Financial Modeling Workshop (IMC 2009)

8/13/2019 Financial Modeling Workshop (IMC 2009)

1/53

Dec. 2009

Confidential

For internal use only

How to build a financial model

Direct Investment - CHO


2/53

Table Of Contents

Financial Model is a Powerful Tool 15 min

Basic Financial Concept Review 45 min

General Modeling Methods and Skills 20 min

Guidance on Related GIC Documents Preparation 15 min

Q&A 25 min


3/53

Financial Modeling Workshop Dec, 2009 2

The Use Of Financial Models

Operation Management

Operation Management

Translate insight and intelligence of a specific industry and acompany to its valuation, consequently lead torecommendation to investment/divestiture of the company

Forecast impact on the company value due to changes instrategy (product, market region, channel, etc)

Deep understanding of interaction between various inputsand company valuation

Evaluate the impact on company valuation caused bypotential acquisition

Evaluate the impact on company valuation under differentfinancing options

Its also used in budget planning, performance evaluation,operation option comparison, etc.

Translate insight and intelligence of a specific industry and acompany to its valuation, consequently lead torecommendation to investment/divestiture of the company

Forecast impact on the company value due to changes instrategy (product, market region, channel, etc)

Deep understanding of interaction between various inputsand company valuation

Evaluate the impact on company valuation caused bypotential acquisition

Evaluate the impact on company valuation under differentfinancing options

Its also used in budget planning, performance evaluation,operation option comparison, etc.

Transaction

Transaction

Equity raise: to determine the share offering price and sharenumbers

Sell company or equity: to determine the selling price

Acquire another company or equity: to determine thetransaction price

Evaluate offers: to determine the offering price by the buyer

is appropriate or not

New project investment: to evaluate how financiallybeneficial a new project investment is for the companyshareholders

Equity raise: to determine the share offering price and sharenumbers

Sell company or equity: to determine the selling price

Acquire another company or equity: to determine thetransaction price

Evaluate offers: to determine the offering price by the buyeris appropriate or not

New project investment: to evaluate how financiallybeneficial a new project investment is for the companyshareholders


4/53


Relationship Between Financial Model And Strategy

Financial modeling aims to mimic the actual business operation as close as possible.

Business operation is guided by strategy.

Strategy planning helps to identify opportunities & risk and develops plan of actions to deal with the

opportunities & risksPlan of actions cover the business model design and redesign, changes in marketing strategy, productstrategy, pricing strategy, human capital strategy, production, logistics, etc.

All the actions will lead to reallocation of company resource or even quest additional resources externally. As a consequence, they will affect the business financially.

Financial model quantifies the effect by translate as truthfully as possible the actual business into asimplified model with changeable inputs and delivers the forecasted output to the users.

Based on the output of financial models, management can have a quantitative understanding of the impacton the business that a specific strategy plan/action would have


5/53


6/53


Terrain Analysis Helps To Locate The Relative Position Of Ourselves

Strategic advantage

S t r a

t e g

i c g o a

l

Industrial

Segment

L ow c os t Dif ferent iat ion

Strategic advantage

S t r a

t e g

i c g o a

l

Industrial

Segment

L ow c os t Dif ferent iat ion

TextText TextText TextText TextText TextText TextText TextText TextText

Value chain Business model, choose what do we do and how do we do


7/53

Table Of Contents





Q&A 25 min


8/53


Concept List

1. Enterprise value and equity value

2. Trading comparable analysis/valuation

3. Transaction comparable analysis/valuation

4. Accrue accounting and effect on depreciation

5. Free cash flow

6. Discount rate

7. Terminal value


9/53


Relationship Of Enterprise Value And Equity Value

Accounting value , as a traditional measurement ofvalue, does not reflect the true value of a company inmost cases as it ignores the future value that the companycan generate for the company stakeholders.

Accounting value holds the historical value, in most casesit takes the forms of total assets, shareholders interest,etc, as we see on the balance sheet.

Market value , which incorporates the future value, is amuch better indicator of company value.

Market value takes the form of stock price, theconsideration paid in merger and acquisitions.

The value in the graph on the left are all of market value.Each piece of value belongs to different stake holders.

Accounting value , as a traditional measurement ofvalue, does not reflect the true value of a company inmost cases as it ignores the future value that the companycan generate for the company stakeholders.

Accounting value holds the historical value, in most casesit takes the forms of total assets, shareholders interest,etc, as we see on the balance sheet.

Market value , which incorporates the future value, is amuch better indicator of company value.

Market value takes the form of stock price, theconsideration paid in merger and acquisitions.

The value in the graph on the left are all of market value.Each piece of value belongs to different stake holders.

Equityvalue

Minorityinterest

Liability Cash Enterprisevalue

+

+

-

From equity value to enterprise value

Net debt


10/53


Comparison Of Major Valuation Methods

Pros: very market orientedCons

constrained by availability of comparablehistorical transaction

Valuation multiples might differ from time totime due to market cycle, etc.

