activities
Cash flow from investing activities
Financing activity: Equity cash flow and debt cash flow
- while incorporating the length of the operating cycle (which in general
does not correspond to the length of the accounting cycle)
- and the collection lapses (working capital).
68
68

Different types of cash flows
1- CASH FLOW (CF) . IMPROPER

-
CF is financing that is internally generated by the firm.
CF = EBITDA net financial expense corporate income tax
CF = net income + depreciation and amortization and impairment

losses - capital gains + losses of asset disposals - net exceptional and
extraordinary items
69
69

2- OPERATING CASH FLOW (OCF)

-
The operating cycle is characterised by a time lag between the

positive and negative cash flows deriving from the length of the
production process (which varies from business to business) and the
commercial policy (customer and supplier credit).
OCF = operating revenues operating expenses

= EBITDA WC
Operating cash flow = net income + depreciation and amortization
of fixed assets - capital gains + losses on asset disposal change in
WC
EXERCICE : comment the 2nd formula based on a operating approach
70
70


3- FREE CASH FLOW (FCF)
- From a cash flow standpoint, capital expenditures modify the
operating cycle in order to generate higher operating inflows and to
achieve a higher profitability. FCF are the flow generated from
economic assets (equity + debt)
- FCF (before tax) can be defined as operating cash flow minus capital
expenditure (investment outlays).
- FCF = EBIT (1- Tax) + DA WC CAPEX (net investments)
- Base of DCF
71
71

NET PRESENT VALUE (NPV)

- From the cash flows of an investment it is possible to determine its
value creation
- NPV represent the value of cash flows linked to the investment
discounted at the rate of return required by the market. This rate of
return depends on the investment risk.
- The NPV represents the expected amount of value creation
anticipated for the investment. An investment may be undertaken if
the NPV is positive.
72
72

NET PRESENT VALUE (NPV)
Time
NPV =
WACC
Perpetual growth rate
73

Turnover - operating charges - financial charges - taxes
CASH FLOW STATEMENT
- Change in working capital (WC)

- Change in debt linked to operating
= Cash flow from operating activities (I)
+ Acquisition of fixed assets (CAPEX)
- Fixed assets transfers
- Change in debt from fixed assets
To determine the cash flows

related to the business, it is preferable to
to establish all the flows related to
the operational activity.
= Cash flow from investment activities (II)
This allows having a better understanding
(I) - (II) = FCF after financial expenses
of the business model and its sensitivity.
- Dividends paid to shareholders

+ Capital increase in cash
+ loans issued - loans reimbursed
= Cash flow from financing activities (III)
Change in cash balance (I - II + III) - Net debt reduction
74

Measuring the impact of decisions on value creation
Strategic, operational and financial

decisions have a strong impact on value
creation.
The measurement of the impact has to take

into account interactions between:
* Profit and loss
* Balance sheet
* Cash flow statement
75

Exercise : Case study FCF Cie
76

Exercise : Case study FCF Cie
Congratulations, you have been designated CFO of FCF company. During your
first meeting, you will analyse the launch of a new business line with the
marketing, operations and budget directors.
A.
In order to boost FCFs sales (growth rate has been slow for a few years), the
marketing director suggests launching a new product to reach a market
segment that has been inaccessible until now.
He proposes to sell this new product at a price of EUR 239 each (year N+1),
which is the same price of other exiting products. The total amount of sales
(existing and new products) is estimated to be 110,000 items.
The sales amount during the previous year (N) was EUR 24,600 KEUR
77

B.
The three directors have developed a business plan to launch the

new line of business. The budget director has analysed the project
feasibility and points out that it will be necessary to finance an
increase in WC, based on the following information:
Information on receivables and inventory of finished goods:
Receivables from clients in year N amounted to EUR 4,420K

Clients/sales ratio is stable in N+1
End inventory in year N amounted to EUR 425K
Change in inventories in work in progress and finished goods (income
statement) in year N amounted to EUR - 425K
Sales in year N+1 are estimated to be equal to amount produced of
110,000 units
78

C. The operations director and the marketing director analysed the impact of
launching the new line of business based on:
i ) Purchase of raw materials related to the new product

Information on purchases of raw materials and suppliers
In N: Purchases of raw materials amount to EUR 8,000K - inventory to EUR800K
Change in raw materials inventory: EUR 0K
Payables to suppliers: EUR 1,200K
Suppliers/purchases ratio is stable in N+1
In N+1: Purchase of 110,000 items at EUR 80 each and the total amount is
consumed
D. As well as...
ii) The launch of a marketing campaign
Information on other external costs (rent, services, marketing, R&D)
In N: EUR 2900K
In N+1: an increase of EUR 500K linked to sales increase (marketing)
79
79

D. next
iii) Hiring of 5 people
Information on employees
In N: EUR 10,500K in N+1: Employment of 5 people with a cost of EUR 120K each
(+50% of welfare costs for the company)
iv) Acquisition of new machinery and modernisation of existing machinery
Information regarding fixed assets
In N:
Number of existing machines: 10 at EUR 400K each

Depreciation over 5 years. Net fixed assets: EUR 1,280K
In N+1 January: Acquisition of 3 machines (EUR400K each). Depreciation in 5 years

Disposal: 2 machines at EUR 0 (N: last year of depreciation waste)
80

E.
The former CFO planned the following financial transactions to finance

the new project:
Information on debt and capital increase
In N:
EUR 1,700K
Cost of debt: 7.65%
In N+1: Debt reduction of EUR 1,300K at 7.65% and debt increase of

EUR 1,200K at 7.20%. Capital increase of EUR500K
F.
Other information
Tax rate: 40% in N and N+1
Dividend pay-out ratio: 45.2%
In N Cash: EUR 500K; registered capital: EUR 1,600K;
reserves: EUR1,080K
Cost of capital: 9%
81
81

Case study FCF Cie - QUESTIONS
1.
In order to study the impact of operational and commercial decisions on

the companys performance and the value creation derived from the new
project, you suggest to draw up the income statement, balance sheet
(year N and N+1), and cash flow statement (N+1);
calculate
the
operating cash flow, FCF for year N+1
2.
. and determine the companys margins and profitability (ROE, ROCE)
3.
Based on a study of the sensitivity of these indicators (cash flows,

margins, profitability, value creation), what commercial, operational and
financial policies would you suggest implementing in order to improve
the companys profitability?
82

Exercise 20: Case study FCF Cie ANSWERS
1A. The marketing director suggests to boost sales by launching a new product. He
proposes to sell it at EUR 239 each (year N+1) which is the same price of existing
products. The total amount of sales (existing and new products) is estimated to
be 110,000 units. The sales amount for year N was EUR 24,600K.
Sales = quantity sold * unit price
= 110,000 * 239 = EUR 26,290 K
Forecast
Income statement
Sales
year n
24 600
% of sales
year n+1
Change
26 290
6,9%
% of sales
83

