Chapter 5 5 Leh) ISCOUNTED eX LOWSRTOs pISCOUNTED CASH FLOWS METHOD In Financial Management, it has been discussed that a way to determine the yalue of an investment opportunity is by determining the actual cash generated by 2 particular asset, Recall that discounted cash flows analysis can be done by determining the present value of the net cash flows of the investment opportunity. In Conceptual Framework and Accounting Standards, it was discussed that the cash flows are presented and analyzed based on their sources and activities which are categorized as operating, investing and financing. in determining the value of an asset, the cash flows are important reference or inputs. In determining the value of the asset, itis essential to include amount of cash that will be available for the claims of the equity owners. The Net Cash Flows refer to the amount of cash available for distribution to both debt and equity claims of the business or asset. This is calculated from the net cash generated from operations and for investment over time. For GCBO, the net cash flows generated will be based on the cash flows from operating and investing activities, since this represents already the amount earned or will be earned from the business and the amount that is required to be infused in the operations to generate more profit Net Cash Flows is preferred as basis of valuation if any of the following conditions are present: + Company does not pay dividends «Company pays dividends but the amount paid out significantly differs from its capacity to pay dividends + Net Cash Flows and profits are aligned within a reasonable forecast period «Investor has a control perspective. If an investor can exert control over a company, dividends can be adjusted based on the decision of the controlling investor. Using net cash flows over other cash flow concepts is more advantageous in 2 valuation activity since this metric can be directly used as input to @ DCF model. This is not the case for other cash flow or earnings measure such as EBITDA, EBIT, net income and cash flow from operations since these metrics might have missed or double counted an item «+ EBITDA and EBIT are both metrics that are before taxes; cash flows that are available to investors should be after satisfying tax requirements of the government gE 2c | —INCEPTS Al Prana consider differences. in Iso dO. not capi, + EBITDA and EBIT pt capture interest payments, dividends eee an outced from Bondholders ty preferen additional investments + Allthese measures also made into the firm for ac investment that are necessary business. Rr id funds do not consider reinvestment of cash ‘itional working capital and fixed ages to maximize long-term stability ops In valuation, analysts find analyzing cash flows and IIS SOUrcES help, understanding the following, nancing for needed investments ~ Are investmens, ch generated from operations or debieguiy ) The best case 7 firms is to fund ig wholly or partly through cash from operations, Hea, investments wo anening rom lenders or shareholders may se, that cash from operations is not enough to support the firm's long-term stability, Reliance on debt financing - Debt financing is an excellent financing strategy especially for expanding companies. However, it can become 2 problem for a frm if its cash from operations is insufficient to repay existing debt obligations. The situation worsens if firms continuously refinance borrowings that come due by another borrowing, «Quality of earnings — Significant disparities between cash flows ang income may indicate earnings does not get converted to cash easily, suggesting low quality. + Source of fi internally funded by ca: financing is necessary There are two levels of Net Cash Flows: (1) Net Cash Flows to the Firm; and (2) Net Cash Flows to Equity. The Net Cash Flows to the Firm is the amount made available to both debt and equity claims against the company. The Net Cash Flows to Equity represents the amount of cash flows made available to the equity stockholders after deducting the net debt or the outstanding liabilities to the creditors less available cash balance of the company. The net cash flows can be determined by referring to the financial statements of the ‘company. Net Cash Flow to the Firm Net cash flow to the firm refers to the cash flow available to the parties who supplied capital (ie. lenders and shareholders) after paying all operating expenses, including taxes, and investing in capital expenditures and working capital as required by business needs. NCF to the firm is cash flowsOTM Keon ea EUcLn eyelet ated from operating activities of the business which is intended t ed return of fund providers, Valuation models based on enterprise valuc 1s cash flows available to all investors — whether debt or equity genet requ encompa’ enterprise value of @ company refers to the theoretical value of its core riness activities as reflected by its net cash flows. This is the basic premise Branost corporate valuation methodologies, et cash flow only capture items that are directly