Analyze comparable historical merger& acquisition transactions to arrive at arange of transaction multiples for thetarget company

The valuation does factor in value ofcontrolling premium

Transaction comparablemethod

Pros:

very market oriented can easily put pieces together to valuecompany with multiple industrial operations

Cons constrained by availability of comparable

public companies

Analyze the trading multiples and

operation situation of comparablepublic companies to arrive at a rangeof trading multiples for the targetcompany

The valuation does not factor in valueof controlling premium

Trading comparable

method

Forecast the future cash flows andterminal value, discount them byappropriate discounts rates, to arriveat valuation result of target company.

More complex, but has most soundtheoretical foundation

Description

Pros: less relied on third party dataCons

not suitable for start-ups or distressedcompanies

very sensitive to the forecasts andassumption

Pros and Cons

Discounted cash flowmethod

Valuation methods

There is no single method is better than others and each is more appropriate for specific situationsMost frequently, combination of 3 methods will be used to cross check and narrow the valuation range.There is no single method is better than others and each is more appropriate for specific situationsMost frequently, combination of 3 methods will be used to cross check and narrow the valuation range.


11/53


Enterprise value (Firm value, FV )Enterprise value (Firm value, FV )Equity valueEquity value

Difference Between Equity Value And Enterprise Value

Equity value + net debt + minority interest +preferred share

(net debt = short term liability + long term liability+ capital lease cash and cash equivalence)

Capture all the valuation of stakeholders,including both equity and debt holders

Major enterprise valuation multiples Enterprise value / revenue

Enterprise value / EBITDA Enterprise value / EBIT Enterprise value / free cash flow to firm

Equity value + net debt + minority interest +preferred share

(net debt = short term liability + long term liability+ capital lease cash and cash equivalence)

Capture all the valuation of stakeholders,including both equity and debt holders

Major enterprise valuation multiples Enterprise value / revenue

Enterprise value / EBITDA Enterprise value / EBIT Enterprise value / free cash flow to firm

Shares outstanding x share price

The interest of common share shareholdersreceives after creditors and preferred sharesshareholders

Major equity valuation multiples Share price / net profit per share (P/E ratio) Equity value / free cash flow to equity Equity value/ equity book value (P/B ratio)

Shares outstanding x share price

The interest of common share shareholdersreceives after creditors and preferred sharesshareholders

Major equity valuation multiples Share price / net profit per share (P/E ratio) Equity value / free cash flow to equity Equity value/ equity book value (P/B ratio)


12/53


Using Different Valuation Methods During The Life Span Of ACompany

Startup

EBITDA*

Develop-ment

Fastgrowth Mature

1.Comparables

-FV/fixed assets

-FV/market size

1.Comparables

-FV/Revenue

1.Comparables

-FV/EBITDA

-FV/Revenue

-P/E

2.DCF

1.Comparables

-FV/EBITDA

-FV/Revenue

-P/E

-P/B

2.DCF

Note: EBITDA, earning before interest, tax and depreciation & amortization


13/53


Trading Comparable Method

Generally, there is always some comparable companies listed on stock exchange. The tradingstock prices are good indicators of how the market/investors value such companies within thesame industry/segment. Using trading multiple ratios of such companies, we can estimate the

value of a target company as if it were listed

For non-public company, the convention is to apply a discount rate of 20-30% off listing companytrading valuations. Moreover, the larger the target company, the smaller the discount rate. Thediscount is roughly a reflection of liquidity risk.

General steps of application of trading comparable method

Select appropriate comparable listed companies

Select appropriate multiples

Estimate the target company value


14/53


Trading Comparable Analysis

Step 1. Select a comparable indus try , as close as possible Different industries are traded at different multiples (investors view

them differently)

Step 4. Select the

most comparablecompanies andmult iples, define therange of multiples andapply on the target toget valuation

Step 4. Select themost comparablecompanies andmult iples, define therange of multiples andapply on the target toget valuation

Step 2. Shortlist the comparable companies within that indust ry Product Scale (Revenue, gross profit, net profit, production) Geographic region Profitability (gross margin, net margin)

Efficiency (turnover ratio), etc.

Step 3. Select multiples and range of multiples TO COMPARE! Which multiples are meaningful when comparing How is the operation of target company compared with the short listed

comparable companies? Better or worse? How much better/worse?Why? It is sustainable?

How different is the target companys business from each comparablecompany? How much would the different impact on the valuations?

How is the capital structure of the target company compared with its

peers? Etc.