1B. The three directors have developed a business plan to launch the new line of
business. The budget director has analysed the project feasibility and points out
that it will be necessary to finance an increase in WC, based on the following
information:
a) Receivables from clients in year N amounted to EUR 4,420K
Receivables from clients / sales (N) = 4,420 / 24,600 = 17.97%
100% - 17.97% = 82.03% paid in cash
Receivables from clients N+1 = 17.97%*26,290 = EUR 4,724K (B/S N+1)
Cash flow statement N+1
Sales collected = 26,290 * 82.03% = EUR 21,566 K (+)
Receivables from clients collected (N) = EUR 4,420 K (+)
84

information:
b) End inventory in year N was EUR 425K
c) Sales in year N+1 are estimated to be equal to the produced amount of 110,000 items at
a cost per item of EUR 170.
Inventory of production (unsold goods)

initial inventory + amount produced = amount sold + final inventory
+
=
+
Initial inventory
amount produced
amount sold
End inventory
EUR 425K
EUR 18,700K (110,000*170)
EUR 18,700K (110,000*170)
EUR XK => X = EUR 425K (B/S inventory N+1 = EUR 425K)
85

information:
d) Change in inventories in work in progress and finished goods (income
statement) in year N amounted to EUR -425K
Change in inventories (unsold goods) = end inventory - initial inventory
= EUR 425K (EUR -425K) = 0 (income statement N+1)
Forecast
Income statement
year n
Sales
24 600
Change in inventory of finished goods

Balance sheet
Receivables
Inventory of finished goods
% of sales
-425
year n+1
% of sales
change
26 290
6,9%
ns
-1,7%
ns
year n
year n+1
change
4 420
4 724
7%
425
425
86
0%
86

1C. The operations director and the marketing director analysed the impact of
launching the new line of business based on taking into account the purchase of
raw materials:
i) In year N: Purchase of raw materials: EUR 8,000K, inventory to EUR 800K
In N+1: Purchase of 110,000 items at EUR 80 each and total amount is
consumed
Purchase of raw materials in N+1 : 80 * 110,000 = EUR 8,800 K (=> Income
statement N+1)
Raw materials = initial inventory + amount purchased = amount consumed
+ end inventory
800 + 8,800 = 8,800 + X => X = 800 (B/S N+1)
Balance sheet
year n
year n+1
change
Receivables
4 420
4 724
7%
Inventory of raw materials
800
800
0%
425
425
87
0%
87

1C. The operations director and the marketing director analysed the impact of launching
the new line of business based on taking into account the purchase of raw materials:
i) In year N: Purchase of raw materials: EUR 8,000K, inventory to EUR 800K
In N+1: Purchase of 110,000 items at EUR 80 each and total amount is consumed
Change in inventory of finished goods (P&L N+1)
= End inventory Initial Inventory = 800-800 = 0
* Suppliers N = EUR 1,200K => Suppliers / purchases = 1,200 / 8,000 =15%
Suppliers N+1 = 15% * 8,800 = EUR 1,320K (B/S N+1)
Share of purchases paid in cash = 1 - 15% = 85%
Purchases collected N+1 = (1-15%)*8,800 = EUR 7,480K (Cash flow statement N+1)
Payables to suppliers EUR 1,200K (paid out in N+1)
88

1C.
Cash flow statement
year n+1 comments

21566 collected 1- receivables from clients n+1
Sales collected
Receivables from clients
4 420 collection of receivables from clients n
Accounts payable suppliers
-1 200 payment of suppliers year n in n+1
Purchases
-7 480 payment of part of purchases in n+1

Forecast
Income statement
year n
Sales
24 600

Purchases
year n+1
change
26 290
6,9%
% in sales
-425
-1,7%
ns
ns
8 000
32,5%
8 800
10,0%
33,5%
0,0%
ns
ns
Change in inventory of raw materials
Balance sheet
% of sales
(celle non pr
year n
year n+1
change
4 420
4 724
7%
800
800
0%
425
425
0%
89

1D. The operations director and the marketing director analysed the impact of
launching the new line of business based on taking into account:
ii) The launch of a marketing campaign with a cost of EUR 500K
Information on other external costs (rent, services, marketing, R&D)
In N: EUR 2900K
In N+1: an increase of EUR 500K linked to sales increase
=> external costs (rent, services, marketing, R&D) = EUR +500K
Other external costs N = EUR 2,900K
(P&L N)
Other external costs N+1 = 2,900 + 500 = EUR 3,400K (P&L N+1 & CF statement)
iii) Hiring of 5 people In N: EUR 10,500K
In N+1: employment of 5
people with a cost of EUR 120K each (+50% of welfare costs for the company)
=> Unit cost = 120 + (120*50) = EUR180K => 5 people = 5*180 = EUR 900K
Personnel (P&L N) = EUR 10,500K Personnel (P&L N+1) = EUR 11,400K (CF stat.)
90

1D. iv) Acquisition of new machinery and modernisation of existing machinery
Information regarding fixed assets
In N:
EUR 1,280K (net)
depreciation over 5 years
Number of existing machines: 10 acquired at EUR 400K each
In N+1:
Acquisition of 3 machines at EUR 400K each (depreciation over 5 years)
Disposal: 2 machines at EUR 0 (N: last year of depreciation waste)
* N: acquisition price / unit = EUR 400K Depreciation period = 5 years

annual depreciation per unit = EUR 80K => Depreciation N = EUR 800K (P&L N)
* N+1: acquisition of 3 machines = 3*400 = EUR 1,200K and annual depreciation per
unit = EUR 80K
* N+1: disposal of 2 machines waste => disposal price = 0
=> total machines = 10 + 3 - 2 = 11
Depreciation N+1 = 80 * 11 = EUR 880K (P&L N+1)
* Net fixed assets N+1 = net fixed assets N + investment disposals depreciation
= 1,280 + 1,200 0 880 = EUR 1,600K (B/S N+1)
Cash flow from investment activities CAPEX = EUR -1,200K
disposals = EUR 0K
91

1D.
Cash flow statement
year n+1 comments

21566 collected 1- receivables from clients n+1
Sales collected
4 420 collection of receivables from clients n
-1 200 payment of suppliers year n in n+1
Purchases
-7 480 payment of part of purchases in n+1
External costs
-3 400 payment of external costs
(celle non pr
-11 400 payment of wages
Personnel costs
= Cash flow from operating activities
-Acquisition of fixed assets (CAPEX)
-1 200
- Disposals of fixed assets
= Cash flow from investment activities
-1 200
Balance sheet
year n
year n+1
change
Net fixed assets
1 280
1 600
25%
4 420
4 724
7%
800
800
0%
425
425
0%
92
92