related to the operating and Mesting activities of the business, Consequently, net cash flow excludes jems associated with financing activities. Net cash flows to the firm can be computed or derived using the following approaches, A, Based from Net Income (or indirect approach) Net Income Available to Common shareholders Php woox ‘Add: Non Cash Charges (net) 200 ‘Add: Interest Expense (net of Taxes 00x ‘AddiLess: Adjustment in Working Capital XXX Less: Net Investment in Fixed Capital (Purchases - Sales of Fixed Capital Investment) 00% Net Cash Flows to the Firm Php 200« + Net Income Available To Common Shareholders. Basic measure of a firm's profitability which refers to the bottom line figure in an income statement. This is the amount left for the common shareholders after deducting all costs, expenses, depreciation, amortization, interest, taxes and dividends to preferred shareholders. This is an accounting measure, meaning that non-cash items like depreciation and amortization is also included as a deduction to arrive at net income. However, this measure does not include changes in working capital nor capital investments made during the specific period which significantly affects a firm's cash flows. + Non-Cash Charges (Net). Pertains to non-cash items that are included in the computation of net income. Analyst usually look at the statement of cash flows to validate potential non-cash charges. If amount in the income statement does ot match amount reflected in the cash flows statement, it can be indicative that a portion of that expense is non-cash. The common non- cash items are the following 108es rau meee n and amortization Depreciation like equipment or int icquires a fixed asset = acquis 2 Mion is made at oi of acy, Wats in the balance sheet. In SUCCEEdINg peng” 3 portion ofthe intial cash outflow is recorded as depreciaye: porirorizaion which reduces net income, despite » Paving an actual cash outiow. AS & result, this shoulg redod back to arrive at the real cash flow. ible ition When a firm asset, the in! and is present o Restructuring charges Restructuring refers to the change in the organizationa, structure or business model of a company adapt to Changing semomic climate or business needs: Most restructurn involves involuntary separation of employees. AS a result, the restructuring requires the company to pay them severance pay. Severance pay should comply with the minimum fFequirements set in the Labor Code of the Philippines Severance pays are normally outright cash outflows. The company may also need to record write-down in value of pension assets (or reversal of previous accruals) as a result of the restructuring activity. This is usually recorded as part of he restructuring expenses (income) in the income statement However, since there are no cash outlays involved in write. downs (reversal gains), this should be added back to (deducted from) net income to get NCF. © Provisions for Doubtful Accounts These are estimated amount to be incurred for the customers inability to pay on time which is cumulatively accounted under the statement of financial position reported against the accounts receivable. Since these amounts represent the value that may have high probability of collection but not yet writen off, meaning there is a positive chance that it can still be Collected then it should be added back to the net income attributable to common.v ‘VALUATION CONCEPTS AND METHODOLOGIES, After-Tax Interest Expense Interest expense (net of any tax savings) o his interest expense is a cash flow intended for Company. This means that when the company pays interest teduces tax to be paid. Hence, the cash outflow is the amount of interest expense less any tax savings. en After-tax interest expense is added back to net incom income since the objective of NCF is to measure the cash flows associated with the operating activity of the business. The impact of financing should be neutralized to arrive at the real business value based on its operations. Working Capital Adjustment Aso known as working capital, this item represents the net investment in current assets such as receivables and inventory reduced by current liabilities like payables. The amount captured is based on the movements in these accounts from prior year. Required investment in current assets tend to increase when a firm's sales grow consistently year on year, Higher receivables and inventories are needed in order to support rising revenues. The company also needs higher financing through accounts payable or taxes payable to fund these receivables and inventories. Increase in current assets means cash outflow while higher current liabilities are cash inflows. Otherwise, the company may miss out on sales growth if they lack the current assets and liabilities to suppor it. Fast growing firms engaged in industries with high working capital needs like retailing and manufacturing tend to have substantial rise in working capital. Companies do not need to pay for taxes when they are investing in their operating capital. On the other hand, if current assets requirement decline, this means that more cash is available to debt and equity providers, thus, added back For NCF and valuation purposes, movements in cash, marketable securities short-term notes payable and current portion of long-term debt is excluded in the computation. Cash is excluded since the purpose of the NCF exercise is to identify what is the real cash flow of the business. Marketable securities are also excluded since these are not directly inked to operations. On the other hand, notes payable and current portion of long-term debt are excluded since they are associated with the financing side of the business. 