15/53


Listeddate

Listedexchange

RevenueNet

incomeOperatingcash flow

Equity

Latestprice(RMByuan)

2008 P/Emultiples

(times)

2007 P/Emultiples

(times)

Totalshares

(millions)

IMCYY - - 821 248 242 675 TBD 15.0x - TBD

China Ship 20-May-98 Shanghai 27,655 4,160 2,622 12,042 72.0 11.5x 8.7x 663 Zhongchuan 3-Jun-97 Shanghai 1,327 92 191 778 17.7 69.4x 153.7x 362 Guangzhou Shipyard 1-Jan-03 Shanghai 6,484 820 -195 2,569 24.3 14.6x 43.0x 495

China Average 31.8x 68.5xUDL Holdings 23-May-01 Hong Kong 62 -2 -19 135 0.036 N/A N/A 5,040 Wonson Intl 17-Jul-07 Hong Kong 1,052 -414 284 2,023 0.459 N/A N/A 33,740 Guangzhou Shipyard 28-Oct-93 Hong Kong 6,484 820 -195 2,569 12.8 7.7x 20.5x 495

Hong Kong Average 7.7x 20.5x

Keppel Corp. 24-Oct-80 Singapore 55,683 6,231 9,655 31,832 36.9 9.4x 5.6x 1,593 Yang Zi Jiang 18-Apr-07 Singapore 7,359 1,624 2,756 4,315 3.9 8.7x 36.1x 3,653

Singapore Average 9.1x 20.8x

Simple Example Of Trading Comparable Analysis

Comparable trading multiples - partial

Note:1. Data as of end of 2008/2007 and all currency is converted into RMB yuan ( ), RMB1= USD0.146=HKD1.133=GBP0.089=SGD0.2122. Limited information of ship yards listed on US or UK exchanges

Closestcomparable

Closestcomparable

Units: RMB millions unless specified

Make sure the fol lowing is t aken care of 1. Check if comparable companies are comparable (Some companies are displayed on your radar monitor by database screening,

however, these companies holds many other industry investment, thus might not be a good comparable)2. Read prospectus and research report to get deep understanding of comparable companies businesses3. Delete obvious bad comparable companies4. Delete obvious outliers5. Delete obvious meaningless multiples6. Calculate average and medium multiples7. Select and adjust multiples (ranges) to apply on the valuation of target company


16/53


Transaction Comparable Method

Selecting appropriate historical M&A transactions is crucial to the valuation result

Industry, business and financial performance of the comparing companies shall be as similaras possible

Transaction consideration shall be close to intended transaction of the target company

It very difficult to gather transaction information of non-public companies, public news might bethe one available information source.

Some considerations when using transaction comparable method

Strategic buyer and financial buyer might offer different premium/discount

Other non-valuation factors might affect the transaction value (negotiation power, governmentinfluence/policy, sellers true intention of exit, etc.)

Timing when different transaction happens (internet bubble, distressed assets during financialcrisis, etc.)


17/53


Simple Example Of Transaction Comparable Application

Step 1 Select comparable transactions (new energy sector, solar energy segment)

Step 2

Select multiples(P/E, P/B, etc .)

Step 3

Compare targetcompany with thecomparablecompanies

Step 4

Apply selectmultip le range toestimate valuation

Step 2

Select multiples(P/E, P/B, etc .)

Step 3

Compare targetcompany with thecomparablecompanies

Step 4

Apply selectmultip le range toestimate valuation

AnnouncementDate

Lead Investor(s) /Buyer Target

TransactionValue

(US$ mm)%

ImpliedValuation (US$

mm)Description of Target(s)

7-Apr CLP Holdings Ltd.(SEHK:2)

Roaring 40sRenewable Energy PtyLtd., 10 Wind Farms inChina

94.2 49 192.2 Operates 10 wind farms in China

20-Apr NAChina RecyclingEnergy Corp(OTCBB:CREG)

2.0 NA NA

Designs, sells and operates topgas recovery turbine systems(TRT) and other renewableenergy products

27-Apr Jinzhou YangguangEnergy Co., Ltd.

Jinzhou JinmaoPhotovoltaicTechnology Co., Ltd.

5.9 NA NA Provides solar PV modules

12-May Wide Success IntlEnterprise LimitedCWIG DiaobingshanWindpower Co., Ltd. 5.0 20 25.1

Engages in wind power electricitygeneration

20-MayZhejiang Yuhui Solar Energy Source Co.,Ltd.

Wuxi Jiacheng Solar Energy Tech. Co., Ltd. 17.3 100 17.3

Manufactures solar cells andmodules

21-MayCathay ForestProductsCorp.(TSXV:CFZ)

Eco-Energy ChinaGroup 2.5 40 6.3

Produces biodiesel and operatesmulti-feedstock biodiesel refineryand jatropha plantations

2-JunMC Capital AsiaPacific Ltd.; STICInvestments, Inc

Yeong Guan EnergyTechnology Group 30.0 30 100

Manufactures and distributes windturbine components

30-Jun International FinanceCorporationSuntech Power Holdings Co. Ltd.(NYSE:STP)

50.0 NA NA

Produces monocrystalline and

multicrystalline silicon PV cells;PV modules; andbuildingintegrated photovoltaicsproducts

Source: Company announcements, Capital IQ, Zero2IPO.com.cn, Quamnet.com, ChinaVenture.com.cn, Yahoo! Finance News and PRNewswire.

