USING FINANCIAL ANLYSIS FOR COMPANY le_analyse_naar... · PDF fileNET LONG – TERM FINANCING ‐Positive NLF: notalllong‐term financingused ‐NegativeNLF: short‐term debt is

USING FINANCIAL ANLYSIS

FOR COMPANY VALUATION

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CONTACTPARMENTIER GUY – MGI BVBAValkenlaan 31 – 2900 Schoten

Tel: 03/685.40.07Mail: [email protected]

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Guy ParmentierBedrijfsrevisor

Executive professor ‐ University of Antwerp Management School 2008 (Real Estate Accounting)

Professor ‐ Karel De Grote Hogeschool Antwerp(Audit/Valuation)

Docent postgraduaat Antwerp ‐ AccountancyGuest professor ‐ University Maastricht (Valuation)Guest professor – University of Economics Nicosia

(Cyprus)Author of the book – Business Valuation ( Intersentia)

ISBN 978-1-78068-016-3

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OVERVIEW OF THE

MAIN VALUATION METHODS Equity Valuation models

Equity Cash Flow value =

Economic Profit Equity value = ABV – BV EXCEEDING ASSETS + + EXCEEDING ASSETS (MINUS TAXES)

Entity Valuation models

Entity DCF Value = + EXCEEDING ASSETS (minus taxes) –INTRESTBEARING DEBTS

Entity Economic Profit value = IC MINUS BV EXCEEDING ASSETS + + EX ASSETS (MINUS TAXES) – INTRESTBEARING DEBTS

Entity APV = + ( FINANCIAL DEBT X TAX RATE ) – INTRESTBEARING DEBTS

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Equity Cash Flow = Incoming Cash Flow ‐ Outgoing Cash Flow= Available cash for company shareholders

ECF = Earnings after Taxes + Depreciations + Amortizations –Δ Working Capital Requirements ‐ Δ Investments (in fixed assets) + Δ Financial debtECF = EAT – Net Investments + Δ Financial debt – Net Investments = New Investments in fixed assets – Depreciations

‐ Amortizations + Δ Working Capital Requirements

1. EQUITY CASH FLOW (ECF)

5

N N+1 N+2

° OPENING BALANCE WCR° CLOSINGBALANCE WCR

€ 1,400

€ 2,700

€ 2,700

€ 2,200

€ 2,200

MUTATION IN WCR € 1,300 € ‐500

6

“Anything can be priced by considering theamount of money a fool is willing to payfor it.”

Quote from an American stock broker

PART I: Financial Analysis

Liquidity

Solvability

1. Balance sheet structures

FINANCIAL ANALYSIS

& COMPANY VALUATION

7

Step 1: calculating net long‐term financing= ‘buffers’ for financing working capital requirements

Step 2: calculating working capital requirements‐> investments = all required financial resources

Step 3: support long term financing ‐> funding working capital requirements

Need to improve financial situation before new strategic investment decisions?

BALANCE SHEET INFORMATION

8

PART I: Financial Analysis

Liquidity

Solvability

1. Balance sheet structures

2. Profit – Loss statements in detail

3. Additional steps

FINANCIAL ANALYSIS

& COMPANY VALUATION

9

Step 4: Tool: depreciations and amortizations to improve short

–term earning?

Step 5: Calculating net operating cash flow

Step 6: Cash flow sufficient for all maturating debt

obligations?

Step 7: validity of balance sheet forecasts in line with future expectations

ADDITIONAL STEPS

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PART I: FINANCIAL ANALYSIS

CHAPTER ONE: THE BALANCE SHEET

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INTRODUCTION TO

BALANCE SHEET

12

BALANCE SHEET

ASSET EQUITY‐LIABILITIES

Ownership Financial Arrangements

Business valuation – Using financial analysis to measure a company’s valueP 13 and following

DE YIN-YANG OF ACCOUNTANCY

13

How are assets paid?Assets = Equity + Liabilities– ‘Box of blocks’

Activa

NON‐CURRENT ASSETSProperty, plant & equipment

Financial assets & intangibles

CURRENT ASSETSPrepaid expensesInventoryAccounts Receivable

Eigen+ Vreemd vermogen

Shareholders’ EquityCapitalReservesAccumulated results

Non‐Current liabilitieslong term financial debt

Current LiabilitiesAccrued expensesAccounts payableShort term financial debts

ASSETS

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Assets

Non currentAssets

Net fixedassets

Currentassets

Inventories AccountReceivable

PrepaidExpenses Cash

Business valuation – Using financial analysis to measure a company’s value P 16

Companies only exist as investors have supplied them with capital”

Substantial risk

‐ Fixed return => debt holders‐ Profits => company owners

Shareholders’ equity= Asset ‐ Liabilities

SHAREHOLDERS:

SUPPLIERS OF CAPITAL

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SHAREHOLDERS’S EQUITY:

A RESIDUAL VALUE

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ASSETS

OWNERS EQUITY

LIABILITIES

Non‐currentassets

Current Assets

Owner’s Equity

Long‐term financial debts

Short‐term financial debts

Accounts payable

Accued expenses

Business valuation – Using financial analysis to measure a company’s valueP 22

LIABILITIES AND

SHAREHOLDERS’ EQUITY

17

Business valuation – Using financial analysis to measure a company’s valueP 22

NET LONG-TERM FINANCING

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NLF = Equity+ Long‐term debt ‐ Net fixed assets

net fixed assets are funded with long‐term financing

!! financed with resources of a similar duration !!Business valuation – Using financial analysis to measure a company’s value P 27 and following

NET LONG – TERM FINANCING

‐ Positive NLF: not all long‐term financing used‐ Negative NLF: short‐term debt is used to finance fixed assets

• Equity increase to invest in fixed assets NLF will not change• Capital for investments in current assest NLF will increase

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In essence, net long‐term financing indicates to what extent net fixedassets are funded with long‐term financing

NET LONG – TERM FINANCING REVISITED

Net short‐term financing = Short‐term (financial) debt – Cash

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=amount of interest‐bearing debt that is not available in cash

PRACTICAL EXAMPLE

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DEEL 1 : De financiele gezondheid van de onderneming – Financial Health

Periode 8 Periode 9

Stap 1 : Berekening van het NBK – Step 1: Calculation Net working capital 2008 - 2009 2009 - 2010

Totaal eigen vermogen - Total capital and reserves 1.077.853,00 1.206.195,00

Schulden op lange termijn - Payables > 1 year 1.007.154,00 769.145,00

Totaal permanent vermogen- total permanent equity : 2.085.007,00 1.975.340,00

Immateriele vaste activa - Intangible fixes assets 0,00 0,00

Materiële vaste activa - Tangible fixed assets 2.015.869,00 1.755.425,00

Financiële vaste activa - Financial fixed assets 0,00 0,00

Vorderingen op lange termijn - Amounts receivable > 1 year 0,00 0,00

Totale vaste activa en vorderingen LT - Total fixed assets & amounts receivable <1 year: 2.015.869,00 1.755.425,00

Netto-bedrijfskapitaal : 69.138,00 219.915,00

NLF


CHAPTER TWO:WORKING CAPITAL

REQUIREMENTS, MANAGERIAL BALANCE SHEET AND MATCHING

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WORKING CAPITAL REQUIREMENT

Working capital requirements (WCR) = all necessary investments for keeping business operations going

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CASH

PROCUREMENT

PRODUCTION

SALESImpact on the balance sheet:

∆ Accounts payable∆ Rawmaterials inventory

Impact on the balance sheet:

∆ Raw materials inventory∆ Work in progress inventory∆ Finished goods inventory

Impact on the balance sheet:

∆ Accounts receivable∆ Finished goods inventory

Payments for nonoperating activities

OPERATIONAL CYCLE


WCR (before cash) = Operating assets – Non interest‐bearing debt

WCR( before cash) = Inventory + (Accounts Receivable ‐ Accounts payable)+ (Prepaid Expenses ‐ Accrued expenses)

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Positive WCR– Operating company assets > Operating company liabilities

Negative WCR– Operating company assets < Operating company liabilities – Increased cash reserve – Finances a part of a companies operations

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(POSITIVE) WORKING CAPITAL REQUIREMENT

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Assets Equity + LiabilitiesNon‐current assets € 6,000 Shareholders' equity € 4,000Property, plant & equipment € 4,000 Capital € 2,000Financial assets & intangibles € 2,000 Reserves € 1,000

Accumulated results € 1,000Non‐current liabilities € 2,500Long‐term financial debt € 2,500

Current assets € 4,000Prepaid expenses € 500 Current liabilities € 3,500Inventory € 1,500 Accrued expenses € 500Accounts receivable € 1,000 Accounts payable € 1,500

Cash € 1,000 Short‐term financial debt € 1,500

(NEGATIVE) WORKING CAPITAL REQUIREMENT

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Assets Equity + LiabilitiesNon‐current assets € 4,000 Shareholders' equity € 2,000

Long‐term (fin.) debt € 1,000Current assets € 2,500Prepaid expenses € 500 Short‐term financing € 3,500Inventory € 500 Accrued expenses € 500Accounts receivable € 500 Accounts payable € 1,500Cash € 1,000 Short‐term financial debt € 1,500


ALWAYS WORK WITH WCR BEFORE CASH

CASH DOES NOT NEED TO BE FINANCED BY COMPANIES!

