Financial Modeling Workshop (IMC 2009)

For internal use only
How to build a financial model

Direct Investment - CHO
Dec. 2009
Confidential
Table Of Contents
Financial Model is a Powerful Tool Basic Financial Concept Review General Modeling Methods and Skills Guidance on Related GIC Documents Preparation Q&A 15 min 45 min 20 min 15 min 25 min
The Use Of Financial Models

Transaction Transaction
Equity Equity raise: raise: to to determine determine the the share share offering offering price price and and share share numbers numbers Sell Sell company company or or equity: equity: to to determine determine the the selling selling price price Acquire Acquire another another company company or or equity: equity: to to determine determine the the transaction price transaction price Evaluate Evaluate offers: offers: to to determine determine the the offering offering price price by by the the buyer buyer is is appropriate appropriate or or not not New New project project investment: investment: to to evaluate evaluate how how financially financially beneficial beneficial a a new new project project investment investment is is for for the the company company shareholders shareholders Forecast Forecast impact impact on on the the company company value value due due to to changes changes in in strategy (product, market region, channel, etc) strategy (product, market region, channel, etc) Deep Deep understanding understanding of of interaction interaction between between various various inputs inputs and and company company valuation valuation Evaluate Evaluate the the impact impact on on company company valuation valuation caused caused by by potential acquisition potential acquisition Evaluate Evaluate the the impact impact on on company company valuation valuation under under different different financing options financing options Its Its also also used used in in budget budget planning, planning, performance performance evaluation, evaluation, operation operation option option comparison, comparison, etc. etc.
Operation Operation Management Management

Translate Translate insight insight and and intelligence intelligence of of a a specific specific industry industry and and a a company company to to its its valuation, valuation, consequently consequently lead lead to to recommendation recommendation to to investment/divestiture investment/divestiture of of the the company company
Financial Modeling Workshop Dec, 2009
Relationship Between Financial Model And Strategy

Financial modeling aims to mimic the actual business operation as close as possible. Business operation is guided by strategy. Strategy planning helps to identify opportunities & risk and develops plan of actions to deal with the opportunities & risks Plan of actions cover the business model design and redesign, changes in marketing strategy, product strategy, pricing strategy, human capital strategy, production, logistics, etc. All the actions will lead to reallocation of company resource or even quest additional resources externally. As a consequence, they will affect the business financially. Financial model quantifies the effect by translate as truthfully as possible the actual business into a simplified model with changeable inputs and delivers the forecasted output to the users. Based on the output of financial models, management can have a quantitative understanding of the impact on the business that a specific strategy plan/action would have
Detailed Terrain Analysis Leads To Effective Strategic Planning

1. Build Build Deep Deep Understanding Understanding of of Underlying Underlying China China Market Market 2a.
Historical Context
Define industry structure (product/segment categorization, value chain, etc.) Demand evolution (users, demand drivers, etc.) How supply evolved to meet demand (competitors, capacity, location, technologies, etc.) Government policy evolution regulations (drivers and results) Industry structure (competition), economics (cost structure, pricing, etc.)
2.
Understand Understand Future Future Trends Trends & & Development Development Scenarios Scenarios 3a.
3.
Indentify Indentify Potential Potential Opportunities Opportunities 4a.
4.
Charting Charting Out Out The The Strategic Strategic Paths Paths
1a.
Drivers Of Future Market Evolution

For each product category, what will drive changes in: Demand-supply, competitive structure (scale, access to raw materials, etc.) Transportation / channel Government policies & regulation Global trade, economics & technology, etc.
Construct Assessment Criteria

Construct criteria with which to assess segment attractiveness, e.g. Size Growth rate Profitability Risk
Overall Chemical Strategic Options Development