1D.
Forecast
Income statement
year n
Sales
24 600

Purchases
External costs (rent, services, marketing, tax)
Personnel
Depreciation
EBIT
% of sales
year n+1
change
26 290
6,9%
% of sales
-425
-1,7%
ns
ns
8 000
32,5%
8 800
10,0%
33,5%
0,0%
ns
ns
2 900
11,8%
3 400
17,2%
12,9%
10 500
42,7%
11 400
8,6%
43,4%
800
3,3%
880
10,0%
3,3%
1 975
8,0%
1 810
-8,4%
6,9%
93

1E. The former CFO planned the following financial transactions to finance the new
project:
Information on debt and capital increase
In N: EUR 1,700K
Cost of debt: 7.65%
In N+1: Debt reduction of EUR 1,300K at 7.65% and debt increase of EUR 1,200K at 7.20%.
Capital increase of EUR500K
* In N: LT debt = EUR 1,700K (B/S N) => fin. expenses (P&L N) = 7.65%*1,700 = EUR130K
* In N+1: debt reduction = EUR -1,300K => deductible fin. expenses = 7.65% * 1,300 =
EUR 99K
Debt increase = EUR 1,200K => additional fin. Expenses = 7.2% * 1,200 = EUR 86K
Total fin. expenses (P&L N+1) = 130 - 99 +86 = EUR 117K (cash flow statement)
LT debt = 1,700 1,300 + 1,200 = EUR 1,600K
* Cash flow from financing activities:
Capital increase = EUR 500K
Loans issued = EUR 1200K
Loans reimbursed = EUR 1300K
94
94

1F. Other information
-

Payout ratio: 45.2%
In N cash: EUR 500K, share capital: EUR 1,600K, reserves: EUR 1,080K
Cost of capital: 9%
* Dividend calculation
Income before interest for year N = EBIT fin. expenses = 1,975-130 = EUR 1,845K
Tax rate of 40% => 1,845*(1-40%) = 1,845 738 = EUR 1,107K
Payout ratio = 45.2% => dividend of year N paid in year N+1 = 1,107*45.2% = EUR 500K
* In N: share capital = EUR 1,600K reserves = EUR 1,080K Net Income = EUR 1,107K
=> Shareholders equity in N = 1,600 + 1,080 + 1,107 = EUR 3,787K
95

1F. Other information
-

Payout ratio: 45.2%
In N cash: EUR 500K, share capital: EUR 1,600K, reserves: EUR 1,080K
Cost of capital: 9%
*Shareholders equity calculation for year N+1:

Income before interest in N+1 = EBIT fin. Expenses = 1,810 117 = EUR1,693K
Tax rate of 40% => Net income = 1,693*(1-40%) = 1,693 677 = EUR 1,016K
En N+1 : share capital = 1,600 + 500 (capital increase) = EUR 2,100K
Reserves N+1 = reserves N + net income (N) dividends N
= 1,080 + 1,107 500 = EUR 1,687K
Net income N+1 = EUR 1,016K
Shareholders equity (N+1) = 2,100 +1,687 1,016 = EUR 4,803K
*Cash N+1 = Cash in opening B/S N (EUR 500K) + change in cash balance (EUR 351K)
Change in cash balance (EUR 351K) = cash flow from operating activities (EUR 1,1651K) +
cash flow from investment activities (EUR -1200K) + cash flow from financing activities
(EUR -100K)
96
96

FCF company
Forecast
Income statement
year n
Sales
% of sales
24 600
year n+1
change
26 290
6,9%
% of sales
-425
-1,7%
ns
ns
8 000
32,5%
8 800
10,0%
33,5%
0,0%
ns
ns
2 900
11,8%
3 400
17,2%
12,9%
10 500
42,7%
11 400
8,6%
43,4%
800
3,3%
880
10,0%
3,3%
1 975
8,0%
1 810
-8,4%
6,9%
130
0,5%
117
-10,0%
0,4%
Earnings before taxes
1 845
7,5%
1 693
-8,2%
6,4%
Corporate tax income
738
3,0%
677
-8,2%
2,6%
1 107
4,5%
1 016
-8,2%
Purchases
External costs (rent, services, marketing, tax)
Personnel
Depreciation
EBIT
Financial expenses
Net income
3,9%
97
97

Balance sheet
year n
year n+1
change
Net fixed assets
1 280
1 600
25%
4 420
4 724
7%
800
800
0%
425
425
0%
Cash
500
851
70%
Total assets
7 425
8 400
13%
Share capital
1 600
2 100
31%
Reserves
1 080
1 687
56%
Net income
1 107
1 016
-8%
Total shareholders equity
3 787
4 803
27%
Long-term debt
1 700
1 600
-6%
Suppliers
1 200
1 320
10%
Overdraft
ns
738
677
-8%
7 425
8 400
13%
Taxes
Total liabilities
98

Cash flow statement
year n+1
21566
Sales collected
4 420
-1 200
Purchases
-7 480
External costs
-3 400
Personnel costs
-11 400
Financial expenses
-117
-738
1 651
- Acquisition of fixed assets (CAPEX)
-1 200
- Fixed assets transfers
= Cash flow from investment activities

FCF
- Dividends paid to shareholders

+ Capital increase in cash
+ Loans issued
- Loans reimbursed
= Cash flow from financing activities
500
500
1200
1 300
-100
Change in cash balance net debt reduction
351
Cash at the beginning of the year

Cash at the end of the year
500
851
-1 200
451
99

2. Etude de cas FCF - Answer element
Margins
N+1
11,3%
10,2%
EBIT / Sales
8,0%
6,9%
Net income / Sales
4,5%
3,9%
N+1
ROE
29,2%
21,2%
ROCE [EBIT-(tax+(tax rate*interest)]/[WC + fixed assets]
20,7%
17,4%
EBITDA / Sales
Profitability
Cash Flow
N+1

= FCF
1 651
451
3. What commercial, operational and financial policies would you recommend to

implement to improve the profitability of the company?
100

Organization of business decisions
Todays challenges for the top
management: Profitability vs. Margin
TOP-DOWN
approach
Impacts of strategic decisions

(operational, commercial
and financial) on
BOTTOM-UP
approach
1. Economic approach (vs. accounting)

2. Value creation (profitability vs. margin)
3. Risk measurement and reward
(shareholder equity and debt)
101
101

IV. DuPont Model definition and target
Issue: how to identify a subset of relevant ratios to perform
the analysis of a company?
The DuPont model, carried out by executives of DuPont de Nemours
company in the 60s, promotes a systematic analysis approach based on a
central ratio, broken down into:
- Three ratios (first level of analysis)
- Which in turn are broken down into other ratios (second level of
analysis)
to avoid missing critical elements and refine the analysis.
It also highlights interdependences among ratios.
102