110TESTS Investment in Fixed Capital ows made 10 purchase OF Pay for o tired to supper existing and future g ett ge from property, plant and equa”? necessary for PI equirements to intangible assets nt reSemark, patent and copyrights. FITS expect that they wy (tf trace more than one year as 2 feSut of these investments penethent in fixed capital assumes: that the projects tne, ”® teceptable and has positive net present value Meg Pertains 10 cash out expenditures that are re needs. Capital vestments use cash, hence, a reduet; ‘ured in the year that the Cash outton ® these can be found in the balance shes nce initial cash payment is made, ne income statement as depreciation any iation and amortization applies Increases in fixed capital in Net Cash Flow. This is capt made. Information related to t and statement of cash flows. O is charged to succeeding year's amortization. Treatment for depreci When gaps exist between amount of capital investment depreciation (called as net capital expencitures), this is usual rel ai to the growth profile of the company. Company expecting high a td eet hgh capi evens compar eamneg while jow-growth companies usually have ne. = expenditures. ea ae Cash paid for acquisition of a new bi usiness also falls i category. The full purchase amount reduces the Net Cash Flowinge year of acquisition. If the acquisition involves non-cash sete e analysts should be careful in capturing only portion den ‘ cash as reduction to Net Cash Flows. sarge On Ons, sine ar if there are sale of capital expenditures that occured is shou ie added back to the Net Cash Flow. This saes esess oe inflow which consequently reduces the investment iia cata iat Period. For example, if a property is sold fo pe Lan is should reduce the amount of investmentin (Le. ultimately, an addition to net cash flows) Hence, net in Here belles need capital is deducted to arrive at Net Cas? secsived Savion negate Net investment signifies that fim ore assets than it purchased for the yea" Analyst should mae Ce ee Statement of cash flows to analyze cash fovs pital investments. There are instances wie?, wT sae Manner companies may obtain fixed capital in exchange of shares which doesn't necessarily have impact to cash flows. Even though transactions might be non-cash for the current year. analysts should be careful in forecasting future fixed capital investments especially i it wil require cash outlays, From Statement of Cash Flows NGF can also be computed using cash flows from operating activities {in the statement of cash flows) as the starting point, Analysts usually start from this item since it already considers adjustment for noncash expenses and working capital investments. As a refresher, the statement of cash flows classifies cash flow into three major sections: cash flow from operating activities, cash flow from investing activities and cash flow from financing activities. Cash Flows from Operating Activities Php xxx ‘Add: Interest Expense (net of Taxes)" Less: Cash Flows from Investing Activities Net Cash Flows to the Firm ‘only if deducted from the operations + Cash flow from operating activities This represents how much cash the company generated from its operations. This shows how much cash is received from customers and how much cash outflows are paid to vendors. This also captures changes in current assets and current liabilities, Normally, this is computed from net income by considering non- cash items and working capital changes. This is considered in computing for NCFF. + Cash flow from investing activities This represents how much cash is disbursed (received) for investments in (sale of) long-term assets like property, plant and ‘equipment and strategic investments in other companies. This is considered in computing for NCFF. If this section reflects transactions involving financial assets, this should be excluded. * Cash flow from financing activities This represents how much cash was raised (or repaid) to finance the company. This is not considered when computing NCFF. ThisCEPTS AND METHODOLOGIES We ;gures will be ACCOUNted for jn fi imply because these Cateiaion of the Net Cash Flows to the Equity. the ful how interest and dividends are classirg, h flows. IFRS allows interest and cividengs der operating or investing activities ypje iis placed under operating or financin, dinary items should also be eliminates Analysts should be min« in the statement