Develop strategic options /scenarios for each of the attractive segments Consider path dependencies (sequencing of investments) Locations Indentify necessary capabilities. E.g. : Partnerships. Technologies, key control points, etc.
1b.
tai Implications / opportunities & risks led an 2b. t aly erFuture rai Demand & Supply Landscape Demand & Supply & Competitive s is n Landscape
Forecast future competitive structure Transport/ channel structure & economics
De
Current demand picture (detail by users, locations, etc.) Current supply picture (detail by plants & location, pro & con analysis) Current value chain and competitive landscape structure (competitive patterns) Transportation / channel structure
Demand forecast (use driver analysis as basis detail by location) Supply forecast (use driver analysis as basis detail by location)
op Bus po in rtu es s4b. Competitive dynamics & Distribution ac nitie Transportation Strategy tio s a IMC ability to meet competitive requirements n Develop options for nd strategic chemical transport & distribution
Feasibility of building defensible competitive advantages Govt. policies, etc. within China
3b.
Apply Assessment Criteria
Apply assessment criteria and prioritize key segments by attractiveness Detail key assumptions and logics Run scenarios, indentify key risks and challenges
1c.
High-level Current Economics
For each major product category/ segment: Economics / high level financial models Technical / technology issues Channel economics Key Success Factors for winning
Terrain Analysis Helps To Locate The Relative Position Of Ourselves
Strategic advantage Strategic goal Industrial
Segment Low cost Differentiation
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Value chain Business model, choose what do we do and how do we do
Table Of Contents
Concept List
1. Enterprise value and equity value 2. Trading comparable analysis/valuation 3. Transaction comparable analysis/valuation 4. Accrue accounting and effect on depreciation 5. Free cash flow 6. Discount rate 7. Terminal value
Relationship Of Enterprise Value And Equity Value
From equity value to enterprise value
Accounting Accounting value value,, as as a a traditional traditional measurement measurement of of value, does not reflect the true value of a company value, does not reflect the true value of a company in in most most cases cases as as it it ignores ignores the the future future value value that that the the company company can can generate generate for for the the company company stakeholders. stakeholders. Accounting Accounting value value holds holds the the historical historical value, value, in in most most cases cases it takes the forms of total assets, shareholders interest, it takes the forms of total assets, shareholders interest, etc, etc, as as we we see see on on the the balance balance sheet. sheet.
+ +
Net debt
Market Market value value,, which which incorporates incorporates the the future future value, value, is is a a much much better better indicator indicator of of company company value. value. Market Market value value takes takes the the form form of of stock stock price, price, the the consideration consideration paid paid in in merger merger and and acquisitions. acquisitions. The The value value in in the the graph graph on on the the left left are are all all of of market market value. value. Each piece of value belongs to different stake holders. Each piece of value belongs to different stake holders.
Equity value
Minority interest
Liability
Cash
Enterprise value
Comparison Of Major Valuation Methods

There There is is no no single single method method is is better better than than others others and and each each is is more more appropriate appropriate for for specific specific situations situations Most Most frequently, frequently, combination combination of of 3 3 methods methods will will be be used used to to cross cross check check and and narrow narrow the the valuation valuation range. range.
Valuation methods
Trading comparable method
Description
Analyze the trading multiples and operation situation of comparable public companies to arrive at a range of trading multiples for the target company The valuation does not factor in value of controlling premium
Pros and Cons

Pros: very market oriented can easily put pieces together to value company with multiple industrial operations Cons constrained by availability of comparable public companies Pros: very market oriented Cons constrained by availability of comparable historical transaction Valuation multiples might differ from time to time due to market cycle, etc. Pros: less relied on third party data Cons not suitable for start-ups or distressed companies very sensitive to the forecasts and assumption
Transaction comparable method
Analyze comparable historical merger & acquisition transactions to arrive at a range of transaction multiples for the target company The valuation does factor in value of controlling premium
Discounted cash flow method
Forecast the future cash flows and terminal value, discount them by appropriate discounts rates, to arrive at valuation result of target company. More complex, but has most sound theoretical foundation
Difference Between Equity Value And Enterprise Value
Equity Equity value value Shares Shares outstanding outstanding x x share share price price The The interest interest of of common common share share shareholders shareholders receives after creditors and preferred receives after creditors and preferred shares shares shareholders shareholders Major Major equity equity valuation valuation multiples multiples Share Share price price // net net profit profit per per share share (P/E (P/E ratio) ratio) Equity Equity value value // free free cash cash flow flow to to equity equity Equity Equity value/ value/ equity equity book book value value (P/B (P/B ratio) ratio)
Enterprise Enterprise value value (Firm (Firm value, value, FV) FV) Equity Equity value value + + net net debt debt + + minority minority interest interest + + preferred preferred share share (net (net debt debt = = short short term term liability liability + + long long term term liability liability + + capital capital lease lease cash cash and and cash cash equivalence) equivalence) Capture Capture all all the the valuation valuation of of stakeholders, stakeholders, including both equity and debt including both equity and debt holders holders Major Major enterprise enterprise valuation valuation multiples multiples Enterprise Enterprise value value // revenue revenue Enterprise Enterprise value value // EBITDA EBITDA Enterprise Enterprise value value // EBIT EBIT Enterprise Enterprise value value // free free cash cash flow flow to to firm firm
10
Using Different Valuation Methods During The Life Span Of A Company