Issue: how to identify a subset of relevant ratios to
perform the analysis of a company?
Central ratio: ROE = Net income / Shareholders equity (SE)

1st level of analysis
Net income = Net income * Turnover * Assets
SE
Turnover
Assets
SE
Financial Profitability = net margin * asset turnover * financial leverage
103

SE
Turnover
Assets
SE
Net margin: measure of a companys sales performance

i.e. the amount of net income generated by one euro of sales
A function of endogenous & exogenous variables that make up the net
income:
- amount sold, selling price,
- purchasing or manufacturing cost of goods sold, sales and
administrative expenses,
- depreciation of fixed assets
- debt interest
- taxes
104

Net income = Net income * Turnover *
SE
Turnover
Assets
Assets
SE
Net margin: more or less high or volatile depending on the sector considered
Objectives of the analysis:
- to analyse the level (high enough?)
- to identify key variables and their sensitivity
- to define actions that can be implemented
105

Net income = Net income * Turnover *
SE
Turnover
Assets
Assets
SE
Asset turnover: measure of asset management performance

i.e. the amount of sales in euros that can generate each euro of investment
in the assets of the company.
Even though the amount of assets necessary to operate depends largely
on the business sector, companies aim to optimise this ratio
EXERCISE : WHAT IS THE RELATION BETWEEN NET MARGIN AND ASSET
TURNOVER? Illustrate for different sectors
106

SE
Turnover
Assets
SE
Exercise: SOLUTION
There is an offset (not perfect)
High net margin + low asset turnover
Low net margin + high asset turnover

107
107

SE
Turnover
Assets
SE
Financial leverage:
leverage: measures the part of the companys assets (equity + debt)
financed by shareholders i.e. debt level of the company
The more important the recourse to the leverage effect is, the higher ROE
under the condition that the cost of debt is more than offset by the additional
net margin generated by the debt and up to an inflexion point (linked to
risk increase correlatively to the debt increase)
108
108

Synthesis of level 1 analysis of DuPont model
Sales performance
Net margin = Net income / Turnover
Financial profitability
(ROE)
Efficiency of asset management

Asset turnover = Turnover / Assets
Insolvency risk
Financial leverage = Assets / Equity
109
109

The DuPont model extended to fund providers
Issue: how to identify a subset of relevant ratios to perform the
analysis of a company?
Central ratio: ROCE = net EBIT/ Assets

1st level of analysis
Net EBIT
Assets
= Net EBIT
Turnover
* Turnover
Assets
Economic profitability = net operating margin * asset turnover

110
110

IV. DuPont Model definition and target Gross margin (COGS/Turnover)
Level 2 analysis of DuPont model
Financial profitability (ROE)
Sales performance
Net margin = NI / turnover
Efficiency of asset management

Asset turnover = Turnover / assets
Debt and insolvency risk management

Financial leverage= Assets / Equity
Operating expenses/ Turnover

Operating margin
Interest / Turnover
Taxes / Income before tax
Days receivables ratio
Days inventory ratio
Days payable ratio
Fixed assets management efficiency
Current ratio
Acid test ratio
Debt ratio
Interest coverage ratio

111
Debt
coverage
ratio
111
111
Net Inc
Sales
Net Inc
Equity
Sales
Assets
Assets
Equity
Sales growth
Sales mix
Pricing
Cost of sales
Selling exp
R&D
Admin expense
Accts receivable
RELATIONS
Inventory turnover
Fixed asset turnover
Debt/equity
Interest coverage
Liquidity ratios
CUSTOMERS
INTERNAL PROCESSES
INNOVATION
INNOVATION
INTERNAL PROCESSES
CUSTOMER
SUPPLIERS & INTERNAL
PROCESSES
FINANCIAL MANAGEMT
112
112
Financial
Customers
Vision &
Strategy
Internal Business
Processes
Learning &
Growth
Source: Perform, Vol 2, Issue 2, Balanced Score Card
113
113

V.1. Background
Stern-Stewart (US) created a tool to calculate the variable part of managers

remuneration based on performance measures.
Criteria:
EVA or Economic Value Added
MVA or Market Value Added

V.2. Value creation
A company creates value when its operations generate profitability above its
financial resources
-
Capital employed (CE)

Cost and return on capital employed
114

V.3. Economic Value Added (EVA)
EVA measures the internal (economic) performance of a company. It is the

difference between the after-tax operating profit and the cost of CE
EVA = EBIT (1 - TC) - (WACC * CE)
If EVA > 0 => value is created for the shareholder

(performance higher than market expectations)
Debate:
What impact do share buybacks followed by their cancellation have on EVA?
115

V.4. Market Value Added (MVA)
MVA measures the external performance of a company.
It is the difference between the market value of the invested capital and its
book value.
Often, the market value of the debt is equal to its book value
=> MVA is equal to the difference between market capitalisation (CAPI) and
book value (BV).
MVA is defined as the market estimate of the present value of EVA flows.
MVA = CAPI - BV = t=1,n EVAt /(1 + WACC)t
116

V.5. Value creation Dashboard Management of a company
NAV
NAV
Shareholders'
equity
Risk
Adjusted
Capital
RAC
Reevaluated
items
RI
Value creation
dash board
&
Sum-of- the-parts
Excess
(EXC)
Value creation dashboard

BUj
RACj
RoRACj
value creation
CoCj(btaj) RoRACj - CoCj
% RACj
V(RACj)
xRACj
V(RAC1)
n
EXC
V(RAC2)
Total
V(RACn)
V(EXC)
V(NAV)
117

V.5. Value creation Dashboard Management of a company
An example of value creation in non-life insurance
Net premiums
Activity j
Activity
of reinsurance
EURm
RAC
RAC
as % of
Margin as
% of
RoRAC
V(RACj)
V(RACj)
xRACj
breakdown
CoC RoRAC-CoC
breakdown premiums breakdown premiums
1. Liablity
1456
10,4%
80%
34,3%
6,0%
7,5%
11,2%
-3,7%
66,7%
14,0%
2. Industrial risks
3. Property damage
897
4951
6,4%
35,3%
30%
20%
7,9%
29,1%
3,5%
3,5%
11,5%
17,7%
9,4%
8,1%
2,1%
9,6%
122,6%
219,5%
5,9%
39,2%
4. Transport
745
5,3%
35%
7,7%
3,8%
10,7%
9,4%
1,3%
114,2%
5,4%
5. Automobile
Total of operational
5963
14012
42,6%
100,0%
12%
24%
21,0%
100,0%
2,5%
3,4%
21,0%
13,9%
7,6%
8,5%
13,4%
5,4%
275,8%
163,3%
35,5%
100,0%
activities
Surplus capital
1000
100,0%
in EURm
Total Group EURm
14012
3400
471
Group valuation
(NAV + RAC)
163,3%
5552
148,9%
6552
RAC: Risk Ajusted Capital
118
Plan
119
Plan