Selected comparable transactions


18/53


Accrual Accounting* And Its Effect On Fixed Assets Depreciation

Accrual, basically means adding something, or the thing that is added. In accounting & finance, the addingtogether of interest or different investments over a period of time, or the gathering or clustering of things. Itimplies a gradual accumulating action/effect.

Example

Accrued revenue: revenue is recognized before cash is received. Accrued revenue (or accrued assets) isan asset, such as unpaid proceeds from a delivery of goods or services, at which such income item isearned and the related revenue item is recognized, while cash for them is to be received in a later period,when its amount is deducted from accrued revenues.

Accrued expense: Expense is recognized before cash is paid out. Accrued expense is a liability with anuncertain timing or amount, but where the uncertainty is not significant enough to qualify it as a provision.

An example is an unpaid obligation to pay for goods or services received from a counterpart, while cashfor them is to be paid out in a latter accounting period when its amount is deducted from accruedexpenses.

Fixed assets depreciation: Cash is paid out at the time of purchasing in one payment generally, but thecost is not expensed right away in the income statement because the equipment or factory building webought will be used for many years. Therefore, on the income statement, only portion of the total cashpayment (original value) is deducted every year (we call the deduction depreciation) and on the balancesheet, the depreciation portion is deducted from the original value every year afterwards. Effect on thecash flow statement: as the cash out flow is at the beginning of purchase, the depreciation in the lateryears is not cash out flow, instead, its a non-cash out flow appeared in the income statement.

Note: Accrual accounting,


19/53


Importance Of Cash Flow

Cash flow is more important than net profit in valuation, as it can lead to more accurate resultby taking the following factors into consideration (which net profit fails to capture by definition):

Working capital requirement (working capital = inventory + account receivables + othercurrent assets payables - other current liabilities)

Time (time value of money)

Moreover, cash flow can, to some extent, narrow the gap due to different accounting principlesadopted by various companies

However, cash flow does not capture the depreciation/amortization, accrued ( ) expense

deferred ( ) expense, etc., it cannot truthfully reflect the profitability of a company

The cash flow here is still not the free cash flow we are going to discuss later


20/53


Time Value Of Money And The Concept Of Discounting

Money has time value: a dollar today is worth more than a dollar tomorrow.

Reason: Money in hand can be invested to value generation activities, hence by the end oftomorrow, it will be more than the amount we have today.

Therefore, the money we are going to receive tomorrow has to be discounted by applying arate (such as bank lending rate, etc.) to reach its valuation of today. The process is called cashflow discounting.

When value a firm, we can not simply add up all the cash flows which are forecasted togenerate in the future, but discount those cash flows to be received at different future timespots to a specific date, say today, then sum up the discounted amounts.


21/53


Simple Example Of Discounting Cash Flow (DCF)

Assuming company A is expected to generate a stream of cash flows, 1 million, 1.1 million, 1.2 million, 1.3million, 1.4 million in the next 5 years, by discounting using a discount rate of 15% per year, the futurecash flows valuation is calculated below

1 1.11.2 1.3

1.4

Year 0 Year 1 Year 2 Year 3 Year 4 Year 5

0.87 0.83 0.79 0.74 0.70


The value today of cash flows forecasted to be generatedin next 5 years

1 1.1 1.2 1.3 1.4

(1+15%) (1+15%)2

(1+15%)3

(1+15%)4

(1+15%)5

= 0.87 + 0.83 + 0.79 + 0.74 + 0.7

= 3.93

= + + + +


22/53


Flow Of Free Cash FlowsThe cash pool holds cash received from varioussources, such as cash sales, collection of accountreceivables, advance from customers, borrowing frombanks, issuance of equity, etc. The cash is used topay suppliers, to make fixed assets purchasing, payexpenses and tax, etc.

The cash in the cash pool is different from netincome. As net income contains effect of many non-cash items, it has to be adjusted to get the free cashflow.

Free cash flow to firm is the cash flow to both equity

holder and bank, as one single entity. As the moneyborrowed from banks is already in the cash pool, itshall not be included in the cash flow generated forthe entity. In other words, the borrowed money is likethe money that is taken from your right pocket (debtholder) and put into your left pocket (equity holder).

(You = the firm)Free cash flow to equity, however, is all the moneythat is put into your left pocket. Therefore, the netborrowing is counted, the after tax interest payment isexcluded (these 2 cash flows are inter-pocket cashflows).

FCFE

InterestpaymentShareholder

Net newborrowing

Cash pool

Working capitalinvestment

Net Capex

Net new

borrowing

Free cash flow to firm(FCFF)

Debt holder


23/53


Definition of Free Cash Flows

Free cash flow to equity

The cash flow remains after all operation / investment deduction and freely available to shareholder

Free cash flow to firm

The cash flow remains after all operation / investment deduction and freely available to shareholder and debt holder

Free cash f low to fi rm (FCFF) =Net income +D&A - Change in working capital - Capex + (1-tax rate) x interest expense

Free cash f low to equity (FCFE) =Net income +D&A - Change in working capital - Capex

+ net new borrowing

Or=FCFF + net new borrowing - (1-tax rate) x interest expense


24/53


Cost Of Equity

Cost of equity can be calculated by using Capital Assets Pricing Model ( CAPM ): Cost of equity = risk free interest rate + beta x (market return risk free interest rate)

Definitions

risk free interest rate: long term Chinese government bond yield Market return risk free interest rate, is also called market premium. Market return, in practice, we use

long term stock market compounded annual return. Market premium reflect the premium investors requireto compensate for the extra risks they take when investing in stock market instead of buying governmentbonds.