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PRACTICAL EXAMPLEStep 2 : WCR berekening – Step 2 WCR calculation

Voorraden - Stocks 303.533,00 341.621,00

Vorderingen op korte termijn - Amounts receivable < 1 year 617.481,00 753.295,00

Overlopende rekeningen - Deferred charges, accrued income 4.564,00 2.072,00

925.578,00 1.096.988,00

MIN

C. Handelsschulden - Trade payables 313.888,00 484.362,00

D. Ontvangen vooruitbetalingen - Prepayments 0,00 0,00

E. Schulden m.b.t. belastingen en bezoldingen - Staff and taxes 244.985,00 169.989,00

F. Overige schulden - Other debts 196.784,00 201.392,00

Overlopende rekeningen - Accrued charges, deferred income 4.339,00 56.544,00

759.996,00 912.287,00

Werkkapitaal - WCR : 165.582,00 184.701,00

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PRACTICAL EXAMPLE

Stap 3 : Vergelijking tussen NBK en WCR –Matching Step 3: Net working Capital and WCR

Netto-bedrijfskapitaal : 69.138,00 219.915,00

Working capital requirements - Werkkapitaal : 165.582,00 184.701,00

-96.444,00 35.214,00

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PRACTICAL EXAMPLEPeriode 8 Periode 9

2008 - 2009 2009 - 2010

Stap 4 : Bereken de toename van het WCR in het laatste jaar :Step 4: Calculate the increase of WCR in the last year 19.119,00Dit is het bedrag dat het bedrijf minder/meer heeft aan werkkapitaal.Amount more / less WCR

Stap 5: Bereken de cashflow uit gewone bedrijfsactiviteit na belastingStap 5: Calculate the ordinary cash flow after taxResultaat uit normale activiteit - Ordinary profit 319.346,98 191.614,68min taxes 34 % -108.577,97 -65.148,99

winst door gewoon werken na fin lasten na belasting - Ordinary Profit after Taxes 210.769,01 126.465,69Afschrijvingen - Depreciations 465.259,00 437.163,27Waardeverminderingen - Amounts written off 0,00 0,00

Cashflow uit gewone activiteit na belasting : 676.028,01 563.628,96Ordinary Cashflow

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PRACTICAL EXAMPLE

Stap 6: vergelijk met de schulden op > 1 jaar die < 1 jaar vervallenStep 6: Matching with Loans > and < 1 year

Cashflow uit gewone activiteit na belasting – Ordinary Cash Flow: 676.028,01 563.628,96A. Schulden > 1 jr < 1 jr - Loan < 1 year 316.316,00 323.104,00

Verschil : 359.712,01 240.524,96

Stap 7: Controleer of wat er overblijft na betaling aan de banken voldoende is om de toename WCR te financierenStep 7: Check if what’s left after Payments to the bank is enough to finance the increase in WCR

Bedrag dat overblijft aan betaling lening bank > 1 jr < 1 jr - Amount that’s left 240.524,96Toename WCR - Increase WCR 19.119,00

Tekort / overschot in het laatste jaar – deficit / surplus in the last year: 221.405,96

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PRACTICAL EXAMPLE

Step 8: Historische cashflow – Step 8 Historical Cash flow

Operationeel resultaat (EBIT) - EBIT 488.852,98 297.841,68

- Belastingen (34 %) - Taxes (34%) -166.210,01 -101.266,17

+ Afschrijvingen - depreciations 465.259,00 437.163,27

BESCHIKBARE CASHFLOW VOOR INVESTERINGEN ( A ) 787.901,97 633.738,78

Available Cash flow before investments

INVESTERINGEN IN VASTE ACTIVA op X-MAANDEN ( B ) -100.000,00 -100.000,00

Investments ( Fixed assets)

MUTATIE BENODIGD WERKKAPITAAL ( C ) 0,00 -19.119,00

mutation WCR

JAARLIJKSE VRIJE CASHFLOW = A + B - C 687.901,97 514.619,78

annual free cash flow

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MANAGERIAL BALANCE SHEET

Managerial Balance Sheet ( MBS) = modified standard balance sheet for improved decision making on business operations MBS facilitate an overall view on operational management by subtracting accounts payable from operating assets:

Business valuation – Using financial analysis to measurea company’s value P 49 and following

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MANAGERIAL BALANCE SHEET


Assets Invested Capital/Capital EmployedNet fixed assets € 6,000 Shareholders' equity € 4,000

Property, plant & equipment € 4,000 Capital € 2,000Financial assets & intangibles € 2,000 Reserves € 1,000

Accumulated results € 1,000Long –term financial debt € 2,500

Working Capital Requirement € 1,000CASH € 1,000 Short‐financial debt € 1,500NET ASSETS € 8,000 INVESTED CAPITAL € 8,000

Net fixed assets + WCR + Cash = Equity + financial debt

Capital Employed = Equity + Long‐term debt + Short‐term debt

Capital Employed = Invested Capital

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NET SHORT-TERM FINANCING REVISITED

Net short‐term financing = Short‐term (financial) debt – Cash

= amount of interest‐bearing debt that is not available in cash

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NET LONG-TERM FINANCING & NET

SHORT-TERM FINANCING

Net short‐term financing = WCR – Net long term financing

Cash should serve as backup to finance unexpected changes in working capital requirements

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MATCHING STRATEGIES

Net long‐term financing = Equity + Long‐term debt ‐ Net fixed assets

THE MATCHING PRINCIPLE PRESCRIBES ALIGNING ECONOMIC ASSET LIFE SPANS TO MATURITY DATES OF ALL FINANCIAL ARRANGEMENTS THAT ARE USED TO

FINANCE THESE ASSETS

Finance long term WCR with long‐term financing Finance seasonal capital requirements with short‐ term financing

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PROVISIONS AND WCR

Example : – Tax provision has been booked year X‐1: 100 000,00 EUR

– The moment this provision needs to be paid Year X : Booking from 16‐account to 45‐account

– At this time this amount can NOT be taken into account forthe WCR calculation!

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ABNORMAL ACCRUALS

ABNORMAL WORKING CAPITAL

ACCRUALS (AWCA)WCR represents: net investment the company needs to finance to keep its operating cycle goingAWCA: two different approaches– for a shareholder – for external parties that are analyzing a company

Compare the estimated WCR with the actual WCR to spot for potential abnormal accruals

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ABNORMAL WORKING CAPITAL

ACCRUALS (AWCA)

ABNORMAL WORKING CAPITAL ACCRUALSAWCAt = WCt ‐ [ ( WCt‐1 / St‐1) x St ]

Versus salesWCt = Working capital requirements 207.880 154.564 438.707 411.814 245.504 380.808 299.532WCt‐1 = Working capital requirements 207.880 154.564 438.707 411.814 245.504 380.808

S = Sales 8.556.235 7.533.578 8.105.117 6.254.853 8.359.771 7.615.665 7.016.922St‐1 = Sales 8.556.235 7.533.578 8.105.117 6.254.853 8.359.771 7.615.665

Abnormal working capital accruals ‐28.470 272.417 73.257 ‐304.896 157.156 ‐51.337

Arithmetic mean: 19.688

Median : 22.393

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AWCA VS SALES

AWCAt = WCt ‐ [ ( WCt‐1 / St‐1) x St ]N‐2 N‐1 N

St = Net sales year t € 8,110 € 8,700 € 9,200St‐1 = " year t‐1 € 7,100 € 8,110 € 8,700

WCRt = Working Capital Requirement year t € 1,000 € 1,400 € 2,700

WCRt‐1 = Working Capital Requirement year t‐1 € 600 € 1,000 € 1,400

WCRt‐1 / St‐1 0.08 0.12 0.16(WCRt‐1 / St‐1) x St € 685 € 1,073 € 1,480

AWCA vs. Sales € 315 € 327 € 1,220

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AWCA VS SALES

R² = 0,0744

‐600.000

‐400.000

‐200.000

0

200.000

400.000

600.000

2007 2008 2009‐2010 2010‐2011 2012

AWCA VERSUS SALES

Tegenover omzet Lineair (Tegenover omzet)

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AWCA VS PURCHASES

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AWCA VS PURCHASES

R² = 0,0509

‐400.000

‐300.000

‐200.000

‐100.000

0

100.000

200.000

300.000

400.000

2008 2009 2010 2011 2012

AWCA VERSUS PURCHASES

Reeks1 Lineair (Reeks1)

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AWCA VS INVESTED CAPITAL

AWCAt = WCt ‐ [ ( WCt‐1 / ICt‐1) x ICt ]N‐2 N‐1 N

ICt = Working Capital Requirement year t € 8,000 € 9,000 € 10,800

ICt‐1 = Working Capital Requirement year t‐1 € 6,900 € 8,000 € 9,000

WCRt = Working Capital Requirement year t € 1,000 € 1,400 € 2,700

WCRt‐1 = Working Capital Requirement year t‐1 € 600 € 1,000 € 1,400

WCRt‐1 / ICt‐1 0.09 0.13 0.16

(WCRt‐1 / ICt‐1 ) x ICt € 696 € 1,125 € 1,680

AWCA vs. IC € 304 € 275 € 1,020

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AWCA VS INVESTED CAPITAL

R² = 0,1808

‐900.000

‐800.000

‐700.000

‐600.000

‐500.000

‐400.000

‐300.000

‐200.000

‐100.000

0

100.000

200.000

2007 2008 2009‐2010 2010‐2011 2012

AWCA VERSUS INVESTED CAPITAL

Tegenover geïnvesteerd vermogen Lineair (Tegenover geïnvesteerd vermogen)

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CHAPTER THREE: BALANCE SHEETS AND

STRATEGIC DECISION MAKING

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BALANCE SHEETS AND

STRATEGIC DECISION MAKING1. Calculating net long‐term financing ‐> financing buffer?2. Converting conventional balance sheet into managerial

balance sheets ‐> WCR?3. Relating WRC to net long‐term financing ‐> structural

liquidity levels over time?

HOW do companies generate their profits and losses?

Relate balance sheet steps to profit and loss statement (four additional steps)

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WCR-TO-SALES RATIOS

WCR‐to‐sales ratio = WCRSales

High WCR‐to‐sales ratio?N‐3 N‐2 N‐1 N

OPERATING ASSETS € 2,400 € 3,000 € 3,900 € 5,300

PREPAID EXPENSESINVENTORYACCOUNTS RECEIVABLE

€ 500€ 1,100€ 800

€ 500€ 1,500€ 1,000

€ 500€ 2,000€ 1,400

€ 500€ 2,300€ 2,500

OPERATING LIABILITIES € 1,800 € 2,000 € 2,500 € 2,600

ACCRUED EXPENSESACCOUNTS PAYABLE

€ 500€ 1,300

€ 500€ 1,500

€ 500€ 2,000

€ 500€ 2,100

WORKING CAPITAL REQUIREMENTS € 600 € 1,000 € 1,400 € 2,700

WCR‐to‐sales ratios may help to determine if increases in working capital requirements are in line with expectations

Business valuation – Using financial analysis to measure a company’s value P 62 and following

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LIQUIDITY AND CONVENTIONAL

FINANCIAL RATIOSCurrent ratio =

Quick Ratio =

Liquidity Ratio =

Liquidity Ratio = =

Net treasury = Net LT Financing – Working Capital Requirement

We recommend you to use net treasury estimates for assessing liquidity levels

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COMBINING LIQUIDITY

AND NET TREASURY

Companies that use net short-term financing tofinance loans of working capital requirementsrun the risk of becoming increasingly dependenton cash.

Business valuation – Using financial analysis to measurea company’s value p 70 and following

53


CHAPTER FOUR: PROFIT AND LOSS STATEMENTS

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PROFIT AND LOSS STATEMENTS

Profit and loss statements = Summary statements of generated revenues with company assets and associated costs

Earnings after taxes = Revenues ‐ Expenses

Gross Profit = Net sales ‐ Costs of goods sold

Operating Profit =

55

Gross profit

‐ Selling, general & administrative expenses

‐ Depreciations

‐ Amortizations


PROFIT AND LOSS STATEMENTS

The Extraordinary Items account provides a balance between revenues and costs associated with infrequent business activitiesEarnings Before Interest and Taxes ( EBIT) =

56


Gross profits‐Selling, General & Administrative expenses‐Depreciations‐Amortizations

EBIT specifies company profit from regular business operations before paying interests and taxes

Regular profit = Operational profit + Financial result= EBIT + Interest income – Interest expenses

EBIT

Earnings Before taxes = Operational profit + Financial results+ Extraordinary items

Earnings After taxes = Earnings Before taxes ‐ Income taxes

Earnings Before Interest and Taxes (EBIT) will provide different results as extraordinary items are included or excluded.