IV. Relative P/E ratio
120
Chapter 4: Peer comparison

Well identified
On the same type of investment
Realised under similar conditions

=> Need to know all the transaction conditions
(in particular, guarantees likely to be granted by the seller, payment details, etc).
We will analyse
1- P/E
2- PEG
3- Relative P/E
4- NAV or BV multiple
5- Operating multiple (sales, EBITDA, EBIT, etc.)
121

PER or P/E: stock price / (restated) net profit per share.
It establishes the relationship between the value of an asset and the net profit it
is going to generate.
Net profit is normalised (economic approach). This means attributable net

profit, excluding exceptional items.
The number of shares must include all existing and potential shares (including
convertible bonds, bonds repayable in shares ORA, warrants BSA, etc.), and
net profit must be restated (financial charge savings)
122

Target: to partly offset the static aspect of P/E
Growth can be included based on: P/En = P/En-1 /(1+gn)

where gn indicates the growth rate of the net profit per share during year n.
PEG = P/E / average profit growth over 3 years
IV. Relative P/E
Target: to take into account that relative P/E can be sensitive to macroeconomic issues apart from different accounting practices in each country
Relative P/E is determined:

- based on a financial market (relative P/E Paris / relative P/E New York)
- based on a sector (average sector relative P/E / average market relative P/E
- based on peersPhilippe
( share
relative
P/E /from
average
relative P/E)
Foulquier
Valuation:
Theory sector
to Practice
123

In sectors where book value accounts for a large part of value, the net asset
value or BV multiple is often used
Including profitability widens the scope of the measure, notably by comparing

NAV multiples with each companys profitability
The regression line is a very good valuation tool when it is statistically relevant
The most common criteria are market capitalisation comparisons with :
Sales
EBITDA
EBIT
Etc.
124
Plan
125
Plan
I. Privatization of ASF
II. ASF: Summary financial statement
III.
ASF: FCFF forecasts

III.1. ASF revenue forecasts (2005-2032)
III.2. ASF cost forecasts (2005-2032)
III.3. ASF FCFF forecasts (2005-2032)
IV. ASF: WACC

IV.1. Current and future financial structure VD / VE
IV.2. Beta of equity
IV.3. Cost of equity with the current financial structure rE,C
IV.4. Cost of equity without debt rU
IV.5. Cost of equity with the future financial structure rE,F s and WACC
V. Equity value per share
126
Chapter 5: Case Study

I. Privatization of ASF
The largest toll motorway operator in France and the 2nd largest in Europe
Three concessions :
ASF: 2478km Expiry:2032

ESCOTA: 459km Expiry:2026
Puymorens Tunnel: 5.5km Expiry 2037
Toll revenues 2005E: 98%
(2% service station sub-concession and lease payments using fibre-optic)
127

2003
2190
6,7%
49
-3,9%
2239
6,4%
2004
2343
7,0%
46
-6,1%
2389
6,7%
Purchases and external charges

-231
-234
-262
-262
-262
Change
1,3% 12,0%
0,0%
0,0%
in % of revenues
-13,0% -12,4% -13,6% -12,5% -11,7%
Personnel expenses
-239
-250
-289
-295
-313
Change
4,6% 15,6%
2,1%
6,1%
in % of revenues
-13,4% -13,2% -15,0% -14,0% -14,0%
Taxes
-213
-239
-254
-266
-278
Change
12,2%
6,3%
4,7%
4,5%
in % of revenues
-12,0% -12,7% -13,2% -12,6% -12,4%
Other operating income/expense
31
31
26
30
32
Change
0,0% -16,1% 15,4%
6,7%
in % of revenues
1,7%
1,6%
1,3%
1,4%
1,4%
-652
-692
-779
-793
-821
Total Charges
Change
6,1% 12,6%
1,8%
3,5%
in % of revenues
-36,6% -36,7% -40,4% -37,7% -36,7%
-264
0,8%
-11,1%
-331
5,8%
-13,9%
-291
4,7%
-12,2%
29
-9,4%
1,2%
-857
4,4%
-35,9%
Toll revenues
Change
Other revenues
Change
Total revenues
Change
1999
1747
35
1782
2000
1840
5,3%
47
34,3%
1887
5,9%
2001
1883
2,3%
47
0,0%
1930
2,3%
2002
2053
9,0%
51
8,5%
2104
9,0%
CAGR
6,0%
5,6%
6,0%
2,7%
6,7%
6,4%
-1,3%
5,6%
128

EBITDA
Change
in % of revenues
Depreciation
Change
in % of revenues
EBIT
Change
in % of revenues
Financial expenses
Change
Total ordinary EBT
Change
in % of revenues
Extraordinary items
Total EBT
Taxes
Tax rate (% EBT)
Minority interest
Net profit
Change
in % of revenues
1999
1130
63,4%
-337
-18,9%
793
44,5%
-438
355
19,9%
2000
2001
2002
2003
2004
1195
1151
1311
1418
1521
5,8% -3,7% 13,9%
8,2%
7,3%
63,3% 59,6% 62,3% 63,3% 63,7%
-352
-397
-422
-444
-476
4,5% 12,8%
6,3%
5,2%
7,2%
-18,7% -20,6% -20,1% -19,8% -19,9%
843
754
889
974
1045
6,3% -10,6% 17,9%
9,6%
7,3%
44,7% 39,1% 42,3% 43,5% 43,7%
-429
-421
-2,1% -1,9%
414
333
16,6% -19,6%
21,9% 17,3%
-475
12,8%
414
24,3%
19,7%
-470
-1,1%
504
21,7%
22,5%
-435
-7,4%
610
21,0%
25,5%
-1
-2
-21
-4
-1
-1
356
416
354
418
505
611
-136
-151
-93
-142
-177
-210
-38,2% -36,3% -26,3% -34,0% -35,0% -34,4%
-2
-1
-1
218
261
219
266
325
398
19,7% -16,1% 21,5% 22,2% 22,5%
Philippe Foulquier
Valuation:
from Theory
12,2% 13,8%
11,3%
12,6%to Practice
14,5% 16,7%
CAGR
6,1%
7,2%
5,7%
-0,1%
11,4%
11,4%
12,8%
129