EBITDA*
1.Comparables -FV/fixed assets -FV/market size 1.Comparables -FV/Revenue 1.Comparables -FV/EBITDA -FV/Revenue -P/E 1.Comparables -FV/EBITDA -FV/Revenue -P/E -P/B 2.DCF 2.DCF
Start up
Development
Fast growth
Mature
Note: EBITDA, earning before interest, tax and depreciation & amortization
11
Trading Comparable Method
Generally, there is always some comparable companies listed on stock exchange. The trading stock prices are good indicators of how the market/investors value such companies within the same industry/segment. Using trading multiple ratios of such companies, we can estimate the value of a target company as if it were listed For non-public company, the convention is to apply a discount rate of 20-30% off listing company trading valuations. Moreover, the larger the target company, the smaller the discount rate. The discount is roughly a reflection of liquidity risk.
General steps of application of trading comparable method Select appropriate comparable listed companies Select appropriate multiples Estimate the target company value
12
Trading Comparable Analysis

Step 1. Select a comparable industry, as close as possible Different industries are traded at different multiples (investors view them differently) Step 2. Shortlist the comparable companies within that industry Product Scale (Revenue, gross profit, net profit, production) Geographic region Profitability (gross margin, net margin) Efficiency (turnover ratio), etc. Step 3. Select multiples and range of multiples TO COMPARE! Which multiples are meaningful when comparing How is the operation of target company compared with the short listed comparable companies? Better or worse? How much better/worse? Why? It is sustainable? How different is the target companys business from each comparable company? How much would the different impact on the valuations? How is the capital structure of the target company compared with its peers? Etc.
Step Step 4. 4. Select Select the the most most comparable comparable companies companies and and multiples, multiples, define define the the range of multiples range of multiples and and apply on the target apply on the target to to get get valuation valuation
13
Simple Example Of Trading Comparable Analysis

Comparable trading multiples - partial
Listed date IMCYY China Ship 20-May-98 Zhongchuan 3-Jun-97 Guangzhou Shipyard 1-Jan-03 China Average UDL Holdings 23-May-01 Wonson Intl 17-Jul-07 Guangzhou Shipyard 28-Oct-93 Hong Kong Average Keppel Corp. 24-Oct-80 Yang Zi Jiang 18-Apr-07 Singapore Average
Units: RMB millions unless specified
Closest Closest comparable comparable

Latest price (RMB yuan) TBD 72.0 17.7 24.3 0.036 0.459 12.8 36.9 3.9
Listed exchange Shanghai Shanghai Shanghai Hong Kong Hong Kong Hong Kong Singapore Singapore
Revenue
Net income 248 4,160 92 820 -2 -414 820 6,231 1,624
Operating cash flow 242 2,622 191 -195 -19 284 -195 9,655 2,756
Equity
2008 P/E multiples (times) 15.0x 11.5x 69.4x 14.6x 31.8x N/A N/A 7.7x 7.7x 9.4x 8.7x 9.1x
2007 P/E multiples (times) 8.7x 153.7x 43.0x 68.5x N/A N/A 20.5x 20.5x 5.6x 36.1x 20.8x
Total shares (millions) TBD 663 362 495 5,040 33,740 495 1,593 3,653
821 27,655 1,327 6,484 62 1,052 6,484 55,683 7,359
675 12,042 778 2,569 135 2,023 2,569 31,832 4,315
Make sure the following is taken care of 1. Check if comparable companies are comparable (Some companies are displayed on your radar monitor by database screening, however, these companies holds many other industry investment, thus might not be a good comparable) 2. Read prospectus and research report to get deep understanding of comparable companies businesses 3. Delete obvious bad comparable companies 4. Delete obvious outliers 5. Delete obvious meaningless multiples 6. Calculate average and medium multiples 7. Select and adjust multiples (ranges) to apply on the valuation of target company
Note: 1. Data as of end of 2008/2007 and all currency is converted into RMB yuan (), RMB1= USD0.146=HKD1.133=GBP0.089=SGD0.212 2. Limited information of ship yards listed on US or UK exchanges Financial Modeling Workshop Dec, 2009 14
Transaction Comparable Method
Selecting appropriate historical M&A transactions is crucial to the valuation result Industry, business and financial performance of the comparing companies shall be as similar as possible Transaction consideration shall be close to intended transaction of the target company It very difficult to gather transaction information of non-public companies, public news might be the one available information source. Some considerations when using transaction comparable method Strategic buyer and financial buyer might offer different premium/discount Other non-valuation factors might affect the transaction value (negotiation power, government influence/policy, sellers true intention of exit, etc.) Timing when different transaction happens (internet bubble, distressed assets during financial crisis, etc.)
15
Simple Example Of Transaction Comparable Application