By excluding extraordinary results EBIT comes to equal operating profits. EBIT figures represent company profit from regular business operations, before paying interests and taxes

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RETURN ON EQUITY &

SUBSTAINABLE GROWTH RATESReturn On Equity % (ROE%) =

Retention rate: Profit after taxes AFTER dividends = 80 000 EUR = 80%Profit after taxes BEFORE dividends 100 000 EUR

Self‐Sustainable growth rate = Return on Equity x Retention rate– This rate specifies maximum company growth without incurring future cash deficits

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‐>Financial components = ‐> solvability =‐> liquidity =


CHAPTER FIVE: PROFIT AND LOSS STATEMENTS

AND STRATEGIC DECISION ‐MAKING

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PROFIT AND LOSS STATEMENTS:

FOUR ADDITIONAL STEPS1. Calculating net long‐term financing 2. Converting conventional balance sheet into managerial balance

sheets3. Relating WRC to net long‐term financing ‐

4. Do companies use annual depreciation and amortizations to adjust company earnings, i.e. EBIT?

5. How to transform earnings into cash flows for more valid indications?

6. Does EBIT or net operational cash flow provide sufficient cash to repay maturing debt obligation

7. How to use analysis of past/ present rate for budget calculations

Make forecast scenarios in line with past performance

60

EBIT & EBITDA DEVELOPMENTS

EBITDA = Net sales – Cost of Sold goods (COGS) ‐ Selling, general & administrative expenses (SG&A)

EBITDA = EBIT + Depreciations + Amortizations

61

N – 3 N – 2 N – 1 N

DEPRECIATIONSAMORTIZATION

€ 350 € 400 € 250

€ 0 € 0 € 0

NET FIXED ASSETS € 5,500 € 6,000 € 7,000 € 7,500

DEPRECIATION PLUS AMORTIZATION TO NET FIXED ASSETS RATIO

6.36% 6.67% 3.57%

To check if low depreciation / amortization to fixed assets ratios result from deliberate adjustments, we recommend you to compare fixed asset values for

various years. Significantly lower values for fixed assets may indicate asset sale and leaseback policies as major drivers of EBIT and EBITDA convergence

NET OPERATING CASH FLOW

Net operating cash‐flow = Incoming cash from operations ‐ Outgoing Cash from operations

– Note: Use net amounts of incoming or outgoing cash flows associated with company operations

– Comparing two snapshots taken at the end of different fiscal years ‐> total net cash flow

NOCF = Sales ‐ Cost of sold goods ( COGS) ‐ General Expensens and personnel ‐ Tax expenses ‐ Δ WCR

– Note: Cash Flow ≠ profits

62

Net operating cash flow represents incoming cash flow from sales after all outgoing cash flow as operating expenses, taxes and working capital requirements have been subtracted

NET OPERATING CASH FLOW

NOCF = EBIT + Depreciations + Amortizations – Tax expenses ‐ Δ WCR

63

N‐2 N‐1 N

EBIT € 2.202 € 2.377 € 2.355

+ DEPRECIATIONS

+ AMORTIZATIONS

€ 350 € 400 € 500

0 0 0

‐ TAKS EXPENSES € ‐569 € ‐604 € ‐581

‐MUTATION IN WCR € ‐400 € ‐400 € ‐1.300

NET OPERATING CASH FLOW € 1.583 € 1.773 € 974

Are companies capable of generating sufficient cash for strategic future investments?

DEBT REPAYMENTS AND NET

OPERATING CASH FLOWMaturing debt = short‐term (current) financial debt =interest‐bearing debt that needs to be repaid during the course of the next accounting year

64

N‐2 N‐1 N

CURRENT FINANCIAL DEBTCURRENT PORTION OF LONG‐TERM DEBT

OWED TO BANKS

€ 1,500€ 500

€ 1,314€ 600

€ 1,966€ 713

€ 1,000 € 750 € 1,253

NET OPERATING

CASH FLOW COVERAGENOCF coverage = NOCF – Long‐term financial debt due within 1 year

How many investments companies are capable of financing <‐> How much investments may be supported on a sustainable basis.

65

N‐2 N‐1 N

EBIT € 2,202 € 2,377 € 2,355

+ DEPRECIATIONS

+ AMORTIZATIONS

€ 350 € 400 € 500

0 0 0

‐ TAKS EXPENSES € ‐569 € ‐604 € ‐581

‐MUTATION IN WCR € ‐400 € ‐400 € ‐1,300

NET OERATING CASH FLOW € 1,583 € 1,773 € 974

LT FIN. DEBT DUE <1 YEAR € 500 € 600 € 713

NOFC COVERAGE € 1,083 € 1,173 € 261

Substantial net operating cash flowssignify that companies are capableof financing changes in workingcapital requirements withoperational cash flows

NET CASH FLOW FROM

INVESTING ACTIVITIESNet cash flow from investing activities = Fixed assets acquisitions

– Fixed assets disposalsEstimated net cash flow from investments in year t =

Fixed assets for year t‐1– Fixed assets for year t– Depreciations – Amortizations

66

N‐2 N‐1 N

OPENING BALANCE FIXED ASSETS € 5,500 € 6,000 € 7,000

CLOSING BALANCE FIXED ASSETS € 6,000 € 7,000 € 7,500

‐ DEPRECIATIONS (and AMORTIZATIONS) € ‐350 € ‐400 € ‐500

CORRECTIONS FOR REVALUATIONS 0 0 € 500?

€ ‐850 € ‐1,400 ?NOFC COVERAGE

NET CASH FLOW FROM

FINANCING ACTIVITIESNet cash flow from financing activities = mutation in long‐term loans

+ mutation in short‐term loans – Long‐term debt repaid– Interest payments – Dividend payments

Calculation Free Cash Flow (figure 63): we recommend you to use the IAS 7 free cash flow framework for analyzing cash position developments with the help of historical data.

67

N‐2 N‐1 N

INCREASE IN LONG‐TERM LOANSINCREASE IN SHORT‐TERM LOANS

€ 600 € 800 € 913

€ 70 € ‐186 € 652

(‐) LONG TERM DEBT REPAID(‐) INTEREST PAYMENTS(‐) DIVIDEND PAYMENTS

€ ‐500 € ‐600 € ‐713

€ ‐305 € ‐365 € ‐420

€ ‐398 € ‐423 € ‐406

NET CASH FLOW FROM FINANCING ACTIVITIES € ‐533 € ‐774 € ‐26

CASH FLOWS

68

N‐2 N‐1 N

CASH FLOWS FROM OPERATING ACTIVITIES

SALES 8,110 8,700 9,200

‐ COST OF GOODS SOLD € ‐4,100 € ‐4,500 € ‐4,800

‐ SELLING, GENERAL AND ADMINISTRATIVE EXPENSES € ‐1,458 € ‐1,423 € ‐1,545

‐ TAKS EXPENSES € ‐569 € ‐604 € ‐581

‐WORKING CAPITAL REQUIREMENT CHANGES € ‐400 € ‐400 € ‐1,300

A. NET OPERATING CASH FLOW (NOCF) 1,583 1,773 974


BEGINNING BALANCE FIXED ASSETS € 5,500 € 6,000 € 7,000

‐ CLOSING BALANCE FIXED ASSETS € 6,000 € 7000 € 7,500

‐ DEPRECIATIONS € ‐350 € ‐400 € ‐500

+/‐ CORRECTIONS FOR REVALUATIONS € 0 € 0 € 0

B. NET CASH FLOW FROM INVESTING ACTIVITIES € ‐850 € ‐1,400 € ‐1,000


INCREASE IN LING‐TERM LOANS € 600 € 800 € 913

+ INCREASE IN SHORT‐TERM LOANS € 70 € ‐185 € 652

‐ LONG‐TERM FINANCIAL DEBT REPAID € ‐500 € ‐600 € ‐713

‐ INTEREST PAYMENTS € ‐305 € ‐365 € ‐420

‐ DIVIDEND PAYMENTS € ‐398 € ‐422 € ‐406

C. NET CASH FLOW FROM FINANCING ACTIVITIES € ‐533 € ‐773 € 26

TOTAL NET CASH FLOW (A + B + C) € 200 € ‐400 € 0

OPENING CASH € 800 € 1,000 € 600

CLOSING CASH (OPENING CASH + TOTAL NET CASH FLOW) € 1,000 € 600 € 600

ADJUSTED CASH FLOW STATEMENTS FOR

STRATEGIC DECISION-MAKING

69

N‐2 N‐1 N


SALES 8,110 8,700 9,200

‐ COST OF GOODS SOLD € ‐4,100 € ‐4,500 € ‐4,800

‐ SELLING, GENERAL AND ADMINISTRATIVE EXPENSES € ‐1,458 € ‐1,423 € ‐1,545

‐ TAKS EXPENSES € ‐569 € ‐604 € ‐581

‐WORKING CAPITAL REQUIREMENT CHANGES € ‐400 € ‐400 € ‐1,300

A. NET OPERATING CASH FLOW (NOCF) 1,583 1,773 974


BEGINNING BALANCE FIXED ASSETS € 5,500 € 6,000 € 7,000

‐ CLOSING BALANCE FIXED ASSETS € 6,000 € 7000 € 7,500

‐ DEPRECIATIONS € ‐350 € ‐400 € ‐500

+/‐ CORRECTIONS FOR REVALUATIONS € 0 € 0 € 0

B. NET CASH FLOW FROM INVESTING ACTIVITIES € ‐850 € ‐1,400 € ‐1,000


INCREASE IN LING‐TERM LOANS € 600 € 800 € 913

+ INCREASE IN SHORT‐TERM LOANS € 70 € ‐185 € 652

‐ LONG‐TERM FINANCIAL DEBT REPAID € ‐500 € ‐600 € ‐713

‐ INTEREST PAYMENTS € ‐305 € ‐365 € ‐420

‐ DIVIDEND PAYMENTS € ‐398 € ‐422 € ‐406

C. NET CASH FLOW FROM FINANCING ACTIVITIES € ‐533 € ‐773 € 26

TOTAL NET CASH FLOW (A + B + C) € 200 € ‐400 € 0

OPENING CASH € 800 € 1,000 € 600

CLOSING CASH (OPENING CASH + TOTAL NET CASH FLOW) € 1,000 € 600 € 600

Positive available cash flow for strategic decisions indicates if operational company earnings suffice to meet financial obligations resulting from past decisions. Positive figures

signal that new investments may be considered

Nondiscretionary versus discretionary cash flows

= Available for Strategic Decision


CHAPTER SIX: FORECAST FOR MANAGERIAL

BALANCE SHEET AND PROFIT AND LOSS STATEMENT

70


BUDGET FORECASTSAnalysis of past figures to forecast future results

Potential adjustments should future situations differ from current

circumstances

EBIT forecasts for year N+1: influence:

– Expected trends and developments for this industry

– Recent investments

71


BUDGET FORECASTS

72

N – 3 N – 2 N – 1 N N+1

EARNINGS BEFORE INTEREST AND TAXES (EBIT) € 1.700 € 2.202 € 2.377 € 2.355

Financial resultExtraordinary items

€ ‐290200

+30%

€ ‐3050

+8%

€ ‐3650

‐1%

€ ‐4200

NET FIXED ASSETS € 1.610 € 1.897 € 2.012 € 1.935

‐ Tax expenses € ‐483 € ‐569 € ‐604 € ‐581

DEPRECIATION PLUS AMORTIZATION TO NET FIXED ASSETS RATIO6.36% 6.67% 3.57%

N+1EARNINGS BEFORE INTEREST AND TAXES (EBIT) € 2.760

Financial resultExtraordinary items

€ ‐300€ 0

EARNINGS BEFORE TAXES (EBT) € 2.460

‐ Tax expenses € ‐738

EARNINGS AFTER TAXES (EAT) € 1.722

Earnings before interest and taxes (year N+1):

€2,760,000 (+17% year N)

MANAGERIAL BALANCE SHEET:

BUDGETS AND FORECASTSForecasting equity

– How much net profits are transferred to equity?– Dividend payments to company shareholders and – The use of internally generated equity capital for reinvestments.

Forecast equity : equity retention rate =

– Assuming no other external equity issues

Forecasting Fixed assets– Historical Date – Depreciations– New Strategic Investments

Forecasting Working Capital Requirements & Cash– WCR

• Analysis of historical data • Assess relative new investments in fixed assets

– Cash Block• What cash amounts need to be accommodated to situations?• Specify amounts for other assets

73

Provide indications on required financial resources


BUDGETS AND FORECASTSBudget WCR & Cash

74


BUDGETS AND FORECASTSForecast Long‐term and short‐term financial debt

– Financial debt forecasts equal all asset forecasts, which are not financed with increased equity as forecasted for a given accounting year

75

N + 1

Net fixed assetsRecurrent WCR

€ 7,700€ 1,939

Needed long‐term financing € 9,639

Shareholders’ equity € 7,139

Long‐term financial debt € 2,500

NET ASSETS INVESTED CAPITAL/CAPITAL EMPLOYED

Ned fixed assets € 7,700 Shareholders’ equity € 7,139

Property, plant & equipmentFinancial & Intagible assets

€ 5,700€ 2,000

CapitalReservesAccumulated results

€ 2,000€ 1,000€ 4,139

Working Capital Requirement € 2,200 Long‐term financial debt € 2,500

Cash € 800 Short‐term financial debt € 1,061

NET ASSETS € 10,700 INVESTED CAPITAL € 10,700

BUDGETS AND FORECASTS: STEPS

1. Equity block 2. Fixed Assets block3. Long term financial debt4. Working Capital Requirements5. Cash block 6. Saldo = Short‐term financial debt block

76

PART II: COMPANY VALUATION

INTRODUCTION

77

COMPANY VALUATION

Company valuation needs to reflect profits and associated risksDifferent investors expectations will lead to different value estimatesTakeover fee and company value do not necessarily go together– Value reflects stakeholder expectations.– Price represents a compromise between perceptions of different stakeholders

regarding variables that affect company value.Use multiple valuation methodsProvide a business case for any profit increases, if you intend to sell your companyPublic versus Private companies

78

OVERVIEW OF THE MAIN

VALUATION METHODS

79

Equity Valuation models

Equity Cash Flow value = + Exceeding assets (minus taxes)

Economic Profit Equity value = Equity – BV exceeding assets + + Exceeding Assets (minus taxes)

Entity Valuation models

Entity DCF Value = + EXCEEDING ASSETS (minus taxes)

Entity Economic Profit value = IC MINUS BV EXCEEDING ASSETS + + EX ASSETS (MINUS TAXES)

Entity APV = + ( Financial debt x tax rate )

REAL TAX RATE –

MARGINAL TAX RATEIn calculating the value of a company we look at the future

We can not be certain the current tax incentives will be maintained in the future

Thus we take the MARGINAL tax rate into consideration

80


WEIGHTED AVERAGE COST OF CAPITAL

81

WACC

The Weighted Average Cost of Capital (WACC)=a measure of average capital costs for each acquired euro ̸dollar

WACC%=KE% x + Kd% x (1‐t) x

Required return on debt:– = Expected company costs of capital from financial institutions– Few Debt contracts: interest rates as stipulated in debt contracts– Multiple contracts: calculate return rates by having interest charges divided by average

amounts of interest‐bearing debt

Required return on equity: – Calculate with CAPM ( Capital Asset Price Models)– Expected return rates on equity:

• Returns on risk‐free investments• Market risk premiums in addition to risk‐free returns • Individual company risk profiles as compared to average company risk profiles

82

CAMP AND BETA

Equity betas or leveraged betas => estimates on company performance as compared to market performance

Systematic risks: which investors cannot avoid by investment diversificationUnsystematic risk: general economic trends that affect entire markets in negative ways or events that will only hit specific companies

CAPM relies on market risk premium: represents the trade‐off between security and volatility

83

βe of 1 company results fluctuate in line with market rates

βe of 2 company shares fluctuate twice as much relative to market index

βe of 0,5 company results will be half as volatile as compared to market indexes

BETA

We can distinguish two types of risks:1 Diversifiable risk = can be eliminated by diversifying the portfolio

2. Market Risk: cannot be eliminated by diversifying the portfolioBeta only measures the portfolio’s market risk

A share’s volatility measures the TOTAL risk; Beta only measures the incrementalrisk

In mathematics volatility is measured by standard deviation and variance ( of ROE)

A Share’s beta is calculated as the covariance between the stock return andmarker return ( ROE), divided by the variance of the market return (1)

Beta’s levered usually have values between 0,7 and 1,3 in 80% of the casesBron: Valuation Methods and Shareholder value Creation, Pablo Fernandez,Elsevier Science 2002, blz 205

84

BETA

Business risks or operational risksBeta estimates that are based on covariance of company shares relative to market indexes suffer from a number of disadvantages– covariance is not stable over time– betas cannot be estimated for companies that are not listed on the stock‐

exchangeβa reflect business risksβe reflect both business

βe = βa x [ 1 + (1 –t) x ]

Ke% =Rf% + (Rm% – Rf%) x βe

Equity risk premium

85

DETERMING THE RISK PREMIUM

86

IMPORTANT

Always take into consideration which Rm% is used for valuation of the company– High % will mean a lower value– Look at what’s realistic for the company : what risks are involved in you’re investment : High risks you may expect high return

– We consider Rm % = 18%‐ 20 % in order to make a conservative valuation of a company

87

INFLUENCE REQUERED

RETURN ON VALUE

88

GERMAN GOVERNMENT BONDS

89

GERMAN GOVERNMENT BONDS

90

IMPLIED PREMIUMS

91

IMPLIED PREMIUMS

92

Implied premiums versus Risk free rates

IMPLIED PREMIUMS

93

London Business School – Global Evidence on the equity risk premium

WHICH RISK PREMIUM

If we look back : 1928 – 2004 : 4,84 % on US EquityMarketIf we look back 1926‐1996 : 7,1%‐7,5% Equity risk premium on NASDQ,AMEX and NYSEThis shows it is important to take into considerationwhich market has been regarded as a benchmark

94

WHICH RISK PREMIUM

Percentages of between 4,84% ‐ 7,5% (as mentionned on previous page) are not realistic forthe valuation of mid‐sized companies!Diversification of risk is not possible whiles takingover a companyThis increase in risk should be compensated by a higher risk premium.

95

DETERMINANTS OF

EQUITY RISK PREMIUMSRisk aversion : equity risk premiums should increase as saving rates decrease in an economy

Economic risk: when inflation, interest rates and economic growth are volatile : higher risk premiums

96

TAKING INFLATION

INTO ACCOUNTWhen we actualize Cash Flows we need to take into account inflation.In the past banks determined their interest rates as following : save return % (example 2%)+ the % of inflation (for example 4 %) : resulting in an interest rate of 6 %Now banks do not take inflation into account , giving you an interest rate of for example 2 %For valuation we need to take the percentage of inflation into account ourselves.

97

TAKING INFLATION

INTO ACCOUNTVOKS = Cash FlowH = inflation rateKr = Cost of equity / WACC%I = taking initial investment into account (because we are calculating a NET present value)

98

SMALL FIRM PREMIUM

Banz( 1981) looked at return on stocks from 1936‐1977 of small companies (bottom 20 % NYSE)He came to the conclusion that they have generated about 6 % more than larger companies.Small companies are also more volatile, and thus, an investment with more risk involvedOperating risk: degree of operating leverage (Damodaran on valuation p51)

Higher risk premium necessary

99

SMALL FIRM PREMIUM

100

EQUITY RISK PREMIUM

101

COUNTRY RISK PREMIUM –

MOODY’S RATING

102

VOLATILITY ON THE MARKET

103

STANDARD ERRORS

104

IMPORTANCE OF PERIOD TAKEN

INTO CONSIDERATION

105

CONCLUSION REQUIRED RETURN

Risk free : 20 year German bond +/‐ 5%Historical premiums : +/‐ 6%/8%Small company : +6%

Required return : +/‐ 19 %Risk premium : difference between Required return and risk

free : 14 % minimum!

Ps : use three step method and remember RM does know an evolution versus Ke due to competition in the market

106

107

GEOMETRIC MEAN VS

ARITHMETIC MEAN

ARITHMETIC MEAN

In its most basic form, you can just take the sum of the different values and divide that sum by the amount of values you added up.

Example: evolution returns

% % % = 3,33%

108

Year 1 +10%Year 2 ‐10%Year 3 +10%

ARITHMETIC MEAN

Perhaps counter‐intuitively at first, this does not however mean that the company in example will be worth 9.99% (3 times 3.33%) more at the end of year 3.

Although the relative gain and loss are the same in year 1 and 2, +‐10%, the final absolute value in year 2 will not be equal to the starting value. This is a result of ‘compounding’, which entails that your starting point in year 1 is not 100, but 100 + the capital increase realized during year 1 (10).

109

Year Return over year (relative) Final (absolute) value Year 0 €100Year 1 +10% €100 + €10 = €110Year 2 ‐10% €110 – €11 = €99Year 3 +10% €99 + €9,9 = €108,9

GEOMETRIC MEAN

More precise than arithmetic mean.