III. ASF: FCFF forecasts
2005
2006
[]
2026
2027
[]
2031
2032
Total Revenues
Purchases and external charges
Personnel expenses
Taxes
Other operating income/expense
Total Charges
EBITDA
Depreciation
EBIT
Tax rate
Net EBIT
+ Depreciation
- Change in WC
+ Capital expenditure
FCFF
130

Volume
Economic growth
Petroleum price
Geographical area
Weight light vehicle / heavy vehicles
Breakdown work / leisure time
Network extension forthcoming
Etc.
Conclusion forecasts
(see Excel file)
131

Price

Agreement with the French government
i) Inflation (0.85% or 0.7%)
ii) Capital expenditure (around EUR3.4bn in 2002-06, and in 2007-12)
Conclusion on total revenue forecasts (see Excel file)
132

Purchase and external costs (mostly maintenance)

Geographical area
- inflation
Traffic volume
- economy of scale
Personnel costs (automatic toll)
Local taxes
Conclusion on total
cost forecasts (see Excel file)
133

Purchase and external costs (mostly maintenance)

Geographical area
- inflation
Traffic volume
- economy of scale
Personnel costs (automatic toll)
Local taxes
Conclusion on total
cost forecasts (see Excel file)
134

III.3. ASF FCFF forecasts (2005-2032)
EBITDA margin
Depreciation
Tax
Net EBIT
Capital expenditure and change in WC
Conclusion on FCFF
forecasts (see Excel file)
135

IV. ASF: WACC
IV.1. Current and future financial structure VD / VE
en MEUR
Debt CNA(*) Fixed rate
Debt CNA(*) Variable rate
Debt from territorial administrations
Other
TOTAL
(*) Caisse Nationale des Autoroutes
2002
7892
746
73
11
8722
2003
7408
746
56
28
8238
2004
7254
746
44
38
8081
Source : Annual report

Current VD / VE
VD = EUR7.6bn
VE = EUR11.3bn
VD / VE = 67%
Future VD / VE
VD = EUR3.8bn
VE = EUR11.3bn
VD / VE=Valuation:
34% from Theory to Practice
Philippe Foulquier
Date
2005
2006
2007
2008
2009
2010
2011
2012
Beyond
Total
mEUR
392
497
458
789
469
821
637
405
3575
8043
136

IV. WACC
IV.2. Beta of equity
IV.2.1. Traditional analyst approach
Current leverage
Beta sector
Tax rate
Current leverage
Relevered beta
0,60
35%
67%
0,86
Future leverage
Beta sector
Tax rate
Current leverage
Relevered beta
0,60
35%
34%
0,73
Levered beta = unlevered beta [1 + (1 - Tax rate) (VD / VE)]
Hamada (1972)
Limits: sector beta unlevered beta

IV.2.2. Multifactor model
rE = rF + k F,k
IV.2.3. Forward looking (fundamental approach)

137

IV. WACC
IV.3. Cost of equity with the current financial structure rE,C
i) Risk free-rate
ii) Risk premium
iii) E
iv) rE,C = 6.4%
C: current financial structure

138

IV. WACC
IV.4. Cost of equity without debt rU
Modigliani Miller: proposition II

rE = rU + (1 TC) (rU - rD) (VD / VE)
where
rE cost of capital for a company with debt

rU cost of capital for a company without debt
rD cost of debt
TC corporate tax
=> rU = 5.7%
139

IV. WACC
IV.5. Cost of equity with the future financial structure rE,F s and WACC
MM II => rE,F = rU + (1 TC) (rU rD,F) (VD,F / VE,F)

where
rE,F cost of capital for a company with future debt structure

rU cost of capital for a company without debt
rD,F cost of debt
TC corporate tax
=> rE,F = 6.0%
WACC = [rD,F (1 TC) (VD,F / (VD,F + VE,F))] + [rE,F (VE,F / (VD,F + VE,F))]
= 5,3%
140

Discounted FCFF
Present value of FCFF
Net Debt
Equity Value
Number of shares
Equity Value per share
141

WACC
3,75%
4,0%
5,0%
5,25%
5,50%
5,75%
6,00%
6,25%
6,50%
6,75%
7,00%
8,00%
Valuation Valuation per

in EURbn share (in EUR)
20007
86,6
19074
82,6
15737
68,1
14992
64,9
14278
61,8
13595
58,9
12941
56,0
12314
53,3
11713
50,7
11137
48,2
10585
45,8
8590
37,2
Discount rate for the French State = 3.75% (bonds - 30 years)

142
Plan
143
Plan
I. Asset valuation (B/S)
II. Asset valuation (B/S) / Cash flow (P&L): mix valuation
III. Case Study: AGF (Allianz Group)
144
Chapter 6: Cash flow-Asset Mix Valuation

The company is worth what is owns (B/S) versus the company is worth
what is earns (CF)
Focus on the tangibles and intangibles which comprise a companys assets

and liabilities
Net asset value - NAV

Each item with no economic justification must be restated, and hidden
wealth must be found
i) Intangible assets
establishment costs
client base
R&D
patents and licences
brands
145

Valuing a patent
assumptions:
royalties = 5% of sales TC = 40%

sales = EUR2bn
perpetual growth rate g = 1%
discount rate i = 10%
solution: VA = EUR667m
watch out for the sensitivity of parameters i and g

146

Brand valuation
by cost
by revenue
by over-price or over-profit
by goodwill
by comparison
147

ii) Tangible assets
iii) Fixed financial assets and current assets
iv) Liabilities
v) Off balance sheet
vi) Net Asset Value: Pros and cons
148

II. Asset valuation (B/S) / Cash flow (P&L): Mix Valuation
II.1. Goodwill
Used in addition to an asset valuation insofar as it is an answer to NAVs lack of
projection momentum.
Goodwill links a dynamic future cash flows valuation and the valuation of asset
values.
II.2. Anglo-Saxon method
Based on shareholders equity profitability cash flows (after financial expenses)
Shareholders equity value:
V = NAVEI + GW
where
NAVEI = NAV excluding intangibles
GW = t=1,n(NPt - [NAVEIt * rE ]) / (1+ rE )t = goodwill
NPt = net profit for year t
rE = ro + (rM - ro)
NP - [NAVEI * rE] = super profit
n = number of years during which we expect the company will keep its
competitive advantage (which is the basis for better profitability than
expected by the market)
149

II.3. Goodwill based on capital employed
Based on capital employed profitability cash flows (shareholders equity +

debt => cash flows before financial expenses).
Value of the company is : V = NAVEI + GW

where NAVEI = NAV excluding intangibles
GW = t=1,n(EBITDAt*(1-TC)-(CEt*WACC))/(1+WACC)t = goodwill
CE = capital employed needed for operations
= tangibles at market value + working capital requirements (WCR)
EBITDAt*(1-TC)-(CEt*WACC) = super profit
n = number of years during which we expect the company will keep its
competitive advantage (which is the basis for better profitability than
expected by the market)
150