Step 1 Select comparable transactions (new energy sector, solar energy segment)
Announcement Date Lead Investor(s) / Buyer CLP Holdings Ltd. (SEHK:2) Target Roaring 40s Renewable Energy Pty Ltd., 10 Wind Farms in China China Recycling Energy Corp (OTCBB:CREG) Jinzhou Jinmao Photovoltaic Technology Co., Ltd. CWIG Diaobingshan Windpower Co., Ltd. Wuxi Jiacheng Solar Energy Tech. Co., Ltd. Eco-Energy China Group Yeong Guan Energy Technology Group Transaction Value (US$ mm) 94.2 % Implied Valuation (US$ mm) 49 192.2 Description of Target(s)
Step Step 2 2 Select Select multiples multiples (P/E, (P/E, P/B, P/B, etc.) etc.) Step Step 3 3 Compare Compare target target company with company with the the comparable comparable companies companies Step Step 4 4 Apply Apply select select multiple multiple range range to to estimate estimate valuation valuation
7-Apr
Operates 10 wind farms in China Designs, sells and operates top gas recovery turbine systems (TRT) and other renewable energy products Provides solar PV modules Engages in wind power electricity generation Manufactures solar cells and modules Produces biodiesel and operates multi-feedstock biodiesel refinery and jatropha plantations Manufactures and distributes wind turbine components Produces monocrystalline and multicrystalline silicon PV cells; PV modules; and buildingintegrated photovoltaics products
20-Apr
NA
2.0
NA
NA
27-Apr 12-May 20-May
Jinzhou Yangguang Energy Co., Ltd. Wide Success Intl Enterprise Limited Zhejiang Yuhui Solar Energy Source Co., Ltd. Cathay Forest Products Corp.(TSXV:CFZ) MC Capital Asia Pacific Ltd.; STIC Investments, Inc
5.9 5.0 17.3
NA 20 100
NA 25.1 17.3
21-May
2.5
40
6.3
2-Jun
30.0
30
100
30-Jun
International Finance Corporation
Suntech Power Holdings Co. Ltd. (NYSE:STP)
50.0
NA
NA
Source: Company announcements, Capital IQ, Zero2IPO.com.cn, Quamnet.com, ChinaVenture.com.cn, Yahoo! Finance News and PRNewswire.
Selected comparable transactions
16
Accrual Accounting* And Its Effect On Fixed Assets Depreciation
Accrual, basically means adding something, or the thing that is added. In accounting & finance, the adding together of interest or different investments over a period of time, or the gathering or clustering of things. It implies a gradual accumulating action/effect. Example Accrued revenue: revenue is recognized before cash is received. Accrued revenue (or accrued assets) is an asset, such as unpaid proceeds from a delivery of goods or services, at which such income item is earned and the related revenue item is recognized, while cash for them is to be received in a later period, when its amount is deducted from accrued revenues. Accrued expense: Expense is recognized before cash is paid out. Accrued expense is a liability with an uncertain timing or amount, but where the uncertainty is not significant enough to qualify it as a provision. An example is an unpaid obligation to pay for goods or services received from a counterpart, while cash for them is to be paid out in a latter accounting period when its amount is deducted from accrued expenses. Fixed assets depreciation: Cash is paid out at the time of purchasing in one payment generally, but the cost is not expensed right away in the income statement because the equipment or factory building we bought will be used for many years. Therefore, on the income statement, only portion of the total cash payment (original value) is deducted every year (we call the deduction depreciation) and on the balance sheet, the depreciation portion is deducted from the original value every year afterwards. Effect on the cash flow statement: as the cash out flow is at the beginning of purchase, the depreciation in the later years is not cash out flow, instead, its a non-cash out flow appeared in the income statement.
Note: Accrual accounting,
17
Importance Of Cash Flow
Cash flow is more important than net profit in valuation, as it can lead to more accurate result by taking the following factors into consideration (which net profit fails to capture by definition): Working capital requirement (working capital = inventory + account receivables + other current assets payables - other current liabilities) Time (time value of money) Moreover, cash flow can, to some extent, narrow the gap due to different accounting principles adopted by various companies However, cash flow does not capture the depreciation/amortization, accrued () expense deferred () expense, etc., it cannot truthfully reflect the profitability of a company The cash flow here is still not the free cash flow we are going to discuss later
18
Time Value Of Money And The Concept Of Discounting
Money has time value: a dollar today is worth more than a dollar tomorrow. Reason: Money in hand can be invested to value generation activities, hence by the end of tomorrow, it will be more than the amount we have today. Therefore, the money we are going to receive tomorrow has to be discounted by applying a rate (such as bank lending rate, etc.) to reach its valuation of today. The process is called cash flow discounting. When value a firm, we can not simply add up all the cash flows which are forecasted to generate in the future, but discount those cash flows to be received at different future time spots to a specific date, say today, then sum up the discounted amounts.
19
Simple Example Of Discounting Cash Flow (DCF)
Assuming company A is expected to generate a stream of cash flows, 1 million, 1.1 million, 1.2 million, 1.3 million, 1.4 million in the next 5 years, by discounting using a discount rate of 15% per year, the future cash flows valuation is calculated below
The value today of cash flows forecasted to be generated in next 5 years