Beta: the relative volatility of specific stock price changes to the overall market return (example on next

slide). It changes over time due to the business nature of the company changes and investorspreservation changes. Levered beta and un-levered beta: as most public companies observed in the stock market borrows

money, hence their betas are levered. We need to translate those levered beta into unlevered. Theformula is as follow (in which, D=debt, E=equity, T=tax rate, Pref.=preferred stock, Mino.=minorityinterest)

Again, use comparable analysis to select the most appropriate betas for the target company

IMC practice : IMC has its own required return on equity for our investments, 16%?20%?30%? But when wesell any stake in our investment, we shall use market required return on equity/investment to value ourbusiness.

Levered beta1+ (D/E)(1-T)+(Mino+Pref.)/E=

Unleveredbeta


25/53


Simple Example Of Cost Of Equity Calculation

Generally there is publication on company beta providedby various financial data vendors, or we can use marketdata to calculate.

A target company, debt ratio=25%, tax rate=25%

Select most appropriate comparable companies in similarbusiness, similar debt ratio to the target company, takeaverage of the comparable beta.

Assuming risk free rate is 4.17%, market premium is 12%,cost of equity is (4.17%+1.12x12%)=17.5%

Generally there is publication on company beta providedby various financial data vendors, or we can use marketdata to calculate.

A target company, debt ratio=25%, tax rate=25%

Select most appropriate comparable companies in similarbusiness, similar debt ratio to the target company, takeaverage of the comparable beta.

Assuming risk free rate is 4.17%, market premium is 12%,cost of equity is (4.17%+1.12x12%)=17.5%

Stock price vs. market index monthly volatility

y = 1.1409x + 0.0417

-40%

-30%

-20%

-10%

0%

10%

20%

30%

-20% -15% -10% -5% 0% 5% 10% 15%

GE stock price change

S & P

5 0 0 c

h a n g e

Levered BetaLevered Beta

Debtratio Tax rate

Leveredbeta

Unleveredbeta

Company A 20% 25.0% 1.24 1.08Company B 25% 25.0% 1.40 1.18Company C 30% 33.0% 1.19 0.99

Company D 35% 12.5% 1.70 1.30Company E 25% 12.5% 1.35 1.11Company F 40% 25.0% 1.64 1.26 Average of

selectcompanies

1.12


26/53


Weighted Average Cost Of Capital (WACC)

The discount rate used to discount f ree cash flow to firm is WACC, or Weighted A verage Cost ofCapital, is calculated as=cost of equity x equity ratio+ (1- tax rate) x cost of debt x debt ratio

Definitions Cost of equity: expected or required rate of return of equity investments Equity: equity market value (in practice we use book value instead of market value, as the market value is

what we are forecasted here and would cause iteration calculation) Equity ratio: equity value /(equity value + debt value)

Debt ratio: 1- equity ratio Debt value: debt market value (in practice we use book value, as using debt market value would implyforecasting long term interest rate, adding 1 more uncertainty factor)

Cost of debt: interest rate charged on the book value of the debt (there might be different rates on loansborrowed from different banks and bonds issued to different creditors)

Tax rate: effective enterprise income tax rate (the interest payment is deducted before income tax atcompany level)

Due to the fact that capital structure (debt ratio and equity ratio) changes over time, different WACC shallbe applied to discount FCFF of each year . In the long term, the company might pay back most of interestbearing debt, or maintain certain level of leverage (by assumption or industrial average level).


27/53


WACC calc example (on the left) Cost of equity = 20%

Cost of debt =6%

Tax rate = 25%

Equity investment = 40

Debt investment = 60

WACC = 20% x 40% + (1-5%) x 6% x 60% = 10.7%

WACC calc example (on the left) Cost of equity = 20%

Cost of debt =6%

Tax rate = 25%

Equity investment = 40

Debt investment = 60

WACC = 20% x 40% + (1-5%) x 6% x 60% = 10.7%

Simple Example Of WACC Calculation

40

60

2.7

8.00

10

20

30

40

50

60

70

80

90

100

Capital Cost of capital

Debt

Equity

Capital structure and cost of capital

R

M B y u a n

100

10.7


28/53


29/53


A Revisit Of Multiples, Firm/Equity Value

Firm value

EBITDA multiple

Gross profit multiple Revenue multiple

Equity value

Price to earning multiple (P/E ratio)