II.4. Sum-of-the-parts
Previous approaches can be refined owing to:
* The economic value based on:
- Allocated capital by activity
- Normalised profitability according to activity
- Cost of capital by activity
* The true value by reconciling the theoretical economic value and
the balance sheet based on :
- The difference between allocated shareholders equity and true
equity (shareholders equity in B&S)
- Revalued assets such as capital gains, over or under provisioning,
goodwill booked B&S, etc.
151

II.4.1. NAV with no growth
V0 = NAVEI +GW = NAVEI + t=1,n [NAVEI (RoNAVEI - rE)]/(1+ rE)t
= NAVEI RoNAVEI / rE
where RoNAVEI = net asset value excl. intangibles profitability
II.4.2. NAV with growth rate g
V0 = NAVEI0 + GW
= NAVEI0 + t=0,n [NAVEIt (RoNAVEI - rE)]/(1+ rE)t
= NAVEI0 (RoNAVEI - g) / (rE - g)
where : NAVEIt+1 = NAVEIt (1 + g)
152

II.4.3. Sum-of-the-parts, allocated capital per activity and GW
Division of NAV between assets allocated to j activities and unallocated
capital, at growth rate g
V0 = NAVEI + GW = (SE - AC) + RI + AC + GW
= (SE - j=1,mACj) + RI + j=1,mACj
+ j=1,m t=0,n [ACjt[RoACj - rEj)]]/(1+ rEj)t
= (SE - j=1,mACj)
surplus shareholders equity
+ RI
revaluation items (including deduction of intangibles)
+ j=1,m ACj (RoACj - gj) / (rEj - gj)
153

II.4.3. Sum-of-the-parts, allocated capital per activity and GW
where :
NAVEI = net asset value excluding intangibles = SE + RI
SE = shareholders equity
RI = revaluation items
= unrealised capital gains - intangibles + other accounting restatements
ACj,t = shareholders equity allocated to activity j over period t with
ACj,t+1= ACj,t (1+g)
RoACj = Return on allocated capital of the activity j
rEj = Cost of capital of the activity j
154

III. Case Study: AGF
III.1. How do we organise fundamental analysis?
A. Market and local constraints

i) General economic backdrop
ii) Regulatory and fiscal issues
iii) The market
155

A. Market and local constraints
i) General economic backdrop
ii) Regulatory and fiscal issues
iii) The market
B. Operating data
i) Companys market positioning
ii) Distribution network
iii) Products and margins
iv) Management and personnel
v) RetrocessionPhilippe
and reinsurance
Foulquier Valuation: from Theory to Practice
156

C. Companys financial data
i) Technical analysis
ii) Asset/liability management (ALM)
iii) Evaluation of economic profit
D. Valuing the companys prospects (simulation)
Matrix 2 columns x 4 lines
C1. Market assumptions
C2. Company assumptions
L1. Change in premium assumptions
L2. Change in claims assumptions
L3. Change in expenses assumptions
L4. Change in financial income assumptions
157

III.2. Valuation
- Determine the number of j activities
- Determine allocated capital for each activity according to the required
economic solvency margin (independent of regulatory standards)
- Determine the allocated capital profitability for each activity
* Normalised profitability on a P&C cycle
* In force and new business in life
* Risk weighted assets and tier one in banking
* Assets under management multiple in asset management activity
158

III.2. Valuation
- Determine the cost of capital for each j activity
- Determine surplus capital compared with allocated capital
* valuation issue (RoAC RE)
* Target and economic interpretation
- Determine asset revaluation items
* Net unrealised capital gains
* Goodwill
* Other accounting restatements
- Determine sensitivity of the valuation to beta and the risk premium
159

160

Total Allocated Capital
AGF - COA
2 702
80%
3 351
649
3 080
1 087
Capital Allocation
Life insurance
Shareholders'equity (SE) / Net Technical Prov
SE / Net technical provisions - unit-linked
Technical provisions - traditional
Technical provisions - unit linked
Minority interests
Health insurance
SE / Net premiums
Net premiums
Minority interests
P&C insurance
SE / Net premiums
Net premiums
Minority interests
Credit Insurance (AGF share)
SE / Net premiums
Net premiums
1 214
(assistance + credit)
207
Philippe Foulquier7852
Valuation:
Minority interests
Assistance (AGF share)
SE / Net premiums
Net premiums
Minority interests
Asset Management & Bank
SE / AuM
AuM for own account
AuM For third party
= Total AuM
Minority interests
Bank
= Allocated
Capital
from Theory
to Practice
2007
2 873
4,8%
1,2%
55 434
17 654
0,0%
649
45%
1 442
0%
3 086
55%
5 611
0%
791
100%
1 098
28%
127
26%
485
50%
207
0,25%
101 233
18 300
119 533
0%
161
7 732
161

Total Excess or Deficit of Capital
Available Capital
NAV Tangible
(+) 50% In-Force Value
= Adjusted Capital
(+) Subordinated debts
(+) Other Financial Debts
= Total Availble Capital
Excess or Deficit / NAV
Excess of Deficit / Adjusted Capital
Excess or Deficit / Total Available Capital
2007
10 099
1 749
11 848
1 544
337
13 729
2 366
4 116
5 997
162

III.1. Life insurance valuation
2007e
Embedded value
Shareholder's equity
(-) Goodwill
(-) Value of Business Acquired (VOBA)
(-) Other intangibles items
(-) Deferred Acqusition Costs
(+) Equalization Reserves
(+) Off-Balance Sheet unrealised capital gains
(-) Off-Balance Sheet Adjustment
= Net Asset Value (Tangible)
(-) Cost of Capital (Life & Health)
(+) In-Force Value (Life & Health)
11 643
-999
-102
0
-692
0
1 000
-752
10 099
-800
3 499
= Embedded value
12 797
163

III.1. Life insurance valuation
Life profit contribution
2007
Profit
554
Life insurance
New business Value
Expected return on EV
Expected return on surplus
Expected return in force value (discount rate)
New business premium (APE)
New business margin
NAV
Life insurance
2 873
In-Force
value
2 699
Normalised
Profit
586
187
399
ROEV
/ ROE
10,5%
3,4%
7,2%
0,0%
8,0%
623
30,0%
Embedded value
5 571
Normalised
profit
586
ROE/ ROEV
10,5%
perpetual
growth
3,0%
Beta
1,10
Cost of
capital
9,0%
Multiple
/ Emb.
Value
1,3
Valuation
7 034
164