=
1 1.1 1.2 1.3 1.4
1 1.1 1.2 1.3 1.4 + 2 + 3 + 4 + 5 (1+15%) (1+15%) (1+15%) (1+15%) (1+15%) 0.87 3.93 + 0.83 + 0.79 + 0.74 + 0.7
= =
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
0.87
0.83
0.79
0.74 Year 4
0.70 Year 5
Year 0
Year 1
Year 2
Year 3
20
Flow Of Free Cash Flows

Cash pool
Working capital investment
The cash pool holds cash received from various sources, such as cash sales, collection of account receivables, advance from customers, borrowing from banks, issuance of equity, etc. The cash is used to pay suppliers, to make fixed assets purchasing, pay expenses and tax, etc.
Net new borrowing
Net Capex
The cash in the cash pool is different from net income. As net income contains effect of many noncash items, it has to be adjusted to get the free cash flow. Free cash flow to firm is the cash flow to both equity holder and bank, as one single entity. As the money borrowed from banks is already in the cash pool, it shall not be included in the cash flow generated for the entity. In other words, the borrowed money is like the money that is taken from your right pocket (debt holder) and put into your left pocket (equity holder). (You = the firm) Free cash flow to equity, however, is all the money that is put into your left pocket. Therefore, the net borrowing is counted, the after tax interest payment is excluded (these 2 cash flows are inter-pocket cash flows).
21
Free cash flow to firm (FCFF)
Debt holder Interest payment
Shareholder
FCFE
Net new borrowing
Definition of Free Cash Flows

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

The cash flow remains after all operation / investment deduction and freely available to shareholder and debt holder
Free cash flow to firm (FCFF)

=Net income +D&A - Change in working capital - Capex + (1-tax rate) x interest expense
Free cash flow to equity (FCFE)

=Net income +D&A - Change in working capital - Capex + net new borrowing
Or=FCFF + net new borrowing - (1-tax rate) x interest expense
22
Cost Of Equity
Cost of equity can be calculated by using Capital Assets Pricing Model (CAPM): Cost of equity = risk free interest rate + beta x (market return risk free interest rate) Definitions risk free interest rate: long term Chinese government bond yield Market return risk free interest rate, is also called market premium. Market return, in practice, we use long term stock market compounded annual return. Market premium reflect the premium investors require to compensate for the extra risks they take when investing in stock market instead of buying government bonds. Beta: the relative volatility of specific stock price changes to the overall market return (example on next slide). It changes over time due to the business nature of the company changes and investors preservation changes. Levered beta and un-levered beta: as most public companies observed in the stock market borrows money, hence their betas are levered. We need to translate those levered beta into unlevered. The formula is as follow (in which, D=debt, E=equity, T=tax rate, Pref.=preferred stock, Mino.=minority interest) Unlevered Levered beta = beta 1+ (D/E)(1-T)+(Mino+Pref.)/E Again, use comparable analysis to select the most appropriate betas for the target company IMC practice: IMC has its own required return on equity for our investments, 16%?20%?30%? But when we sell any stake in our investment, we shall use market required return on equity/investment to value our business.
23
Simple Example Of Cost Of Equity Calculation
Stock price vs. market index monthly volatility

