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This term assume that many of the balance-sheet and income-statement items
are directly or indirectly related to sales.
The mathematical structure of solving the models involves finding the solution to a
set of simultaneous linear equations predicting both the balance sheets and the
income statements for the coming years.
However, the user of a spreadsheet need never worry about the solution of the
model; the fact that spreadsheets can solve-by iteration-the financial relations of the
model means that we only have to worry about correctly stating the relevant
accounting relations in our Excel Model!
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Given: A company XYZ has a current sales level of $1,000 (in Thousands). The
firm expects its sales to grow at a rate of 10% per year, and it anticipates the
following financial statement relations:
Current Assets 15% of end of year sales
Current Liabilities 8% of end-of-year sales
Net fixed Assets 77% of end-of year sales
Depreciation 10% of the average value of the
books during the year
Debt The firm will not repay nor will
borrow any more money over 5
years.
Cash and Marketable Securities We will consider this for now, the
balance sheet ‘PLUG’
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
The dollar signs ($) for fixing the columns and the rows of the input cells are very
important when forecasting!
If you fail to put them in, the model will not copy correctly when you project years
2 and beyond.
The ‘PLUG’: Is the balance sheet item that will close the model:
In General the ‘PLUG” in a pro forma model will be one of three financial balance-
sheet items: (1) Cash and Marketable Securities, (2) Debt, or (3) Stock.
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
The mechanical meaning of the ‘PLUG’ if we decided that ‘PLUG’ is Cash and
Marketable Securities item in the balance sheet. Then,
COGS=Sales*(COGS/Sales)
The assumption for now: That only expenses related to sales are
COGS (Yet, we will discover later an advanced case study where we will
model every major item and we’ll put our own logical assumption
Cash &Marketable Securities = Total liabilities and equity – Current Assets – Net
fixed Assets
You should make sure that the net fixed assets should not include LAND,
because land as a fixed asset should not be depreciated
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Primary purpose:
To provide information about a company’s cash receipts
and cash payments during a period.
Secondary objective:
To provide cash-basis information about the company’s
operating, investing, and financing activities.
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Classification of Typical
Cash Inflows and
Outflows
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Classification of Typical
Cash Inflows and
Outflows
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Steps in Preparation
Three Sources of Information:
1. Comparative statements of financial position.
2. Current income statement.
3. Selected transaction data.
Example
Step 2: Determine the Net Cash Flow from Operating
Activities Net Income versus Net Cash
Flow from Operating Activities
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
We would like also to note, that most companies have employee stock options
and preferred stock. The value of options (You can determine it using Black
Scholes calculator) and the value of preferred stocks should also be removed
from the enterprise value to determine the clean equity value.
In addition, some firms have minority interests and the value of minority interests
should also be eliminated from enterprise value (EV), to arrive to the equity
value.
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
If you are using FCFF to determine the enterprise value, then by discounting all
FCFFs projected to the present, you will arrive to the EV.
Yet, we are concerned about the equity value! To do this you should subtract
from EV the following items:
Note: If you removed during your calculation of PV,FCFF the value of non-operating
assets (i.e.: investments in other assets, or value of cash & marketable
securities), then this should be added again to PV, FCFF to arrive to the EV.
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
When using FCFF your valuation method, don’t forget to discount using
WACC!
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Illustration
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
You can construct a sensitivity analysis by testing one or two variables how do they
affect the value of your outcome if those variables.
Follow the Instructor carefully to illustrate in details about the construction of data
tables and their purposes
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
DEBT as a ‘PLUG’
Having Cash and marketable securities as the ‘PLUG’ will be illogical if the Cash
and marketable securities account turn to be negative in any year!
In our previous model, if we try to change some of the given numbers slightly, we
can see that we will have such a case where Cash and Marketable Securities
account will turn to be negative.
We will use debt as our “PLUG’ with Cash and marketable securities
remaining also a ‘PLUG’ due to this reason, and for other reasons such
as:
1- Companies might have strict target debt/equity ratios
2- Companies might need additional financing, so it will borrow
money
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Current assets + Net fixed assets > Current liabilities + Last year’s debt
+ stock + Accumulated retained earnings?