of cast received to be classified un’ interest and dividends paid ou! activities. One-time or extraor' from the computation C. From Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) EBITDA, net of Taxes. Php vox ‘Add: Tax Savings on Noncash Charges. Ea ‘Add / Less: Working Capital Adjustments a Less: Investment in Fixed Capital Xe NetGash Flows tothe Fim | Pp xxx + EBITDA or Eamings Before Interest, Taxes, Depreciation ang Amortization pertains to income before deducting interest, taxes, depreciation and amortization expenses, net of taxes Since the basis of the computation for the NCFF is already the earnings after excluding the financing costs, taxes and other non cash charges, the NCFF should only consider the amount net of the applicable taxes to be paid. This to conservatively show the EBITDA at the amount net to be realized by the investor, ‘+ Tax Savings on Non-cash Charges. Non-cash charges are not typically adjusted if NCFF starts with EBITDA. However, it is important that analyst should check whether non-cash charges were already deducted in computing for EBITDA or not. If deducted, then there is a need to add the item back. Ifnon-cash charges are not yet deducted from EBITDA, there is no need to add it back to compute for NCFF, Instead of adjusting for the full amount, analyst should add back the corresponding tax savings related to this non-cash charges 10 EBITDA. Several non-cash charges such as depreciation and amortization are tax-deductible. This means that occurrence of these expenses reduces the taxes that the company should p2: SS era es eePUNT wn ea thus, reducing cash outflow. This is added back capture this impact. ech EBITDA ito Concepts on investments in fixed and working capital is same as previous discussion. Net Cash Flow to Equity Net Cash Flow to Equity or NCFE refers to cash available for common equity participants or shareholders only after paying operating expenses, satistying operating and fixed capital requirements and settling cash flow transactions involving debt providers and preferred shareholders. NCFE can be computed from NCFF by considering items related to lenders and preferred shareholders. NCFE signifies the level of available cash that a business can freely declare as dividends to its common shareholders. This may stil differ significantly from the dividends actually declared and paid out since this decision is made upon the discretion of a company's board of directors. Companies tend to manage their dividend policy: some slowly increase dividends over time while some maintain current dividends despite actual profitability. As a result dividend trend is seen as less volatile compared to earnings as this is managed by the board of directors. Net Cash Flows to the Firm Php x ‘Add: Proceeds from Borrowings 5x, Less: Debt Service XX ‘Add : Proceeds from Preferred Shares Issuance 20 Less: Dividends on Preferred Shares XXX, Net Cash Flows to the Equity Php xxx * Proceeds from Borrowing This refers to the amount of cash received by the company as a result of borrowing of long-term debt. Since NCFF did not include items related to financing, it did not capture cash received by the company from lenders Since the cash from the borrowing is with the company already, it is added back to NCFF and forms part of the cash flow available to common shareholders.Reese = Debt Service used to service the loans oy 4 of loan repayment and the inert Debt Service is the total amount financing. This # the total aout expenses, net of income tax bene considered as part of the financing activites a, cement tl east term debt of the compary. The amount fo be es ce a the equivalent tax benefits from the interest The tax st Accord ity aoa ies alowed by the tax regime where the BUSINESS Operales. Pies, wie that ths amount must be similar should an adjustment was mage, compute for the NCFF. + Proceeds from Issuance of Preferred Shares ame with the debt, preferred shares as another form of financing, other than the issuance of ordinary equity, must also be factored in the calculation of the net cash flows available to equity. ‘+ Dividends on Preferred Shares, Since payments made to preferential shareholders in the fom of dividends are outflows. This must be incorporated in the calculation asa reduction of the net cash flows to equity. Similarly, given the above formula as guiding principle, NCFE can te determined under the following approaches: A. Based from Net Income (or indirect approach) ‘Net income Available to Common shareholders Php ‘Add: Non Cash Charges (net) 20 ‘Add: Interest Expense (net of Taxes) 20 ‘AddiLess: Adjustment in Working Capital 20 ‘Less: Net Investment in Fixed Capital (Purchases - Sales of Fixed Capital investment) x Net Cash Flows to the Firm x0 ‘Add: Proceeds from Borrowing xe Less: Debt Service Xx} ‘Add - Proceeds from Preferred Shares Issuance. Hes Less: Dividends on Preferred Shares Xo UNet Cash FlowstotheEquity | Php x28)r ON ee aU PMG eRele I 5, From Statement of Cash Flows Cash Flows from Operating Activities Php xo [dd: Interest Expense (net of Taxes) = Less: Cash Flows from Investing Activities | xxx ‘Net Cash Flows to the Firm = ‘Add: Proceeds from Borrowing er Less: Debt Service Xxx ‘Add : Proceeds from Preferred Shares Issuance Xxx Less: Dividends on Preferred Shares Xxx Net Cash Flows to the Equity Php xxx c. From Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) EBITDA, net of Taxes Php 1x ‘Add: Tax Savings on Noncash Charges XXX ‘Add / Less: Working Capital Adjustments 2X Less: Investment in Fixed Capital 2x Net Cash Flows to the Firm Xxx ‘Add: Proceeds from Borrowing 200 Xx Less: Debt Service ‘Add : Proceeds from Preferred Shares Issuance Yo Less: Dividends on Preferred Shares X00 ‘Net Cash Flows to the Equity Php 200 Terminal Value Since GCBOs is assumed to operate in a long period of time to almost Datpetuty, the risk and returns are inherent to the opportunity at the end of the projection period should also be quantified. Furthermore, the economic valve that will be generated by the assets is expected to be stable after some Point in time since the projections are reliant on certain assumptions made. The challenge for the determination of the value of the asset is to also account ‘orthe economic returns that it will generate in perpetuity. This is addressed bythe Terminal Value. Terminal Value represents the value of the company "perpetuity or in a going concern environment. In practice, there are several “ays on how to determine the terminal value.SMe |ETHODOLOGIES Basis of Terminal Value 1. Liquidation Value ome analysis find that the terminal Value be based on the estimateg salvage value of the assets. ‘Methodologies on how to determing tn satvage or liquidation value was discussed" Chapter 3 e 2. Estimated Perpetual Value the terminal value is by using the farthes, ‘Another way to determine te divided by the cost of capital less the cash flows you can estimal growth rate. CFng eo Tg TV = Terminal Value CF = Farthest net cash flows 1= cost of capital g = growth rate For example, a Filipino company is expecting for 15% returns for a venture and assumes that their net cash flows for the n are as follows: ee Year Net Cash Flows (in millon Php) 5.00 5.50 6.05 6.66 7.32 In Soniye you may note that the net cash flows are are ae Pasar this is a GCBO, and it is expected that meet a ehave on a normal trend. The growth rate (3) sing compounded annual growth rate formula = 1x 100%Sroka eae Manele NCFo = net cash flows atthe beginning NCF, = latest net cash flows a test time Substituting the given figures, the growth is computed as g= () = 1} x 100% 9 = (1.10 - 1) x 100% 9 = 10% Since the growth rate is 10%, it will be applied on the farthest cash flows i.e. on the 5" year equivalent to Php7.32, thus the farthest cash flows is now Php8.05 or will substitute the CFp.;. It is now assumed that the cash flows will continuously growth at the rate of 10% per annum. Thus, the formula can now be applied. CFs ng __ Phy 8.05 5% TV = Php161 In some cases, that the historical growth pattern is undetermined, some analysts only consider the cost of capital or their required return to determine the terminal value. In the given illustration, you may note that difference on the terminal value: Fr rvNT Reese (acres) 15% — 0% 15% Tv TV = PhpS3.06 You may observe that the terminal value in this case is more conservative by about Php107. 3. Constant Growth Challenges for some valuators is to determine the amount of required return for a specific type of asset or investment. In lieu of the required return, they use the growth rate as the proxy especially if the growth is constant and significant. 4, Scientific Estimates Other valuators especially those with vast experience already in some types of investments uses other basis for them to determine the reasonable terminal value. Using guesstimates is not prevented because in the end, equity values will still be based on negotiation. There is no perfect approach to determine the terminal value. Actually, some risk averse investors don't consider the terminal value in their valuation. The differences in their appreciation on the determination or even the inclusion of the terminal value is dependent on their risk appetite. Then again, the valuation method will only serve as a reference to determine the reasonable value for the equity or the asset being purchased. This is why negotiation plays a key role in finalizing the determined value. Other inputs in the Net Cash Flows The present value of the Net Cash Flows represents the value of the assets It may be recalled further that the assets are financed by debt and equity Hence, these are the claims which are presented at the right side of the Statement of Financial Position, under an account form of reporting The discounted cash flows analysis factors in all the projected stream of cash flows that the project, opportunity or investment and valuing it in present time to determine whether the investment made on this year would be less thanRN Nannon yeera the value it wll generate in the future, that means the investment yielded an ‘amount