Levered Levered Beta Beta
y = 1.1409x + 0.0417 30%
Generally Generally there there is is publication publication on on company company beta beta provided provided by by various various financial financial data data vendors, vendors, or or we we can can use use market market data to calculate. data to calculate. A A target target company, company, debt debt ratio=25%, ratio=25%, tax tax rate=25% rate=25%
20%
10%
0% -15% -10% -5% -10% 0% 5% 10% 15%
-20%
Company A Company B Company C Company D Company E Company F Average of select companies
Debt Levered Unlevered Tax rate ratio beta beta 20% 25.0% 1.24 1.08 25% 25.0% 1.40 1.18 30% 33.0% 1.19 0.99 35% 12.5% 1.70 1.30 25% 12.5% 1.35 1.11 40% 25.0% 1.64 1.26 1.12
S&P 500 change
-20%
-30%
Select Select most most appropriate appropriate comparable comparable companies companies in in similar similar business, similar debt ratio to the target company, take business, similar debt ratio to the target company, take average average of of the the comparable comparable beta. beta. Assuming Assuming risk risk free free rate rate is is 4.17%, 4.17%, market market premium premium is is 12%, 12%, cost cost of of equity equity is is (4.17%+1.12x12%)=17.5% (4.17%+1.12x12%)=17.5%
-40%
GE stock price change
24
Weighted Average Cost Of Capital (WACC)

The discount rate used to discount free cash flow to firm is WACC, or Weighted Average Cost of Capital, is calculated as =cost of equity x equity ratio + (1- tax rate) x cost of debt x debt ratio Definitions Cost of equity: expected or required rate of return of equity investments Equity: equity market value (in practice we use book value instead of market value, as the market value is what we are forecasted here and would cause iteration calculation) Equity ratio: equity value /(equity value + debt value) Debt ratio: 1- equity ratio Debt value: debt market value (in practice we use book value, as using debt market value would imply forecasting long term interest rate, adding 1 more uncertainty factor) Cost of debt: interest rate charged on the book value of the debt (there might be different rates on loans borrowed from different banks and bonds issued to different creditors) Tax rate: effective enterprise income tax rate (the interest payment is deducted before income tax at company level) Due to the fact that capital structure (debt ratio and equity ratio) changes over time, different WACC shall be applied to discount FCFF of each year. In the long term, the company might pay back most of interest bearing debt, or maintain certain level of leverage (by assumption or industrial average level).
25
Simple Example Of WACC Calculation
Capital structure and cost of capital

100 90
WACC WACC calc calc example example (on (on the the left) left)
Cost Cost of of equity equity = = 20% 20% Cost Cost of of debt debt =6% =6%
100
80 70 60 Debt
Tax Tax rate rate = = 25% 25% Equity Equity investment investment = = 40 40 Debt Debt investment investment = = 60 60 WACC WACC = = 20% 20% x x 40% 40% + + (1-5%) (1-5%) x x 6% 6% x x 60% 60% = = 10.7% 10.7%
RMB yuan
60 50 40 30 20 10 0 Capital 40
Equity
10.7
2.7 8.0 Cost of capital
26
Discounting Cash Flow Method
Methodology Methodology Use Use discount discount rates rates to to discount discount cash cash flows flows generated generated by by target target company company assuming assuming the the company company is is operating operating into into perpetuity perpetuity Generally Generally cash cash flows flows are are divided divided into into 3 3 portions: portions: Year Year 0 0 cash cash flow flow (most (most of of Capex Capex happens happens now) now) Year Year 1 1 to to the the last last year year in in the the forecasted forecasted period period Any Any cash cash flow flow after after the the last last year year in in the the forecasted period, the value of which forecasted period, the value of which is is called called terminal terminal value value Generally Generally the the forecasted forecasted period period span span 10 10 years, years, at at least to cover the mature period of the company least to cover the mature period of the company (after (after that that the the cash cash flow flow become become relatively relatively stable) stable) However, However, the the longer longer the the forecasted forecasted period, period, the the uncertainty uncertainty and and subjective subjective is is the the forecasts forecasts
Using Using different different discount discount rates rates to to discount discount different cash flows different cash flows Enterprise Enterprise value value is is calculated calculated by by discounting discounting free free cash cash flow flow to to firm firm (FCFF) (FCFF) using using weighted weighted average average cost cost of of capital capital (WACC) (WACC) as as the the discount discount rate rate Equity Equity value value is is calculated calculated by by discounting discounting free free cash cash flow flow to to equity equity (FCFE) (FCFE) using using cost cost of of equity equity as as the discount rate direct the discount rate - direct Or, Or, subtract subtract debt debt from from enterprise enterprise value value and and add add back back cash, cash, we we get get equity equity value. value. -- indirect indirect As As FCFF FCFF is is claimable claimable by by both both equity equity holder holder and and debt debt holder, holder, therefore, therefore, FCFF FCFF has has to to be be discounted discounted by by WACC. WACC. Direct Direct method method is is recommended, recommended, as as WACC WACC changes changes over over time time Forecast Forecast of of risk risk free free rate, rate, long long term term debt debt interest rates and debt ratio adding interest rates and debt ratio adding 3 3 more more uncertainty factors uncertainty factors
27
A Revisit Of Multiples, Firm/Equity Value