Example: evolution returns

– 1 = 2.88%

110

Year 1 +10%Year 2 ‐10%Year 3 +10%

Result : annual increase of 2,88 %Arithmetic mean : 3,33 %Conclusion: geometric mean results in lower percentage (this is useful for CF calculations, not for risk premium calculations)

Attention:– This formula can not be used for negative figures– For negative figures you need to use percentages

GEOMETRIC MEAN

111

When evaluating past returns (with compounding), use the geometric average– This generally gives a lower, and thus safer result

When calculating the average risk premium, use the arithmetic average– This generally gives a higher, and thus safer result (Higher risk premium = lower company value)

WHEN TO USE GEOMETRIC AVERAGES

AND WHEN ARITHMETIC AVERAGES

112

GEOMETRIC MEAN –

EQUITY RISK PREMIUMS

113

EQUITY RISK PREMIUMS

VERSUS BILLS

114

London Business School –Global Evidence on the equity risk premium

SURVEY ON RISK PREMIUMS

115

London Business School –Global Evidence on the equity risk premium

116

RETURNING TO THE WACC

WACC%

117

WACC% = Ke % x + Kd % x (1‐t) x Figure 107: WACC estimates (euro in ‘000s) N‐2 N‐1 N N+1

Equity (adjusted book value) € 4,000 € 4,986 € 5,934 € 7,139

Invested Capital € 8,000 € 9,000 € 10,800 € 10,700

Equity ratio 0.50 0.55 0.55 0.67

Required on equity 24% 23% 23% 20%Weigted cost of equity 12.1% 12.5% 12.5% 13.3%

Interest‐bearing debt € 4,000 € 4,014 € 4,866 € 3,561Invested Capital € 8,000 € 9,000 € 10,800 € 10,700Interest‐bearing debt ratio 0.50 0.45 0.45 0.33

Required return on debt 7.8% 9.1% 9.5% 7.1%Kd x (1‐t) 5.5% 6.4% 6.6% 5.0%Weighted cost of debt (after‐taks) 2.7% 2.8% 3.0% 1.7%

Weighted Average Cost of Capital 14.9% 15.4% 15.5% 15.0%

PRACTICAL EXAMPLE

118

Periode 8 Periode 92008 - 2009 2009 - 2010

Calculate cost of Invested Capital

Berekening van de WACC – Calculation of WCR2009 - 2010

Stap 1: Beta – Step 1 Beta

Gegevens - Data

Beta asset 0,5risicoloze rente -Risk Free Return 4%verwacht marktrendement - Expected Market Return 20%

Intrest bearing debt 1.160.024,00

Schulden op lange termijn (enkel rentedragende schulden)-Long-term Debts ( inerest bearing) 769.145,00

Schulden op korte termijn (enkel rentedragende schulden)- Short- Term Debts ( intrest bearing) 390.879,00A. Schulden op meer dan één jaar - Loan < 1 year 323.104,00B. Financiële schulden - Financial debts 67.775,00F. Overige schulden - Other debts (Standaard op nul)- Other Debts 0,00

Equity 1.206.195,00

Beta-equity = B asset x [ 1 + ( 1 - tax rate ) x Intrest bearing debt/equity ]

Beta-equity = 0,5 * [ 1 + ( 1 - 0,34 ) * 1160024 / 1206195 ]

Beta equity = 0,82

PRACTICAL EXAMPLE

119

Cost of Equity

Ke = Risicovrije rente + (Beta-coëfficiënt x (de rendementseis -risicovrije rente))Ke= Risk free return + ( Equity Beta x( Required Return - Risk Free return)Ke = 0,04 + 0,82 x ( 0,2 - 0,04 )

Kost eigen vermogen (Ke)- Cost of Equity 17,08%

Cost of Debt

kost VLT - Cost of LT debts 4%min belasting/taxes 2,64%

kost VVKT - Cost of ST debts 10%Min belastingen/taxes 6,60%

PRACTICAL EXAMPLE

120

Calculate total debt – Equity

Totaal eigen vermogen - Total capital and reserves 1.206.195,00 50,98%Schulden op lange termijn - Payables > 1 year 769.145,00 32,51%A. Schulden op meer dan één jaar - Loan < 1 year 323.104,00 13,65%B. Financiële schulden - Financial debts 67.775,00 2,86%

Totaal- Total 2.366.219,00Management Balanstotaal- Management Balance Sheet total 2.556.219,00

PRACTICAL EXAMPLE

121

Percentages X costs

Verhouding Kost TotaalTotaal eigen vermogen - Total capital and reserves 50,98% 17,08% 8,71%Schulden op lange termijn - Payables > 1 year 32,51% 2,64% 0,86%A. Schulden op meer dan één jaar - Loan < 1 year 13,65% 2,64% 0,36%B. Financiële schulden - Financial debts 2,86% 6,60% 0,19%

WACC 10,11%

Calculate cost of invested equity

Invested capital = geinvesteerd vermogen : 2.791.761,00 2.366.219,00Wacc 10,11% 10,11%

Cost invested capital - kost van het geinvesteerd vermogen : 282.337,24 239.301,19


CHAPTER EIGHT: KEY VALUATION CONCEPTS

122

EQUITY VERSUS

ENTITY VALUATION

Equity approaches usually start by considering profits after taxes and interestEntity approaches take both equity AND financial debt holders in account for company valuation

What exactly is company value?

123


ECONOMIC PROFITS AND

DISCOUNTED CASH FLOW

124

Establishing company value:

Discounted cash flow models:Free cash flows Equity cash flows

Economic profit models

ECONOMIC PROFITS

Profit margin: profit margins per invested euro/dollarMultiply profit margin with all invested resourcesEquity Approaches

– Return on equity %=

– EP = (Return on equity – Required return on equity) x Adjusted Book Value of equity of the previous year

– Ept = (ROE % ‐ Ke % ) x Ebvt‐1– Ept = PATt ‐ (Ebvt‐1 x Ke %)

125

Equity value = Adjusted book value equity + + EX Assets (-Tax)

ECONOMIC PROFITS

Calculation in 6 septs:

1. Calculate adjusted company book values for the previous year

2. Calculate current required return on equity

3. Multiply the outcomes of steps 1 and 2 and subtract this product from company earnings after taxes

4. Step 3 provides you with economic profit for a single year. Calculate average profits with historical

data and use this figure as benchmark

5. Divide the average economic profit (step 4) by required return on equity (step 2) minus specified

growth rates to calculate present values for average economic profits

6. Add all present values of economic profits to adjusted book values

Using various annual economic profits will prevent invalid residual values that result from using a single reference years. Should you prefer direct calculations of company equity, economic profits provide more reliable values as compared to equity cash flow generated values

126

GROWTH RATE

127

N‐1 N N+1NOPLAT € 1,664 € 1,649 € 1,932Invested capital at the start of the fiscal year € 8,000 € 9,000 € 10,800Return on Invested Capital 20.8% 18.3% 17.9%

Net Investment € 1,400 € 1,800 ‐€ 300NOPLAT € 1,664 € 1,649 € 1,932Investment rate 84.1% 109.2% ‐15.5%

Growth rate (ROIC x IR) 17.5% 20.0% ‐2.8%

RETURN ON EQUITY & ECONOMIC PROFITS

Return on equity % = – Adequate? Depends on shareholders’ opinion

Economic profit = (Return on equity – required return on equity) (Equity Based) x equity invested at the start of the fiscal year

– Economic profits represent all company profits that exceed required profits for covering all associated risks and costs with conducting business operations.

Equity value=(Adjusted book value – Exceeding assets) + + ex assets (‐Tax)

128

These calculations include all invested equity as well as present values of expected future economic profits

This value makes use of expected company profits in terms of invested equity as these profits exceed all required profits for compensating equity owners in view of all entrepreneurial risks

RETURN ON INVESTED CAPITAL AND

ECONOMIC PROFITSReturn on invested capital = all company profits from business operations in terms of all used resources for investments in assets

Return on Invested Capital % =

– Note: EBIT minus operating taxes, or EBIT x [1‐t], is often referred to as NOPLAT – High EBIT ≠ high ROIC– Invested capital = Equity + interest bearing debts

129

Company X Company YEBIT € 20 € 100(1‐taks rate) 70% 70%NOPLAT € 14 € 70

Invested Capital € 100 € 700

Return on Invested Capital 14.0% 10.0%

RETURN ON INVESTED CAPITAL AND

ECONOMIC PROFITSTaking cost of capital into account– Weighted Average Cost of Capital (WACC)

Economic Profits = (ROIC % – WACC %) x Invested CapitalROIC % = Operating margin x capital turnover x (1‐ tax rate)

= x x ( 1‐tax rate)

130

ECONOMIC PROFITS

Entity approaches• Net Operating Profit Less Adjusted Taxes = Earnings Before Interest and taxes

‐ Operating taxes• NOPLAT = EBIT x (1 – real tax rate%)

• Invested Capital = Equity + Interest‐bearing debt= Equity + LT financial debt + ST financial debt

• ROIC % =

Operational profit levels irrespective of used financial arrangements.

• WACC% = Ke % x x Kd% x (1‐t) x • Economic Profit (EP) = Invested Capital x (ROIC% – WACC %)• Economic Profit (EP) = NOPLAT ‐ (Invested Capital x WACC %)

131

Entity value= (Invested Capital –Exceeding assets) + + ex assets (- Tax)

EXCEEDING ASSETS

Equity ApproachesExample 1: exceeding asset : 200 000 (book value) 250 000 (actual value) = 50 000 (plusvalue)

tax rate 34% Equity: 1 000 000Economic profit: 150 000

Equity value =

(Adjusted book value equity – Exceeding assets) + + EX assets(-Tax)

Adjusted book value equity = 1 000 000 + 50 000 – 17 000 = 1 033 000

(1 033 000 – 200 000) + 150 000 + (250.000– 17 000) = 1 816 000 €20%

132


EXCEEDING ASSETS

Equity Approaches

Always take in account debts relating to exceeding assets and calculate withnet exceeding assets

Example 2: exceeding asset : 200 000 (book value) 250 000 (actual value) = 50 000 (plusvalue)exceeding debt: 100 000tax rate 34% Equity: 1 000 000Economic profit: 150 000

Equity value =

(Adjusted book value equity – NET Exceeding assets) + + EX NET assets(-Tax)

Adjusted book value equity = 1 000 000 + 50 000 – 17 000 = 1 033 000

(1 033 000 – (200 000 – 100 000)) + 150 000 + (250 000 – 100 000 – 17 000)= 1 816 000 €

133

EXCEEDING ASSETS

Entity ApproachesExample 1: Exceeding asset : 200 000 (book value) 250 000 (actual value) = 50 000 (plusvalue)

Tax rate 34% Equity: 1 000 000Economic profit: 150 000WACC: 15%

Entity value =

(Invested Capital – Exceeding assets) + + ex assets (- Tax )