sufficient to cover the investment and allowing the investors to earn ‘more. Same principle applies that the best opportunity is the one that will yield the highest present value or solely if the opportunity will result into a positive ‘amount it should be accepted. Conservatively, the total outstanding liabilities must be considered and deducted versus the asset value to determine the amount appropriated to the equity shareholders. This is called the equity value. The opportunity that will result in the highest equity value is considered. DCF Analysis is most applicable to use when the following are available + Validated Operational and Financial Information + Reasonable appropriated cost of capital or required rate of return + New quantifiable information illustrative Example No.1 Bagets Corporation has projected to generate revenues, cash operating expenses, and the corresponding tax payments for the next five years: Revenue | Cash Operating ] Taxes | Working Capital Expenses. Adjustments. i 92.88 65.02 45.57 18.58 2 97.52 68.26 48.23 19.50 3 102.40 71.68 51.04 20.48 4 107.52 75.26 54.01 21.50 5 112.90 79.03 57.15 22.58 The investment in fixed capital that was purchased and invested in the company amounted to Php100 Million. To be financed by: © 60% from loan borrowing with an annual interest of 10% payable equally in five years. First payment will be due after 1 year; and + 10% preferred shares with 8% coupon rate. It you are going to purchase 50% of Bagets Corporation, assuming a 15% fequired return, how much would you be willing to pay? Based on the foregoing information, the value of Bagets Corporation equity is Php22,80 Million. If the amount at stake is only 50% then the amount to be Paid is Php11.4 Million (Php22.80 x 50%).wir RU keenest ean meTHOD' Discounted Cash Flows Analysis a oar a0 rs eam 7-756 maz - Sto ce 1990-2048 tes cash overating Expenses ed (ess Worng Catal Adstment a Terminlvue ee PraceedsromPrefened shores ess: OmdendtPreterred shares et cash Flows to Equny mao Shan Fae _i__og7_02 scouted econ ows CRED jem Notes to Analysis / Terminal Value Calculation Fryer _ 45.86x (1+ 5%) aM r-9 15% — 5% Php 481.50 /2 Proceeds from Borrowings and Debt Service Financial Models in Discounted Cash Flows Analysis Financial Modelling is a sophisticated and confidential activity in a company ‘or for an analyst. Information is can also be considered as competitive advantage of a company or a person. Most of the companies hire financial modelers to assist them in determining the value of GCBOs or other opportunities. They also ask them to validate ballpark estimates and may also be used to determine impairments. Most financial modelers have extensive financial acumen and vast knowledge and experience, Financial modelers normally are economists, financial managers, and accountants. Management accountants are good candidate for this role given their ability to understand ‘operational models and design long term financial strategies. ERayant In order to develop financial models, the following steps needs to bi opserved wd 4, Gather historical information and references Historical information must be made available before the financial model is to be constructed. Historical information may be generated from, but not limited to the following: audited financial statements, corporate disclosures, contracts, and peer information. , Audited Financial Statements are the most ideal reference for the historical performance of the company. The components of the Audited Financial Statements enable the analyst or the financial modeler to assess the future of the company based on its past performance. Statement of Income are used to determine the historical financial performance, Statement of Financial Position is used to determine the book value of the assets and the disclosed stakes of the debt and equity financiers, Statement of Cash Flows illustrate how the company historically financing its operations and investments. Statement of Changes in Stockholder’s Equity provides the information on how much is the claim and dividend background of the company. One of the most important components of the financial statements are the Notes to the Financial Statements. It provides the summary of important disclosure that should be considered in the valuation. The financial modeler must be able to quantify these disclosures and more importantly the risks involved Corporate disclosures are also key in developing the financial model. Corporate disclosures provide more context for the future plans and strategies of the company. This will enable the analysts or the financial modelers to identify the risks about the GCBO and quantify them accordingly. Since these are available to the public, itis the same information that is known to others. The difference among modelers are their personal appreciation to risk and their client's appetite for risks. Contracts are formal agreements between parties. In valuing the GCBOs, it 's important for the modeler to also know the existing contracts and the covenants contained