Firm value EBITDA multiple Gross profit multiple Revenue multiple
Company A
Company B
Sales Gross profit EBITDA Net income Earning per share Stock price Firm value
P/E Firm / Sales Firm / Gross profit Firm / EBITDA
40.0mm 14.0mm 12.0mm 8.0mm 0.4 8 100.0mm

20.0x 2.5x 7.1x 8.3x
25.0mm 12.0mm 10.0mm 6.0mm 0.6
Equity value
10 75.0mm
16.7x 3.0x 6.3x 7.5x
Price to earning multiple (P/E ratio) Book value multiple
28
Terminal Value Calculation
Terminal value: discounting cash flow method presumes the target company will continue operation into perpetuity. In our practice, our forecast period cannot extend to perpetuity. Therefore, we have to using simplified method to calculate value of cash flows generated beyond our forecasted period. The total value of cash flow generated after the forecasted period is call terminal value. Valuation of terminal value: there are 2 methods, perpetuity growth model and exiting multiple model Perpetuity growth model: assuming the cash flow grow at a fixed growth rate into perpetuity. Such a stream of cash flow can be summed up using a formula below (in which, g = perpetuity growth rate, r = discount rate)
TV = FCF x (1+g) (r - g)
Exiting multiples model: assuming the company is sold at the end of forecasting period, use multiples of EBITDA (for firm value) or net income (for equity value) to estimate the value. This approach is more market oriented, however, the defect is that it use current market valuation multiples to value the target in several years later (underlying assumption: the market valuation multiples changes little over time)
29
Simple Example Of Terminal Value Calculation Perpetuity Growth Model

Step1. FCF calculation
1.2 1.3 1.4
1.1
Step 1. calculate the cash flow of final year in the forecasted period Step 2. analyze the comparable companies, to define the range of perpetuity growth rates Step 3. apply a specific perpetuity growth rate (g) for the target company and estimate the terminal value Step 4. use the same discount rate used to discount final year cash flow (or the long term discount rate) to discount the terminal value back to time 0 Note: DCF approach is very sensitive to the terminal value result
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Step2. Assuming g=2%, r=15%, then

11.0
Step3. TV=1.4 x (1+2%)/(15%-2%)=11.0

1.3 1.4
1.1
1.2
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Step4. Discounting
5.47
0.87 0.83 0.79
0.74
0.7
The final year has to be a normal operating year, during which no big fluctuation happens and no big capex investment occurs
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
30
Simple Example Of Terminal Value Calculation Exiting Multiples Model

Step1. FCF calculation
1.2 1.3 1.4
1.1
Step 1. calculate the cash flow of final year in the forecasted period Step 2. analyze the comparable companies, to define the range of exiting multiples. Firm value multiples includes FV/EBITDA, FV/EBIT or FV/Rev; equity value multiple includes P/E, P/B ratios Step 3. apply a specific exiting multiple for the target company and estimate the terminal value Step 4. use the same discount rate used to discount final year cash flow (or the long term discount rate) to discount the terminal value back to time 0 Again, the final year has to be a normal operating year, during which no big fluctuation happens and no big capex investment occurs
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Step2. Assuming exiting multiple is 7 times, discounting rate=15%, then Step3. TV=1.4 x 7 =9.8
9.8
1.1
1.2
1.3
1.4
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
Step4. Discounting
4.87
0.87 0.83 0.79
0.74
0.7
Year 0
Year 1
Year 2
Year 3
Year 4
Year 5
31
Definitions For Key Deal Evaluation Terms