Book value multiple

Company A Company B

Sales 40.0mm 25.0mm

Gross profit 14.0mm 12.0mm

EBITDA 12.0mm 10.0mm

Net income 8.0mm 6.0mm

Earning per share 0.4 0.6

Stock price 8 10

Firm value 100.0mm 75.0mm

P/E 20.0x 16.7x

Firm /Sales 2.5x 3.0x

Firm /Gross profit 7.1x 6.3x

Firm /EBITDA 8.3x 7.5x


30/53


31/53


1 1.11.2 1.3

1.4


1 1.11.2 1.3

1.4


Simple Example Of Terminal Value Calculation Perpetuity GrowthModel

Step 1. calculate the cash flow of final year in theforecasted period

Step 2. analyze the comparable companies, todefine the range of perpetuity growth rates

Step 3. apply a specific perpetuity growth rate (g)for the target company and estimate the terminalvalue

Step 4. use the same discount rate used todiscount final year cash flow (or the long termdiscount rate) to discount the terminal value back totime 0

Note: DCF approach is very sensitive to the

terminal value result

The final year has to be a normal operating year,during which no big fluctuation happens and no bigcapex investment occurs

Step2. Assuming g=2%, r=15%, then

Step3. TV=1.4 x (1+2%)/(15%-2%)=11.011.0

0.87 0.83 0.79 0.74 0.7


5.47

Step1. FCF calculation

Step4. Discounting


32/53


1 1.11.2 1.3

1.4


1 1.11.2 1.3

1.4


Simple Example Of Terminal Value Calculation Exiting MultiplesModel

Step 1. calculate the cash flow of final year in theforecasted period

Step 2. analyze the comparable companies, todefine the range of exiting multiples. Firm valuemultiples includes FV/EBITDA, FV/EBIT or FV/Rev;equity value multiple includes P/E, P/B ratios

Step 3. apply a specific exiting multiple for thetarget company and estimate the terminal value

Step 4. use the same discount rate used todiscount final year cash flow (or the long termdiscount rate) to discount the terminal value back totime 0

Again, the final year has to be a normal operatingyear, during which no big fluctuation happens andno big capex investment occurs

Step2. Assuming exiting mul tiple is 7times, discounting rate=15%, thenStep3. TV=1.4 x 7 =9.8

9.8

0.87 0.83 0.79 0.74 0.7


4.87

Step1. FCF calculation

Step4. Discounting


33/53


Definitions For Key Deal Evaluation TermsCash on Cash Payback Number of years for undiscounted yearly Free Cash Flows to fully

recover cost of capital expenditure (in the case of a project) orinvestment (in the case of investment in an investee company) onan ungeared basis (ie. no debt).

Equity Payback Number of years for undiscounted yearly Free Cash Flows to fullyrecover equity portion of capital expenditure (in the case of project)or investment (in the case of investment in an investee company)on a geared basis (ie. with debt).

Free Cash Flows(ungeared)

Net cash after tax (based on project specific tax rates) fromoperation less total capital expenditure (in the case of a project); ortotal receipts from the investment less total amount invested (in thecase of an investee company).

Free Cash Flows(geared)

Net cash after interest and tax (based on project specific interestand tax rates) from operation less equity portion of capitalexpenditure and debt repayments (in the case of a project); or totalreceipts from the investment less equity invested and interest &debt repayments (in the case of an investee company).

Project IRR Internal Rate of Return from yearly Free Cash Flows or netinvestment receipts on an ungeared basis.

Equity IRR Internal Rate of Return from yearly Free Cash Flows or netinvestment receipts on a geared basis.

Project NPV Yearly Free Cash Flows (ungeared) discounted to Year 0, usingdiscount rate of 8%, 12%, 16% plus one considered appropriate byproject team.

Equity NPV Yearly Free Cash Flows (geared) discounted to Year 0.

Terminal Value Value of asset upon divestment, end of project, or end ofprojections. [ Kindly state the basis (e.g. sale value, replacement value, net

book value, earnings/EBITDA multiple etc) in the assumptions. Please state thevalue if projections are 5 years or less]

Addi tional terms

There are more than one way to interpret theconcepts below

1. ROE : Net income during the investmentperiod divided by equity investment at theperiod beginning (or the maximum amount theshareholders put into the company/project)

2. ROI : Net income during the investment

period divided by the total investment at theperiod beginning (or the maximum amountboth shareholders/bonder holders and banksput into the company/project)


34/53


Demo Valuation - Discounting Free Cash Flows


35/53

Table Of Contents





Q&A 25 min


36/53


Consistent Format Is Crucial- Major format guidelines

Base case, Optimistic case, Pessimistic case

Everything in one tab is recommended, for easier formula check (without getting lost switching back and

forth between tabs even separate files) and print formatting. However, DCF valuation and index pages can

be in separate tabs.