In this case even if cash and marketable securities are equal to 0, we need to
increase debt balances in order to finance the firm’s productive activities.
Current assets + Net fixed assets < Current liabilities + Last year’s debt+ Stock+ Accu. R.E ?
If this relation holds, then there is no need to increase debt, and, in fact, the firm has to have
positive cash and marketable securities as a balancing item, and the fact that we have made cash
the plug will take care of this concern
Suppose that the firm has a target ratio of debt to equity: In each of the projected
years (1-5), it wants debt and equity on the balance sheet to conform to a certain
ratio
Be as much as dynamic as you can! Tie the debt level of year 2 with a separate
cell stating the target or expected debt-to-equity ratio in year 2. Tie the debt level of
year 3 with a different cell stating the target debt-to-equity ratio expected in year 3
etc…
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
As we can see from the example the firm issued new debt years 4 and 5; in year
1 the stock account grows (indicating that new equity is issued), whereas in
subsequent years stock decreases (including a repurchase of equity).
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Project Finance
Project finance is only possible when the project is capable of producing enough
cash to cover all operating and debt-servicing expenses over the whole tenor of the
debt.
The Debt Service Coverage Ratio (DSCR) is the major measuring ratio for a project
finance.
It should not exceed a predetermined level (In most cases it should be less than
1.60)
Special case, DSCR can be 1.15 for power plants with strong off-take agreements.
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Project Finance
It is perfect that we study project finance modeling, because project
finance include many restrictions and covenants.
In a typical case of Project finance, the firm borrows money in order to
finance a project
1-The firm is not allowed to pay any dividends until the debt is paid off.
2-The firm is not allowed to issue any new equity.
3-The firm must pay back the debt over a specified period.
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Project Finance
Example: The following simplified example uses a variation of the version of our basic
model with cash balances. A new firm or project is set up; in year 0,
The firm has assets of 2,200, which are financed with 200 of current liabilities, 1,100
of equity, and 1,000 of debt.
The debt must be paid off in equal installments of principal over the next five years.
Until the debt is paid off, the firm is not allowed to pay dividends (if there is extra cash,
this will go into a cash and marketable securities account).
Note: The ROE in project finance is simply the IRR of the cash and equity inflows.
Simply your initial investment is the – ve equity flow and the ending value is: Ending
Accumulated RE + Capital Stock + Dividends+ ve equity flows ( If allowed to pay
dividends).
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
• For each line item in the financial statements, show ratios for the items and
show assumptions for the ratios
Private equity investors Private equity funds are Private equity funds are
are known as limited special purpose vehicles managed by private equity
partners (LP) established for a limited firms which acts as
duration general partners (GP)
LP #1
LP #2
XYZ Advisors L.L.P.
Established as a limited
LP #3 liability company
.
.
.
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Financial Modeling: why do private equity professionals build detailed financial models
when assessing a potential investment opportunity: seven key reasons to keep in mind
Portfolio Company
Entry Exit
Management
1. To build deep insights into 4. To set, at entry, management 7. To assess, before the time of
the likely growth prospects of incentives linked to the entry, what could be the
a company and its financial model. most likely exit route
requirements for funding, depending on the size and
both present and future. growth prospects of a
5. To benchmark over the company based on its
2. To put a value on a company course of the holding period projected performance at the
at entry whether on the basis a company’s actual tail end of the financial
of a DCF or comparable performance against its model.
multiples (using historical or financial plan.
forward-looking multiples).
2. Avoid modeling around potential drivers that represent averages in themselves. Break them down into
inputs and let the output represent the weighted average. This is one of the most significant modeling flaws
often leading to wrong outputs.
3. Try to understand how each driver is likely to behave during the forecast period, e.g., some costs (e.g.,
variable) will behave as a % of sales while others (e.g., fixed) are likely to move more along inflation.