in it. Large accounting firms offer transaction advisory services to assist their clients who enter info new ventures. Due diligence is necessary to verify any contingent liability and other legal risks surrounding that opportunity and quantify it accordingly to have a more conservative value. The modeler must be able to classify the probability of these from occurring, Gathering this information is important to have a reasonable basis to quantity 2nd incorporate it in the financial model.nS NIN (Oe maton ae also essential inputs oy or Peer infomation an other pub information ave as acts opus financial model. Peer information provides: po vero in the valuation process. Peers may he risks identified or willbe assumed Deena Soa sas sper ag ote conten TA Meg y 2a the organization may also be considered as peers. However, the informat, | ws consider information ands nny shonin restead bylaw since thee * on Fer eet hes and autes can also DE USE 8 PEEnfomagy | in the Phitppines, reliable sources could be the National Library any | im dies, Researches and studies share = ae A ay oe ea of Covelomen ofthe aril noel an nation nancial adel must be able to fe te information hat souls be necosay forte vahaton Relevance an relat of omatig or ott are important Nota njrmatio shous Be ven consideration ites agencies Maer is another consideration, Even f there are ational information founa rot cathered, there shoul bea sense of materially assessment nied Na earn that projections remain to be estimates. Therefore, only relevant items should used, ne be considered in the valuation, any forn 2. Establish drivers for growth and assumptions The us GDP ( Once all relevant information was gathered and validated, drivers and prices assumptions can be established by conducting financial analysis. Drivers are of the suggested to be those validated and is represented by authorities like government or experts. Growth drivers are normally based on population, since most of the businesses are consumer goods. if services, industry growth may be used as a driver. In the Philippines, information is avaiable {rom the Philippine Statistics Authority. Because the government needs to be transparent to its citizens, it fortunate that the information can be found in the Government website or is disclosed to public through media with wider reach and scale. toar ——— aRenae Uae ees pation Nation! Mat sik is NE ~% Gperdiues, Sen ie wale, ae Se fei RN foe ley opi m HER Fp 31300009 Pep neran Philippine Statistics Authority Dashboard For other economic factors, drivers, and estimates, Bangko Sentral ng Pilipinas and National Economic and Development Authority are also other agencies that can be relied with. Certain statistical information can also be found from the websites or research centers of the Local Government Units and National Government Agencies. Research organizations may also be used, however, strong validation and evaluation needs to be done to isolate any form of biases that may affect value. The usual growth indicators used are: inflation, population growth, GNP or GDP growth. In economics, the inflation is the result of the movement of prices from a year to another. This is calculated by comparing the movement of the price of the basket of commodities from a year to another or @ period to another. Inflation is computed using this formula. CP CP CPI, = consumer price index ~ current year CPI, = consumer price index - base year The consumer price index represents the price of the basket of commodities in financial modelling, you need the inflation to be used for a particular period. I lures, There are two ways as driver for certain operating and capital expendi to calculate the value: (1) nominal and (2) real. Nominal financial models are already in current prices, meaning, the prices Slated in the model already assumes that the prices grew or decline, in the case of inflation or deflation respectively. Some uses the headline inflation to determine the current price. Real financial model, on the other hand, does not include the effect of changes in prices, but rather preserve the price offoes Rea au if no changes iin pri itures, 28 ices nite ne cost of CaPital Should algg operating expenses and capital oes ‘occur. I the financial model isin excludes the effect of inflation. 