Start with assumptions and operation ratios key assumptions and operation forecast overview

Followed by forecasted income statement, balance sheet and cash flow statement

Major schedules

1. Revenue schedule

2. COGS schedule

3. Expenses schedule

4. Debt schedule

5. Capex and depreciation & amortization schedule


37/53


Format issues - cover


38/53


Format issues model

Project nameProject name unitunit

CommentComment

SBUnameSBUname

Pagenumber Page

number

DateDateDoc

nameDoc

name

Actual Actual

CalculatedCalculated

Green i flinked

from otherfiles

Green i flinked

from otherfiles


39/53


Format issues DCF


40/53


Plan Ahead - Structure

Cover sheetCover sheet

Assumption Assumption Working schedulesWorking schedules DCF outcomeDCF outcome

Majorassumptions (needto go over withmanagement orexternal consu ltants)

Based onhistorical orindustrial relativeposition of the targetcompany

Majorassumptions (needto go over withmanagement orexternal consu ltants)

Based onhistorical orindustrial relativeposition of the targetcompany

M a

j o r s c

h e

d u

l e s

M a

j o r s c

h e

d u

l e s

Income statements

Balance sheet

Cash flow statements

Revenue schedule

COGS schedule

Expense schedule

Capex and D&A schedule

Debt schedule

etc.

Income statements

Balance sheet

Cash flow statements

Revenue schedule

COGS schedule

Expense schedule

Capex and D&A schedule

Debt schedule

etc.

WACC or cost of equitycalculation

Firm value and equity valuecalculation

WACC or cost of equitycalculation

Firm value and equity valuecalculation

Major operatingratio overview(EBITDA/EBIT/Netprofit margins, etc. )

Investment return

highligh ts, NPV, IRR,ROE, ROI, paybackperiod, etc.

Sensitivi ty analysis(put in cover sheet)

Major operatingratio overview(EBITDA/EBIT/Netprofit margins, etc. )

Investment returnhighligh ts, NPV, IRR,ROE, ROI, paybackperiod, etc.

Sensitivi ty analysis(put in cover sheet)

When assumption

from diff erentsources contradictagainst each, makereasonableadjustments

When assumption

from diff erentsources contradictagainst each, makereasonableadjustments

N o

t e s

N o

t e s

Faithfull y mimic t he business model and structure

Clear, concise, logical, detailed, easy to understand and followthe relationship and l ogic between numbers

Flexible, with built in formula for sensiti vity analysis

Faithfull y mimic the business model and structure

Clear, concise, logical, detailed, easy to understand and followthe relationship and l ogic between numbers

Flexible, with built in formula for sensiti vity analysis

Reader friendlyReader friendly

Model producer and dateIndex

Key conclusion

Model producer and dateIndex

Key conclusion


41/53


Constructing A Financial Model Major Steps

Draft t he model structure(scratch paper, write key log icand major drivers)

Draft t he model structure(scratch paper, write key log icand major drivers)

Make assumptionsMake assumptions

Start to build a modelStart to build a model

Forecast

Operation forecast

Capex f orecast

Working capital f orecast

Debt financing forecast

Forecast

Operation forecast

Capex f orecast

Working capital f orecast

Debt financing forecast

Discount rate calculation(WACC or Cost of equity)

Discount rate calculation(WACC or Cost of equity)

Balance sheet

Cash flow statement

Balance sheet

Cash flow statement Income statementIncome statement

Discounting cash flowDiscounting cash flow ValuationValuation Major ratio overview

Major conclu sion

Major ratio overview

Major conclu sion


42/53


Generating Income Statement

RevenueRevenue

M a j o r

b u s

i n e s s

M a j o r

b u s

i n e s s

O t h e r o p e r a

t i o n

O t h e r o p e r a

t i o n

COGSCOGS

Propertysales

Propertysales

Propertyrental

Propertyrental

PropertyCOGS

PropertyCOGS

LeasingCOGS

LeasingCOGS

ResidentialResidential

OfficeOffice

HotelHotel

Shopping mallShopping mall

Restaurant/SPA/Theater Restaurant/SPA/Theater

OthersOthersOthersOthersParking lotParking lot

LandLand

Raw materialRaw material

Fuel and utili tyFuel and utili ty

OverheadOverhead

D&AD&A

OthersOthersOthersOthersOthersOthers

ExpenseExpense

Propertydevlp

Propertydevlp

Leasingexp.

Leasingexp.

OverheadOverhead

MarketingMarketing

Trip & entertainTrip & entertain

Office rental &

equip.

Office rental &

equip.

D&AD&A

OthersOthersOthersOthersOthersOthers

Other operatingincome

Other operatingincome

- -

EBITEBIT - InterestInterest TaxTax- =

NetIncome

NetIncome


43/53


Generating Balance Sheet

Remember, we have forecasted income (=Revenue COGS expenses taxes) in the incomestatements, we can use those items and major operation assumption to drive the balance sheet forecast.

Current assets and current liabilities are items that caused by operating activities, such as procurement,credit sales, short term borrowing, etc.

Items are forecasted by using inventory turnover days, account receivable turnover days, account payableturnover days

1. Inventory = COGS (excl. D&A) x inventory turnover days / 365 days

2. Account receivable = Revenue x account receivable turnover days / 365 days

3. Account Payable = COGS (excl. D&A) x account payable turnover days /365 days

4. Other account receivables/payables: use different assumption according to business nature of theseitems, could be inter-company lending, payable to construction contractors

The assumption of turnover days shall be consistent with target company historical operation data andindustrial average.