Invested capital = 1 000 000 + 50 000 – 17 000 = 1 033 000

(1 033 000 – 200 000) + 150 000 + (250 000 – 17 000) = 2 066 000 €15%

134

EXCEEDING ASSETS

Entity Approaches

Always take in account debts relating to exceeding assets and calculate withnet exceeding assets

Example 2: exceeding asset : 200 000 (book value) 250 000 (actual value) = 50 000 (plusvalue)exceeding debt: 100 000tax rate 34% Equity: 1 000 000Economic profit: 150 000WACC: 15%

Entity value =

(Invested Capital – NET Exceeding assets) + +ex NET assets (- Tax )

Invested capital = 1 000 000 + 50 000 – 17 000 = 1 033 000

((1 033 000) – (200 000 – 100 000) + 150 000 + ((300 000 – 100 000) – 17 000) = 2 116 000 €15%

135

ENTITY APPROACHES TO

ECONOMIC PROFITS, OR EVAEconomic Value Added (EVA): calculation

1. Calculate Net Operating Profit Less Adjusted Taxes

2. Establish Invested Capital for the previous fiscal year

3. Calculate the Weighted Average Cost of Capital

4. Insert all inputs in the following equation:

Economic Profit (EP) = NOPLATt ‐ (Invested Capitalt‐1 x WACCt)

5. Estimate expected growth rates

6. Calculate entity values by inserting data in the following equation

Entity value = Invested Capital0 +

7. Subtract all financial debt to arrive at equity values

136

GROWTH RATE

137




EVA

138

Figure 121: Economic profits (euro in ‘000s) N‐2 N‐1 N N+1NOPLATInvested capital

€ 1,664 € 1,649 € 1,932€ 8,000 € 9,000 € 10,800

Return on Invested Capital 20.8% 18.3% 17.9%

Weighted Average Cost of Capital 15,4% 15,5% 15,0%

Spread between ROIC and WACC 5,4% 2,9% 2,9%Invested capital € 8,000 € 9,000 € 10,800

Economic Profits (Entity) € 435,2 € 256,6 € 313,6

Economic ProfitN‐2 N‐1 N N+1



Equity ratio 0.50 0.55 0.55 0.67

Required on equity 24% 23% 23% 20%Weigted cost of equity 12.1% 12.5% 12.5% 13.3%

Interest‐bearing debt € 4,000 € 4,014 € 4,866 € 3,561Invested Capital € 8,000 € 9,000 € 10,800 € 10,700Interest‐bearing debt ratio 0.50 0.45 0.45 0.33

Required return on debt 7.8% 9.1% 9.5% 7.1%Kd x (1‐t) 5.5% 6.4% 6.6% 5.0%Weighted cost of debt (after‐taks) 2.7% 2.8% 3.0% 1.7%


WACC

Figure 121: Economic profits (euro in ‘000s)

N‐2 N‐1 N N+1

Earnngs before Interest and taxex (EBIT) € 2,207 € 2,377 € 2,355 € 2,760‐ Real taks rate x EBIT ‐€ 661 ‐€ 713 ‐€ 707 ‐€ 828

NOPLAT € 1,541 € 1,664 € 1,649 €1,932

NOPLAT

EVA

Management implications of economic profits:– Economic Profit = Invested Capital x NOPLAT/invested capital – WACC%– Be very cautious with equating economic profits or EVA to company value creation for identical fiscal

years– Never ever use economic profits or EVA indices that only relate to single fiscal years for awarding

management bonuses– Economic profits indicate whether companies succeed or fail to create value through business

operations. Economic profits, however, do NOT necessarily express value creation for any specified time interval

Growth rate = (Average) ROIC% x Investment rate %Investment rate =

Entity value = (Invested Capital – exceeding assets) + + ex assets (‐Tax‐Equity value = (IC – exceeding assets) + ‐ financial debt + ex assets (‐Tax)

139

PRACTICAL EXAMPLE

140

Stap 1: bereken de NOPLAT - Calculate NOPLAT

sub 1: berekenen het effectieve bel % versus ordinary profit- Calculate the effective tax% vs EBIT

ORDINARY PROFIT 319.346,98 191.614,68

taxes -118.011,00 -65.127,00

% bel / EBIT 36,95% 33,99%

Bedrijfsresultaat - Operating profit - (EBIT) 488.852,98 297.841,68

36,95% 33,99%

min taxes % -180.649,99 -101.231,99

NOPLAT : 308.202,99 196.609,69

PRACTICAL EXAMPLE

141

Calculate total Invested CapitalTotaal eigen vermogen - Total capital and reserves 1.077.853,00 1.206.195,00Schulden op lange termijn - Payables > 1 year 1.007.154,00 769.145,00A. Schulden op meer dan één jaar - Loan < 1 year 316.316,00 323.104,00B. Financiële schulden - Financial debts 390.438,00 67.775,00

Invested capital = geinvesteerd vermogen : 2.791.761,00 2.366.219,00

PRACTICAL EXAMPLE

142

Stap 1: bereken de NOPLAT - Calculate NOPLATsub 1: berekenen het effectieve bel % versus ordinary profit- Calculate the effective tax% vs EBITORDINARY PROFIT 319.346,98 191.614,68taxes -118.011,00 -65.127,00% bel / EBIT 36,95% 33,99%

Bedrijfsresultaat - Operating profit - (EBIT) 488.852,98 297.841,6836,95% 33,99%

min taxes % -180.649,99 -101.231,99

NOPLAT : 308.202,99 196.609,69

Stap 2: bereken het totaal geinvesteerd vermogen- Calculate total invested CapitalTotaal eigen vermogen - Total capital and reserves 1.077.853,00 1.206.195,00Schulden op lange termijn - Payables > 1 year 1.007.154,00 769.145,00A. Schulden op meer dan één jaar - Loan < 1 year 316.316,00 323.104,00B. Financiële schulden - Financial debts 390.438,00 67.775,00

Invested capital = geinvesteerd vermogen : 2.791.761,00 2.366.219,00

Stap 3: bereken nu het rendement van het totaal geinvesteerd vermogen - Calculate return of total invested capitalNOPLAT : 308.202,99 196.609,69Invested capital = geinvesteerd vermogen : 2.791.761,00 2.366.219,00

Rendement - Return = ROIC : 11,04% 8,31%

PRACTICAL EXAMPLE

143

Stap 5 : bereken nu de waarde van de vennootschap op basis van de economic profit - Economic Profit ValuationEconomic ProfitNOPLAT : 308.202,99 196.609,69min kost van het geinvesteerd vermogen - cost invested capital -282.337,24 -239.301,19

Economic Profit : 25.865,75 -42.691,50

waarde van de onderneming op basis van de EP methode - EP valuationInvested capital = geinvesteerd vermogen : 2.791.761,00 2.366.219,00EP/ WACC 255.761,52 -422.135,12min rentedragende schulden - interest bearing debts -1.713.908,00 -1.160.024,00

waarde - value 1.333.614,52 784.059,88

maar als de waarde lager is dan het EV dan nemen we de waarde van het EV 1.077.853,00 1.206.195,00Use Capital and Reserves if valuation < Capital and Reserves

ENTITY APPROACH

& ADJUSTED BOOK VALUEEntity approach Adjusted book value

144

Entity approaches consider companyvalue to equal amounts of alreadyinvested capital plus potential futureprofits as generated with availablecapital.

Economic Profit Entity Value =Invested Capital +

=>Equity Value= Entity value‐ financial debt

Adjusted Book Value =Book value equity+ Revaluation surpluses– Latent taxes

Adjusted Book Value method reflects company value in terms of book values along with corrections for differences between book values and market values and adjusted for relevant taxes.

COMPANY VALUATION:CASH FLOW ‐METHODS

145

1. EQUITY CASH FLOW ECF

Equity Cash Flow = Incoming Cash Flow ‐ Outgoing Cash Flow– = Available cash for company shareholders

ECF = Earnings after Taxes + Depreciations + Amortizations – Δ Working Capital Requirements ‐ Δ Investments (in fixed assets) + Δ Financial debt

ECF = EAT – Net Investments + Δ Financial debt – Net Investments = New Investments in fixed assets – Depreciations

‐ Amortizations + Δ Working Capital Requirements

146

N N+1 N+2Opening Balance WCR € 1,400 € 2,700 € 2,200Closing Balance WCR € 2,700 € 2,200

Mutation in WCR € 1,541 € ‐500

1. EQUITY CASH FLOW (ECF)

∆ Financial Debt

147

N N+1 N+2Opening Balance long‐term financial debt € 2,700 € 2,900 € 2,900Closing Balance long‐term financial debt € 2,900 € 2,500

Opening Balance short‐term financial debt € 1,314 € 1,966 € 861Closing Balance short‐term financial debt € 1,966 € 1,061

Changes in LT financial debt € 200 € ‐400Changes in ST financial debt € 652 € ‐905

∆ Financial debt € 852 € ‐1,305

ECF =Earning after tax ( EAT)+ depreciations & amortizations‐ Increase in WCR‐ Principal payment of financial debts+ Increase in financial debts‐ Increase in other assets‐ Gross investment in fixed assets(+ Book value of fixed assets sales)

Equity value = ECF/Ke% + exceedingassets (‐Tax)


EQUITY CASH FLOW

ECF = EAT + Depreciations – Δ Investments – Δ WCR + Δ Financial debt

148

N‐2 N‐1 N N+1Asset beta 0.74 0.74 0.74 0.74

Interest‐bearing debt € 4,000 € 4,014 € 4,866 € 3,561Adjusted book value (equity) € 4,000 € 4,986 € 5,934 € 7,139Debt‐to‐equity ratio 100% 81% 82% 50%

1 + (1‐tax rate) x debt‐to‐equity ratio 1.70 1.56 1.57 1.35

Equity Beta 1.26 1.16 1.16 1.00

N‐2 N‐1 N N+1Risk‐free retum 3.5% 3.5% 3.5% 3.5%

Required return 20% 20% 20% 20%Risk premium 16.5% 16.5% 16.5% 16.5%Equity beta 1.26 1.16 1.16 1.00

Required return on equity 24.3% 22.6% 22.7% 20.0%

Equity Value = E0 = PV [Ket; ECFt] = +…+


EQUITY CASH FLOW

Considerations– Equity cash flow may fail to represent company equity, as our company

expects to invest quite substantially after year N‐2. – we used a reference year that is characterized by massive debt repayments to

calculate our residual value

Be very cautious about links between debt creation, equity cash flows and company values, should you decide to select equity cash flow as your method of company valuation. In case you decide to use equity cash flow methods, be sure to use formulas for calculating equity or leveraged betas that increase in line with significant debt‐to‐equity increases

149


PRACTICAL EXAMPLE

150

Equity Cash flow

Resultaat voor belastingen - earnings before taxes 319.346,98 193.468,68

Correcties- uitzonderlijke opbrengsten - extraordinary income 0,00 -2.500,00+ Uitzonderlijke kosten - extraordinary charges 0,00 646,00