1019 the CPlis 151 mean With the given equation tolustrate- nay Ne ae sblahed's Prana 1. In , the cost of the pe ee few. hence, ination is expected a pean assy 100%], On the other hand, f the CPI i bie for 2029 2 E5611 x) ras ese at S74 (44 is , = 1x 100%). ting for how mt To illustrate its application, sures eo pea os m ch is ie comuraton cost 2 ae communication cess © Be ncrportey e calcul ion . in the financial model is PnpS.132 Millon rowth rate. Population growth rate is factored the demand of the product, particularly for tre erchandlsing or manufacturing business. The services sector may use the growth rate in the businesses oF the industtY OF sector that they are going Moe aye. The formula to caleuate for the population growth rate is similar with the inflation, except that the input is the population count of @ particular segmentin a particular year. Toilustrate, suppose that in Barangay An 2018 the population is 25,200. The survey is conducted in 2020 and the population 1=.26-460. Using the formula of inflation to calculate for population growth rate (Other indicator is population oi in to serve as a growth driver fo 26,460 (Gena) =3* 100% 95% To illustrate the application, assuming that the estimated consumption of pan de sal in Barangay A is 5 pcs average per head. If you are going to project the number of pan de sal to be sold in 2021, it wll be 138,915 units computed as follows: Current pan de sal sold (26,460 x 5) 132,300 Increase in pan de sal (26,460 x 5% x5) _ 6,618 Total estimated pan de sal 138,915 Financial ratios may be used as tools to determine the growth drivers and assumptions. Trend analysis will also help you establish the trajectory of ‘growth pattern. The financial modeler must assess whether the company cafReh esae eu ose eere sy sustain the pattern otherwise it is conservative to assume a less aggressive growth. Normally the weighted growth patter will be considered in the long- term financial perspective. It must be assessed whether the average year on year growth will be sustained or may be surpassed To illustrate, PUP Company's historical production grows 10% per year. Itis expected that in the next five years the probability are as follows Scenario Rate | Probability A 5% 10% B 10% 40% c 15% 50% With the given information, the weighted average growth rate to be used is 42% computed as follows: ‘Scenario Rate Probability | Weighted ) 2) (Nx) A 5% 10% 0.5% B 10% 40% 4.0% c 15% 50% 75% Total 12.0% In this situation, the financial modeler can safely use the 12.0% for projecting sales moving forward. Hence, if the sales for this year was reported to 8,500 units then under the average sales computed will result to 9,520 units sold. 3. Determine the reasonable cost of capital In determining the reasonable cost of capital, the financial modeler must be able to use the appropriate parameters for the company. Generally, cost of debt and cost of equity are weighted to determine the cost of capital reasonable for the valuation. 4. Apply the formulae to compute for the value Normally in Financial Modelling, DCF is used to calculate for the value. Since ‘Most information are already available in Financial model, it can be easier to Use other capital budgeting techniques like Internal Rate of Return, Profitability Index etc. 126IES SITES For example, Delight Bakery Inc. projected volume Se eee ih every year, and the estimate nits, assuming 5% grow!! ves cas eeepc het income margin of 2%, Deights equipment is Capable of producing the Volume required for 10 years. it was noted that the company has outstanding debt of PhpS00,000 Using the inputs, the financial model may be presented through: 1 [belt Sterne 2 Franc! Moxel ft years__Yewt Yew 3] vaume ios sas teem 6) pce 5 a a5 1s 5 7) Revenue Bans 2187918 2287810 LAID ASS 5 caenitinceme Marin Kk ae ahah 8) casnnetincone yas arse, See anos wa 10) Discount rector wean? os os” oe” 11) Dscouned net cath Flows Traasecs serene 570060 551028 52, tnterpie Value lum) 1179,28.30 =SUM(OLEEH) Me equtyvalve Ta e10 Observe that the enterprise value is calculated by getting the sum of all discounted net cash flows. Alternatively, NPV function can be used in electronic spreadsheets. Below is an illustration where both should arrive at the same resuits, An ® 2: & nn ae 2 ie s “ 1 eligi itary ie 2 Farol Mode, “ Yenst___Yeur2__veurs__veura__veus_ 5) Voune SN RSIS esas sae amar 6) bce i ear ees) a 7) Revenue RNS ass aaa eae 2 ©) caontet income warn Ee ae ee SIGNS TSS3 wasn ana oi" om’ an’ oss a 378358.09 30 Ga. 5,709.59 HNSIOIE TAS — RS ase e200 paysioze a 37,0230 -SumMoTEE) 0) scour Factor 10s Discourted Net Cash lows 2 emerpeite Value (sum) 13) trerpise Valve (ry) 1.729,70230 “wove 0018) Me, Less Debt 500.00, 15, Equity Value 1229.70.10PTA Oran ese 5, Make scenarios and sensitivity analysis based on the results The advantage of having a financial model is that you can easih previous illustration the cost of capital used is 10%, How about if you find that cost of capital will be 12% or 15%, what will be the Enterprise Vue? itthis is the case, we need to design the financial model to accommodate this through the use of Data Table feature in Microsoft Excel. First, design a table where the values will be inputted. Next, select the table we prepared by highlighting cells C17 to D19 and you goto DATA Tab and go to ‘What if Analysis then select ‘Data Table’ Data Table Dialogue box will appear and will ask you to enter the inputs. Since the table we are doing provides for a columnar input. Then we'll input C17 in the COLUMN INPUT and click OK. Data Table x | | govrinput cl + | Column input cell: scsi t OK cast | Then the results will now be shown to you in the table. A 8 c D 15 6 1 Equity Value 17) Base 10% 1,229,742.10 18, Scenario! 12% 1,142,000.20 19/ Scenario It 15% 1,023,049.99 20