III.2. Other activities valuation
Normalised profit contribution
ROEV
/ ROE
14,3%
Dividend
2,5%
2007
Normalised
Profit
Profit
149
93
95,5%
99,5%
4,2%
150%
156%
CG
yield
6,0%
8,5%
0,0%
4,0%
912
516
360
120
95,3%
99,3%
5,0%
180%
188%
CG
yield
6,0%
8,5%
Bonds and other

Assurance crdit
Combined ratio
Financial yield
Ratio of provisioning
Financial assumptions
Equity
78%
25%
Dividend
2,5%
4,0%
196
75%
4,4%
116%
yield
8,5%
Bonds and otherPhilippe Foulquier Valuation:
from Theory to Practice
3,5%
83%
Health insurance
Combined ratio
Financial yield
Equity
Bonds and other
P&C insurance
Technical profit
Realised capital gains
Combined ratio
Financial yield
Equity
Dividend
2,5%
4,0%
253
71,0%
110%
CG
6,0%
%
5%
95%
17%
70%
23%
%
22%
%
17%
165

III.2. Other activities valuation
Normalised profit contribution
Assistance
Financial services
Holding
Central costs
Capital excess
Debts
Cost of Debt
= Adjusted Profit
(-) GW
(-) Exceptional
= Net profit
ROE / ROEV
2007
Profit
1 929
Normalised
Profit
22
109
97
0
174
-77
4,1%
1 619
1 929
17%
1 619
13%
24
109
-72
0
0
0
ROEV
/ ROE
17%
53%
13%
166

III.3. Total Valuation
Valuation (end of 2007)
NAV
InForce
value
Life & Health Insurance

3 521
Life Insurance
2 873
Health Insurance
649
Non-Life Insurance
4 004
P&C Insurance
3 086
Credit Insurance
791
Assistance
127
Asset Management & Bank
207
Central Costs net
0
= Operational Activities 7 732
Surplus/Deficit of capital, net 2 366
= Total Group
10099
Valuation per Share (EUR) 55,5
2 699
2 699
2 699
2 699
Em bed- Sustaina
ded
ble
value
earnings
6 220
5 571
649
4 004
3 086
791
127
207
0
10 431
2 366
12 797
70,3
679
586
93
734
516
196
22
109
0
1 522
97
1 619
ROE/
ROEV
Grow th Beta Cost of Multiple Valuation

Capital / Em b.
Value
10,9%
10,5%
14,3%
18,3%
16,7%
24,8%
17,3%
52,6%
3,0%
3,0%
3,0%
2,2%
2,0%
3,0%
3,0%
3,0%
14,6%
4,1%
12,6%
2,7%
1,09
1,10
1,00
1,15
1,20
1,00
1,00
1,00
1,1
1,00
2,7% 1,1
8,9%
9,0%
8,5%
9,2%
9,4%
8,5%
8,5%
8,5%
9,0%
9,0%
8,5%
8,9%
1,3
1,3
2,1
2,4
2,0
4,0
2,6
9,0
1,9
0,5
1,6
8 371
7 034
1 336
9 602
6 141
3 129
331
1 866
0
19 839
1 142
20 981
115,3
167
Bibliography
S.A. Ross, R.W. Westerfield, J.F. Jaffe, B.D. Jordan, Modern Financial
Management, Eighth Edition, McGraw-Hill, 2008

Richard A. Brealey, Stewart C. Myers, Franklin Allen, Principles of
Corporate Finance, Eighth Edition, McGraw-Hill/Irwin, 2004
Aswath Damodaran, Investment Valuation, Second Edition, Wiley, 2002
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Valuation: From Theory

Philippe Foulquier, PhD, EFFAS

Philippe Foulquier Valuation: from Theory to Practice

Philippe Foulquier Valuation: from Theory to Practice

Chapter VI. Case Study AGF (Allianz Group) Valuation

Philippe Foulquier Valuation: from Theory to Practice

Chapter I. Financial Flows & Risk Price of the main protagonists

Food for thought

An inexperienced appraiser too often clings

There are no absolute values, because things do

Chapter I. Financial Flows & Risk Price of the main protagonists

Philippe Foulquier Valuation: from Theory to Practice

Chapter I. Financial Flows & Risk Price of the main protagonists

Difference between the value and the price of a company

relationship between the buyers and the sellers

Philippe Foulquier Valuation: from Theory to Practice

Chapter I. Financial Flows & Risk Price of the main protagonists

Philippe Foulquier Valuation: from Theory to Practice

Chapter I. Financial Flows & Risk Price of the main protagonists

Cash and bank

Philippe Foulquier Valuation: from Theory to Practice

Chapter I. Financial Flows & Risk Price of the main protagonists

Employees & suppliers

Income bf. Taxes

Corporate income tax

Shareholders are paid after that all other commitments of the

Chapter I. Financial Flows & Risk Price of the main protagonists

It is important for operational choices to know the risk

Chapter I. Financial Flows & Risk Price of the main protagonists

Philippe Foulquier Valuation: from Theory to Practice

Chapter I. Financial Flows & Risk Price of the main protagonists

Capital at the beginning

Capital at the end

V(t+1) = V(t) + 5% V(t) = V(t) (1+5%)

Chapter I. Financial Flows & Risk Price of the main protagonists

Philippe Foulquier Valuation: from Theory to Practice

Chapter I. Financial Flows & Risk Price of the main protagonists

Chapter I. Financial Flows & Risk Price of the main protagonists

Philippe Foulquier Valuation: from Theory to Practice

Chapter I. Financial Flows & Risk Price of the main protagonists

IRR Internal Rate of Return (or yield to maturity)

Philippe Foulquier Valuation: from Theory to Practice

Chapter I. Financial Flows & Risk Price of the main protagonists

IRR Internal Rate of Return (or yield to maturity)

1. Based on a 10% discount rate, determinate the discounting factors and

Philippe Foulquier Valuation: from Theory to Practice

Chapter I. Financial Flows & Risk Price of the main protagonists

IRR Internal Rate of Return (or yield to maturity)

A 10% discount rate produce the following discounting factors

Philippe Foulquier Valuation: from Theory to Practice

Chapter I. Financial Flows & Risk Price of the main protagonists

The Limits of the IRR

Based on a 5% discount rate:

Chapter I. Financial Flows & Risk Price of the main protagonists

Exercise: Reinvestment rate - Solutions

Philippe Foulquier Valuation: from Theory to Practice

Chapter I. Financial Flows & Risk Price of the main protagonists

Exercise: Multiple IRR or no IRR

Consider the following investment and calculate IRR. What is your

Philippe Foulquier Valuation: from Theory to Practice

Chapter IV. Peer comparison

Chapter V. Case Study Privatisation of ASF

Chapter VI. Case Study AGF (Allianz Group) Valuation