Gecorrigeerd operationeel resultaat – Corrected Operational Result 319.346,98 191.614,68

- Belastingen op belastbare basis:(Tax-rate :Total tax paid/ Ordinary profit) -108.577,97 -65.148,99

Netto operationeel resultaat – Net Operational Result 210.769,01 126.465,69

+ afschrijvingen - Depreciations 465.259,00 437.163,27

Beschikbare cashflow voor investeringen – Available Cash flow forinvestments 676.028,01 563.628,96

- Gemiddelde investeringen - Average investments -100.000,00 -100.000,00

- Mutatie benodigd werkkapitaal - Mutation Work Capital Requirments -19.119,00

- Kapitaalaflossing- Capital Repayment -323.104,00

Equity Cashflow 121.405,96

PRACTICAL EXAMPLE

151

Calculate value based on Equity Cash flow

Equity Cashflow 121.405,96

Ke - Cost of Equity (zie berekening WACC) 17,08%

(when applicable : PLUS exceeding assets )

Waarde op basis van de Equity Cashflow - Equity Cashflow valuation 710.895,50

maar als de waarde lager is dan het EV dan nemen we de waarde van het EV 1.206.195,00

Use Capital and Reserves if valuation < Capital and Reserves

Bijgevolg weerhouden we de waarde volgens de Equity Cashflow op 1.206.195,00

2. FREE CASHFLOW (FCF)

FCF = EBIT‐ Operating Taxes NOPLAT

+ Depreciations and amortizations ‐ Increase in working capital NET INVESTMENT‐ Investments fixed assets

152

N+1

EQUITY CASH FLOW € 717

+ Interest charges x (1‐t)‐ Changes regarding financial debt

+ € 210‐(€ 1,305)

FREE CASH FLOW € 2,232


FROM NOPLAT TO FCF

FCF = NOPLAT ‐ Net investmentsEntity value =Discounted cash flows identify company earnings and adjust these earnings for cash flow estimatesDiscounted cash flows link company earnings to all outgoing cash flows in order to establish company profitsTo their advantage discounted cash flow incorporate all required company investments for generating profitsHowever, both methods only consider additional investments as opposed to taking all previously invested capital for generating company earnings into account

153


FREE CASH FLOWDefinitie beschikbare cashflow voor intrest = entity benaderingResultaat VOOR belastingen

+ uitzonderlijke kostenuitzonderlijke opbrengsten

+ ondernemersgebonden kostenondernemersgebonden opbrengsten

_______________________________________Gecorrigeerd operationeel resultaat‐ belastingen op het operationeel resultaat (1)_______________________________________Netto operationeel resultaat+ afschrijvingen+/‐ voorzieningen ( in principe NIET toe te voegen vb discussie belasting, risico: cfr art 50 KB) +/‐ waardeverminderingen ( in principe NIET toe te voegen want is vaak def verlies)________________________________________Beschikbare cashflow voor investeringenMin gebudgetteerde gemiddelde investeringen per jaar (= replacement investments)+/‐mutaties in gebudgetteerd werkkapitaal ( +:/‐)________________________________________Beschikbare cashflow

Opgepast in de praktijk voor de mutaties in de bedrijfskapitaal. ( Working capital ‐WCR)Definitie WCR:Het betreft de voorraden en de vorderingen verminderd met de niet rente dragende schulden. Deze laatste omvatten dus in essentiede leveranciers en de overige schulden.

(1) The tax payable on the ebit must be calculated Directly (Valuation methods and Shareholder value Creation, Academic Press , 2002, blz 40, Pablo Fernadez)

154Business valuation – Using financial analysis to measurea company’s value P 164 and following

FREE CASH FLOW

Discounted Free Cash Flow calculation1. Calculate company NOPLAT2. Estimate expected changes in working capital requirements3. Estimate expected investments in fixed assets and deprecations4. Calculate expected growth rates with data derived from steps

1,2 and 35. Calculate the WACC6. Insert this number in formula

Entity Value = FCF / ( WACC% – g %) (+ exceeding assets)

155


FREE CASH FLOWFree Cash Flow Growth Rate !

WACC

Investment rate

156




Figure 107: WACC estimates (euro in ‘000s) N‐2 N‐1 N N+1



Equity ratio 0.50 0.55 0.55 0.67

Required on equity 24% 23% 23% 20%

Weigted cost of equity 12.1% 12.5% 12.5% 13.3%

Interest‐bearing debt € 4,000 € 4,014 € 4,866 € 3,561


Interest‐bearing debt ratio 0.50 0.45 0.45 0.33

Required return on debt 7.8% 9.1% 9.5% 7.1%

Kd x (1‐t) 5.5% 6.4% 6.6% 5.0%

Weighted cost of debt (after‐taks) 2.7% 2.8% 3.0% 1.7%


N‐1 N N+1Net Investment € 1,400 € 1,800 ‐€ 300NOPLAT € 1,664 € 1,649 € 1,932

Investment rate 84.1% 109.2% ‐15.5%

N‐1 N N+1Earnngs before Interest and taxex (EBIT) € 2,377 € 2,355 € 2,760‐ Real taks rate x EBIT ‐€ 713 ‐€ 707 ‐€ 828

NOPLAT € 1,664 € 1,649 €1,932

+ Depreciations (and amortizations) + € 400 + €500 + €500‐ Investments (cf. fixed assets) ‐ €1,400 ‐€ 1,000 ‐ € 700

‐ Changes in working capital requirements ‐ € 400 ‐ € 1,300 ‐ (€ ‐500)

FREE CASH FLOW € 264 € ‐152 €2,232

Entity Value= +…+ + .

PRACTICAL EXAMPLE

157

Calculate value of company based on Free Cash Flow

NOPLAT : 308.202,99 196.609,69min gem investering per jaar per hypothese - Average investment per year per hypothese -100.000,00 -100.000,00min toename WCR - min increase WCR -19.119,00afschrijvingen - depreciations 437.163,27

Free cashflow 514.653,96

Waarde volgende de FCF - FCF valuationFCF/wacc 5.088.917,35min rentedragende schulden - interest bearing debts -1.160.024,00

waarde volgens FCF berekening - FCF valuation 3.928.893,35

maar als de waarde lager is dan het EV dan nemen we de waarde van het EV 1.206.195,00Using Capital and Reserves if valuation < Capital and Reserves

Bijgevolg weerhouden we de waarde volgens FCF berekening op 3.928.893,35

CONCLUSIONS

Equity cash flow represents all available cash for company shareholders– We recommend you to be very careful in using equity cash flows for company valuation.

Free cash results from cash flow generated by company business operations after all required reinvestments have been paid for.

Valuation quality largely depends on the quality of associated assumptions. In addition, selected valuation methods differ in terms of reliability regarding value estimates as various assumptions affect estimates in different ways

Work with multiple valuation methods as well as data sets that cover multiple years and include historical averages

158

NET PRESENT VALUEFor a correct understanding of discounted cash flows models, we need to consider the ‘Net Present Value’ Net Present Value (or NPV) = frequently used to determine whether new investments make financial sense or if it is profitable to continue existing projects.Present Value =

159

Net present value = ‐ initial investment

NPV> 0 The project is executed/sustained

NPV = 0 Management is indifferent

NPV < 0 Th project is rejected


FINANCIAL ANALYSIS AND

COMPANY VALUATIONHistorical data serves as starting points for valuation and should be adjusted to represent future situationsEstimate future NOPLAT and net investments to estimate company valueWCR• Preparations for takeover negotiations pay off by improving bargaining positions

with respect to earnings forecasts

Growth rate• Distinguish between active and passive future ownership for company valuation

and to incorporate relevant data on time, effort and risks for establishing growth rates and weighted average costs of capital

BetaEquity Value Entity Value

160

3-STEP-METHOD

161Business valuation – Using financial analysis to measurea company’s value P 148 and following

NOPLAT AND ROIC

ADJUSTMENTS1. Conduct separate valuations for operational and non‐operational assets

– Remove non‐operational assets from Invested Capital

– Remove any included non‐operational income from EBIT

2. Capitalize amortizations of Research & Development expenses– Include R&D investments in invested capital

3. Capitalize operating leases– Companies that lease assets will be characterized by relatively low operating profits and by artificially high returns on

capital

– Capitalizing operating leases with economic profit valuation

• Operational leases should be capitalized to reflect real profits from operations and to represent all economic debt associated with company operations

– =>Adding debt that is ‘avoided’ by leasing assets to company capital investments

– =>Recalculating rental expenses in terms of interest fees

– By adding present values of economic profit to all invested capital and including all asset value of operating leases, we may arrive at entity values

– Finally, we may calculate equity values by subtracting all financial debt and include added debt that is implied by capitalizing operational leases to invested capital.

162

CONCLUSIONManagerial balance sheets allow for better links between financial company performance and management decisionsThe first step: calculating and monitoring NLFThe second step: calculating company WCRThe third step: what extent NLF covers WCRThe fourth step: monitoring EBIT and EBITDA developmentsThe fifth step: calculating net operating cash flowStep six: calculate if net operating cash flow generates sufficient financial resources to cover maturing debt obligationsStep seven illustrate the use of this information for creating or checking balance sheet forecasts

– Economic profit models : all investments will contribute value to companies, if return on required resources exceeds all associated costs of these resources

– Discounted cash flow methodes: Discounted cash flow methods establish entity or equity values by considering future free cash flow or future equity cash flow. Discount rates are used to calculate present values of future cash flow

163

TAX RATE

164

Historical tax rate of the companyExample:

Result 100 000

Taxes 33,99% 33 990

Tax burden: 33,99%

Result 100 000‐ Tantièmes (loyalties) 90 000Taxable result 10 000

Taxes 33,99% 3 399

Tax burden: 3,399%

When calculating the historical tax rate of the company, make sure you calculate the tax burden before loyalties (tantièmes) are taken into account.