Due to tighten credit policy and better/worse inventory control, these assumptions might change over time.Model shall reflect the trend in our assumptions.


44/53

C h Fl I A R l C


45/53


Cash Flow In A Real Company

Shareholder

Inventory

Accountreceivable

Accountpayable

Government

Companyfund

Debt holder

Fixed assets

Dividend

Capital injection Net borrow ing

Interest

CollectionPayment

Production

Investment

tax

Cash sales

DepreciationOperation

Investment

Financing

G t C h Fl St t t I di t M th d


46/53


MethodMethod

Generate Cash Flow Statement Indirect Method

Based on the accounting principle, cash flowstatement can be generated by using last year &current year balance sheet, and income statement

Step 1. Start from net income from incomestatement

Step 2. Add back depreciation and amortization,and other non-cash cost items (such as badaccounts provision, capitalized expenses, etc.)

Step 3. Deduct increase in current assets (excl.

cash), add increase in current liabilities. The 2actions in net, deduct the working capitalinvestment

Step 4. Deduct capex

Step 5. Add net funds from equity/bonds raise andnet new bank borrowing

Step 6. Add year BGN cash to get year END cashbalance.

s a m p l e

G l M d li g M th d A d Skill Li ki g E thi g


47/53


General Modeling Methods And Skills Linking EverythingTogether

Starting from income statements, net income = Revenue COGS expenses - taxes

1. Interest income = saving rate x average of cash balance of year BGN and END

2. Interest expense 2 items

1) Interest expense of loan = interest rate x loan balance at year BGN;

2) Interest expense of necessary to finance = interest rate x average of necessary to finance at year

BGN and END

3. necessary to finance a transition item used to balance the balance sheet, basically is of short-

term financing in nature and shall be zero after the balance sheet is balanced

4. Necessary to finance (its included in current liability in the B/S, not included in C/F, but as a

calculation outcome of C/F), defined as shortage (if any) of cash balance compared with minimum

cash requirements.

Income statement

Linking Everything Together (Cont)


48/53


Linking Everything Together (Cont)

Secondly, use the forecasted ratio and various schedules to complete the balance sheet, with cash balance

to be linked with cash flow statements

The link causes circular calculation

Solution: under Excel spreadsheet tool bar, choose Tools Options Calculation tab

tick Iteration enter 100 (shall be enough)

Finally, cash flow statement (slightly different from what you commonly see).

Start from net income, adjusted for non-cash gain/loss, such as D&A, gain/loss on assets, etc.

Adjust for working capital changes, such as AR, inventory, AP, tax payable, etc.

Adjust for financing cash flows (borrowings & pay back, and equity injection) and investment cash

flows (Capex)

Arrives at cash balance at year end (or year beginning of next year), which will be linked to B/S

Balance sheet & cash f low statement forecasts and Iteration


49/53

Table Of Contents





Q&A 25 min


50/53


51/53

Investment Paper Supports Assumptions Used In The Model


52/53


Investment Paper Supports Assumptions Used In The Model

1. Macro Environment

Analyze the macro economy (most probably need to cover global economy and trade policies/trend) to identify variables that affect an industrys

sales How do these variables affect the sales? by how much? Quantify it (for example, household disposable income vs. residential real estate

investment)

What is the expectation of future change of these variables?

2. Industry Market Environment

Demand forecast (major downstream and end customer demand analysis and forecast, quantity growth assumption in the model shall be based onthis forecast)

Supply forecast (major upstream industry analysis. Capacity adding forecast. If oversupplied, price will go down/at least not go up in our financialmodel assumption, vice versa)

Competition (Major competitors, their strategy and business model, market shares, industrial profitability. If the market structure is stable, if themodel assumes to grab share from them/grow faster than them, sales expense could be higher than their/industrial average level)

3. Product s Market

Customer analysis (who are they type of customers, what is their purchasing behavior-what do they seek, price sensitivity, brand loyalty/cost ofswitch supplier, etc. Our model might be structured to forecast the sales to different customer segment)

Demand and supply analysis for each product category, future trend, what is our advantage and disadvantage (to compromise our disadvantage,probably mean higher capex for better equipment to offer additional features on our product, or higher COGS due to different raw materials, orhigher marketing expense, or higher R&D expense, or higher labor cost to maintain better quality of product or customer service . All these shall bereflected in our assumptions in the financial model)

Substitutes (any threaten from or market share loss caused by substitute products? Any related policy issue? This will affect our long term revenuegrowth assumption if substitute product would not cause major threats in the short run)

Aim: To identify the driver & risks of business, and quantify analysis to helpmanagement to make decision

GIC IP Industrial profile

1.Macro Environment

2.Industry Market Environment

3.Product Market


53/53

Table Of Contents





Q&A 25 min