4. Make sure your model has plenty of cross-checks to ensure that (1) assumptions make sense and (2) your
model is built properly.
5. A model should be dynamic, i.e., any change to any assumption cell should dynamically impact the full
model. Beware: there should be no manual adjustment whatsoever.
6. Ideally, every cell should represent either a single assumption input (A1 = 10) or a formulaic output linking
only cells together, i.e., A11 = A1+A10. This is particularly important to build dynamic models that are also
easy to audit.
Case Study
CEMENTO Inc,
This case was developed solely as the basis for CAFM® program and is not
intended to serve as an endorsement, source of primary date, or illustration of
effective or ineffective management.
The company recovered its full market share following the refurbishment of its
floating terminal in 2004 and the implementation of a new strategy aimed at
building market share and profitability commensurate with the company’s capacity
potential.
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Case Study
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Case Study
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Case Study
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Case Study
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Case Study
Cemento used to sell three types of cement products:
1-Portland Cement
2- Sulfate Resisting Cement (SRC)
3- White Cement distributed in bulk and bags.
Bulk cement was sold principally to ready mix concrete companies and
construction contractors in cement silos.
In 2006, bulk and bag sales represented 86.8% and 13.2% of total sales
respectively, a mix typical of the industry; both NCC’s and NPCC’s bags sales
represented approximately 40% of total cement sales.
In the case of Cemento, lower bags sales were due to the company’s historical
emphasis on bulk sales.
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Case Study
In order to grow market share, the management were now trying to progressively
change this mix by putting more emphasis on cement bags. The management knew
they had little choice.
To take advantage of short term opportunities in Iraq, the management applied
and received government approval to sell 10% of its total imported cement volume
to Iraq.
Case Study
Case Study
Cemento’s main procurement cost consisted of cement purchases, which
amounted to USD13.2 million, corresponding to 88.3% of total operating costs in
2006 (Exhibit 7).
Case Study
In the last five years ended December 31, 2006, the company purchased cement
from approx. 15 cement producers across Middle Eastern and Asian markets.
In order to hedge against fluctuating cement and shipping prices, Cemento
principally entered into annual contracts, minimizing quantities purchased from spot
markets.
For 2007, the company had already negotiated and signed contracts to import
cement covering a significant portion of its forecasted annual requirements at a
cost which would allow the firm to lock in a gross profit per ton of around USD6.5
for the year.
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Case Study
Cemento now employed 53 people, with 79% of all employees focused on
operating the
Company’s terminal operations (Exhibit 9).
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Case Study
In order to prepare the company for growth, Cemento was now planning to increase
its staff base from 53 employees in 2006 to 75 employees in 2007 with a focus on
expanding the company’s:
As a result, Cemento was expected to create new capacity for future growth by
bringing its employee productivity level below its current level of 17,500 tons
per operations employee.
The company considered a long-term productivity level of approx. 19,000 tons per
employee as efficient.
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
Case Study
Exhibit 10 below provides select salary data points:
Advanced Modeling and Valuation
Project Finance and Manufacturing Companies
References
1. Aswath Damodaran (2001), The dark side of valuation: Valuing young, distressed, and
complex Businesses( 2nd ed.) ,FT Press.
2. Alastair L. Day (2012), Mastering financial modeling in Microsoft excel(3rd ed.), FT
Publishing.
3. Simon Benninga (2008), Financial modeling (3rd ed.) MIT Press.
4. Chandan Sengupta (2010), Financial analysis and modeling( 2nd ed.), Wiley Finance.
5. Masari, M., & Gianfrate, G. (2014). The valuation of financial companies: Tools and
techniques to value banks, insurance companies, and other financial institutions (1st ed.).
Wiley Finance.
6. Koller, T., & Goedhart, M. (2010). Valuation: Measuring and managing the value of
companies (5th ed.). Hoboken, N.J.: John Wiley & Sons.
7. Kieso, D., Weygandt, J., & Warfield, T. (2014). Intermediate accounting (15th ed.). Wiley
John, & Sons, Incorporated