FINANCIAL MODELING

165

TAKING INFLATION INTO ACCOUNT

VOKS = Cash FlowH = inflation rateKr = Cost of equity / WACC%I = taking initial investment into account (because we are calculating a NET present value)

166

Financieel beheer – intersentia p 335

BETA UNLEVERED

Bu = Be(1+(1‐t)(VV/EV))

167

STANDARD DEVIATION

168

SIMPLE EXAMPLE

STANDARD DEVIATIONNumbers : 9,2,5,4,12,7,8,11,9,3,7,4,12,5,4,10,9,6,9,4

169

SIMPLE EXAMPLE

STANDARD DEVIATION

170

SIMPLE EXAMPLE

STANDARD DEVIATIONSum up the (in this example) 20 results

171

SIMPLE EXAMPLE

STANDARD DEVIATION

172

COVARIANCE

A mesure to see the correlation between two independent variablesSimplified formula

173

COVARIANCE

Formula extended for observations that stretch over multiple observations (e.g. years):

Cov (x,y) =

– xi and yi are the observed values of x and y for observation period i– ∑ is the sum over the different observa on periods

174

COVARIANCE

Example

Result = positive: indicates that turnover and EBIT tend to move in the same direction for this company over the observed years

175

N‐3 N‐2 N‐1 NNet sales (turnover) € 7,100 € 8,110 € 8,700 € 9,200EBIT € 1,700 € 2,202 € 2,377 € 2,355

Average valuesNet sales (turnover) € 8,278EBIT € 2,159

N‐3 N‐2 N‐1 N(xi ‐ E[x]): Turnover ‐ average turnover ‐1,178 ‐168 423 923(yi ‐ E[y]: EBIT ‐ average EBIT ‐459 44 219 197

(xi ‐ E[x]) (yi ‐ E[y]) 539,884 ‐7,286 92,316 181,271

∑ (xi ‐ E[x]) (yi ‐ E[y]) 806,185Number of observed periods 4Covariance 201,546

COVARIANCE

The covariance of two variables divided by the product of their standard deviations

176

CORRELATION

177

CORRELATION BETWEEN

TURNOVER AND FCFρ(turnover, FCF) = ,

178

N‐3 N‐2 N‐1 NNet sales (turnover) € 8,110 € 8,700 € 9,200FCF € 641 € 264 ‐€ 152

Average valuesNet sales (turnover) € 8,670FCF € 251

Covariance N‐3 N‐2 N‐1 N(xi ‐ E[x]): Turnover ‐ average turnover ‐560 30 530(yi ‐ E[y]): FCF ‐ average FCF 390 13 ‐ 403

(xi ‐ E[x]) (yi ‐ E[y]) ‐218,549 386 ‐213,661

∑ (xi ‐ E[x]) (yi ‐ E[y]) ‐431,824Number of observed periods 3Covariance ‐143,941

CORRELATION BETWEEN


179

Std (turnover) N‐3 N‐2 N‐1 N(xi ‐ E[x]): Turnover ‐ average turnover ‐560 30 530(xi ‐ E[x])² 313,600 900 280,900

∑ (xi ‐ E[x])² 595,400Number of years 3Variance (turnover) 198,467Standard deviation (turnover) € 445

Std FCF N‐3 N‐2 N‐1 N(xi ‐ E[x]): FCF ‐ Average FCF € 390 € 13 ‐€ 403(xi ‐ E[x])² € 152,308 € 166 € 162,516

∑ (xi ‐ E[x])² 314,990Number of years 3Variance (FCF) 104,997Standard Deviation (FCF) € 324

CORRELATION BETWEEN


Always make the common sense considerations on made investments and impact on turnover when interpreting the correlation between turnover and free cash flow.

180

Covariance (Turnover ‐ FCF) €² ‐143,941.33Std (Turnover) € 445.50Std (FCF) € 324.03Correlation ‐1.00

CORRELATION BETWEEN

TURNOVER AND ECFρ(turnover, FCF) = ,

181

N‐3 N‐2 N‐1 NNet sales (turnover) € 8,110 € 8,700 € 9,200ECF € 598 € 122 € 907

Average valuesNet sales (turnover) € 8,670ECF € 542

Covariance N‐3 N‐2 N‐1 N(xi ‐ E[x]): Turnover ‐ average turnover ‐560 30 530(yi ‐ E[y]): ECF ‐ average ECF 56 ‐ 420 365

(xi ‐ E[x]) (yi ‐ E[y]) ‐31,173 ‐12,610 193,273

∑ (xi ‐ E[x]) (yi ‐ E[y]) 149,490Number of observed periods 3Covariance 49,830

CORRELATION BETWEEN


182

Std (Turnover) N‐3 N‐2 N‐1 NTurnover € 8,110 € 8,700 € 9,200Average turnover € 8,670

(xi ‐ E[x])² 313,600 900 280,900

∑ (xi ‐ E[x])² 595,400Number of years 3Variance (turnover) 198,467Standard deviation (turnover) € 445

Std ECF N‐3 N‐2 N‐1 N(xi ‐ E[x])² 3,099 176,680 132,982

∑ (xi ‐ E[x])² 312,761Number of years 3Variance (ECF) 104,254Standard Deviation (ECF) € 323

CORRELATION BETWEEN


The correlation between the turnover and ECF is 0.35. There is as such a weak linear relationship: when turnover increases, equity cash flow increases to a small amount.

However, the main considerations formulated above with the free cash flow (regarding data sample size and considerations about investments) also apply for the ECF. Additionally, the mutations in financial debt play an extra major factor. The increase in ECF in year N is mainly due to additional financial debt.

183

Covariance (Turnover ‐ ECF) € 49,830.00Std (Turnover) € 445.50Std (ECF) € 322.88Correlation 0.35

CORRELATION BETWEEN

TURNOVER AND ECFTurnover vs EBIT most straightforward: less amount of additional considerations– Positive correlation (> 0,5) :

increasing turnover = increasing EBIT– Negative correlation (< 0,5): important trigger to contemplate whether

to increase operational beta in cost of equity calculations or not

Key when making conclusions concerning FCF and ECFLimited data sample: consider the drivers of FCF and ECF before interpreting the correlation

184

CORRELATION BETWEEN

TURNOVER AND ECF

185

PV OF FINITIVE ANNUITY

186

CALCULATING CURRENT VALUE

OF DEBT EXAMPLE€ 1 billion debt€ 60 million interest expenses – maturity of 6 years(6 % Intrest)Current cost of debt is 7,5 % (including intrest coverage ratio=default spread)

187

PV OF FINITIVE

GROWING ANNUITY

188

PV OF INFINITE

GROWING ANNUITY

189

190

EXPECTED RETURN –

VERWACHT RENDEMENTE(Ri) = verwachte rendement voor aandeel iN = het aantal waarnemingen in de steekproefRt = het historische rendement op dag t

191

RISK/VARIANCE OF THE SHARE

Var (Ri) = variance of the share

192

BETA TURNOVER VS

EBIT/FCF/ECFTurnover EBITTurnover FCFTurnover ECF

193Handboek financieel beheer – intersentia p 204

BETA TURNOVER VS

EBIT/FCF/ECFβi = ,

βEBIT = ,

ρ(turnover, EBIT) = ,


RELATIONSHIP REAL RATES –

NOMINAL RATESReal = ((1+nominal)/ (1+ inflation))‐1Nominal = ((1+ real) x (1+ inflation))‐1

The relationship between real and nominal rates therefore is not arithmetic. The rates do not just add up as there is a compounding effect. For example, if the real rate is 3% and the inflation rate is 4%, the nominal rate is not 7% (3% + 4%) but 7.12%.


THREE STAGE GROWTH MODEL

196

THREE STAGE GROWTH MODEL

197

SUSTAINABLE GROWTH

Gs = sustainable growth rate= Bs X ROEs (return on equity)

Bs= plowback ratioBs= (Annual earnings – annual dividends)

annual earnings

198

EXERCISE 1: STANDARD

DEVIATION AND CORRELATION


Turnover EBIT

2005 85.000,00 EUR 40.000,00 EUR

2006 36.000,00 EUR 20.000,00 EUR

2007 120.000,00 EUR 85.000,00 EUR

2008 90.000,00 EUR 75.000,00 EUR

2009 100.000,00 EUR 80.000,00 EUR

2010 130.000,00 EUR 90.000,00 EUR

STANDARD DEVIATION

SOLUTION (turnover)Mean = ( 85.000,00 EUR + 36.000,00 EUR + 120.000,00 EUR + 90.000,00 EUR + 100.000,00 EUR + 130.000,00 EUR) =

561.000,00 EUR / 6 = 93.500,00 EUR

200

STANDARD DEVIATION

SOLUTION (TURNOVER)

201

STANDARD DEVIATION

SOLUTION (TURNOVER)Variance = (1/6) x 5.467.500.000,00 =

911.250.000,00

Standard deviation =square root of 911.250.000,00 EUR=30.186,92 EUR


CORRELATION SOLUTION

– PART 1

203


– PART 2

204


– PART 34305000000

Vierkantswortel(5467500000x 4000000000)

Correlation = 0,920552929

205

BETA EBIT

Beta EBIT = COV ( EBIT, TUROVER)VARIANCE ( TURNOVER)

COV = SUM(( EBIT –Mean EBIT)x( TURNOVER‐MeanTURNOVER))n‐1

VAR = SUM (TUROVER – MEAN TURNOVER)²n‐1

206

BETA EBIT

COV

207

Cov = 4.305.000.000,005

=861.000.000,00 EUR

BETA EBIT

Variance of turnover=

= 5.467.500.000,005

= 1.093.500.000,00

208

BETA EBIT

BETA EBIT = 861.000.000,00 = 0,7873799..1.093.500.000,00

If the turnover increases by 1 EUR, EBIT will increase by0,7873799… EUR

209

EXERCISE 2 – STANDARD

DEVIATION AND CORRELATION

210

Turnover EBIT

2005 1.000.000,00 EUR 20.000,00 EUR

2006 36.000,00 EUR 1.000,00 EUR

2007 250.000,00 EUR 50.000,00 EUR

2008 90.000,00 EUR 30.000,00 EUR

2009 100.000,00 EUR 80.000,00 EUR

2010 300.000,00 EUR 80.000,00 EUR

STANDARD DEVIATION

SOLUTION (EBIT)Mean = (20.000,00 EUR + 1.000,00 EUR + 50.000,00 EUR + 30.000,00 EUR + 80.000,00 EUR + 80.000,00 EUR)

= 261.000,00 EUR / 6 = 43.500,00 EUR

211

STANDARD DEVIATION

SOLUTION (EBIT)

212

STANDARD DEVIATION

SOLUTION (EBIT)Variance = (1/6) X 5.247.500.000,00

= 874.583.333,33

Standard Deviation = Square root of 874.583.333,33 EUR=29.573,36 EUR

213

CORRELATION SOLUTION –

PART 1

214


PART 2

215


PART 3‐10020000000

Vierkantswortel(646200000000 x 5247500000)

=‐0,172071134

216

ESTIMATING COST OF DEBT

217


218


219


220

GECUMULEERDE

ACTUALISATIEFACTOR

221


PART 3€ 1 billion debt€ 60 million interest expenses – maturity of 6 years (6 % Intrest)Current cost of debt is 7,5 % (including intrest coverage ratio=default spread)

222

THE END

THANK YOU FOR YOUR ATTENTION!

223

ISBN 978-1-78068-016-3

224

Documents

USING FINANCIAL ANLYSIS FOR COMPANY le_analyse_naar... · PDF fileNET LONG – TERM FINANCING ‐Positive NLF: notalllong‐term financingused ‐NegativeNLF: short‐term debt is