Cash on Cash Payback Number of years for undiscounted yearly Free Cash Flows to fully recover cost of capital expenditure (in the case of a project) or investment (in the case of investment in an investee company) on an ungeared basis (ie. no debt). Number of years for undiscounted yearly Free Cash Flows to fully recover equity portion of capital expenditure (in the case of project) or investment (in the case of investment in an investee company) on a geared basis (ie. with debt). Net cash after tax (based on project specific tax rates) from operation less total capital expenditure (in the case of a project); or total receipts from the investment less total amount invested (in the case of an investee company). Net cash after interest and tax (based on project specific interest and tax rates) from operation less equity portion of capital expenditure and debt repayments (in the case of a project); or total receipts from the investment less equity invested and interest & debt repayments (in the case of an investee company). Internal Rate of Return from yearly Free Cash Flows or net investment receipts on an ungeared basis. Internal Rate of Return from yearly Free Cash Flows or net investment receipts on a geared basis. Yearly Free Cash Flows (ungeared) discounted to Year 0, using discount rate of 8%, 12%, 16% plus one considered appropriate by project team. Yearly Free Cash Flows (geared) discounted to Year 0. Value of asset upon divestment, end of project, or end of projections. [Kindly state the basis (e.g. sale value, replacement value, net
book value, earnings/EBITDA multiple etc) in the assumptions. Please state the value if projections are 5 years or less]
Additional terms There are more than one way to interpret the concepts below 1. ROE: Net income during the investment period divided by equity investment at the period beginning (or the maximum amount the shareholders put into the company/project) 2. ROI: Net income during the investment period divided by the total investment at the period beginning (or the maximum amount both shareholders/bonder holders and banks put into the company/project)
Equity Payback
Free Cash Flows (ungeared)
Free Cash Flows (geared)
Project IRR
Equity IRR
Project NPV
Equity NPV Terminal Value
32
Demo Valuation - Discounting Free Cash Flows
33
Table Of Contents
Consistent Format Is Crucial

- Major format guidelines
Base case, Optimistic case, Pessimistic case Everything in one tab is recommended, for easier formula check (without getting lost switching back and forth between tabs even separate files) and print formatting. However, DCF valuation and index pages can be in separate tabs. Start with assumptions and operation ratios key assumptions and operation forecast overview Followed by forecasted income statement, balance sheet and cash flow statement Major schedules 1. Revenue schedule 2. COGS schedule 3. Expenses schedule 4. Debt schedule 5. Capex and depreciation & amortization schedule
35
Format issues - cover
36
Format issues model

unit unit Project Project name name
Page Page number number
Actual Actual
Comment Comment
Calculated Calculated Green Green if if linked linked from from other other files files
Date Date
Doc Doc name name
SBU SBU name name
37
Format issues DCF
38
Plan Ahead - Structure

Cover Cover sheet sheet
Model Model producer producer and and date date Index Index Key Key conclusion conclusion
Assumption Assumption
Working Working schedules schedules
DCF DCF outcome outcome
Major schedules schedules Major
Major Major assumptions assumptions (need (need to to go go over over with with management management or or external external consultants) consultants) Based Based on on historical historical or or industrial industrial relative relative position position of of the the target target company company
Income Income statements statements Balance Balance sheet sheet Cash Cash flow flow statements statements Revenue Revenue schedule schedule COGS COGS schedule schedule Expense Expense schedule schedule Capex Capex and and D&A D&A schedule schedule Debt Debt schedule schedule etc. etc.
WACC WACC or or cost cost of of equity equity calculation calculation Firm Firm value value and and equity equity value value calculation calculation
Major Major operating operating ratio ratio overview overview (EBITDA/EBIT/Net (EBITDA/EBIT/Net profit profit margins, margins, etc. etc. )) Investment Investment return return highlights, highlights, NPV, NPV, IRR, IRR, ROE, ROE, ROI, ROI, payback payback period, period, etc. etc. Sensitivity Sensitivity analysis analysis (put (put in in cover cover sheet) sheet) Reader Reader friendly friendly
When When assumption assumption from from different different sources sources contradict contradict against against each, each, make make reasonable reasonable adjustments adjustments
Faithfully Faithfully mimic mimic the the business business model model and and structure structure Clear, concise, logical, detailed, easy to understand Clear, concise, logical, detailed, easy to understand and and follow follow the the relationship relationship and and logic logic between between numbers numbers Flexible, Flexible, with with built built in in formula formula for for sensitivity sensitivity analysis analysis
Notes Notes
39
Constructing A Financial Model Major Steps

Draft Draft the the model model structure structure (scratch (scratch paper, paper, write write key key logic logic and and major major drivers) drivers) Start Start to to build build a a model model Make Make assumptions assumptions Forecast Forecast Operation Operation forecast forecast Capex Capex forecast forecast Working Working capital capital forecast forecast Debt Debt financing financing forecast forecast
Discount Discount rate rate calculation calculation (WACC (WACC or or Cost Cost of of equity) equity)
Balance Balance sheet sheet Cash Cash flow flow statement statement
Income Income statement statement
Discounting Discounting cash cash flow flow
Valuation Valuation
Major Major ratio ratio overview overview Major Major conclusion conclusion
40
Generating Income Statement

Revenue Revenue
Property Property sales sales Property Property rental rental
COGS COGS
Property Property COGS COGS Leasing Leasing COGS COGS
Expense Expense
Property Property devlp devlp Leasing Leasing exp. exp.
Residential Residential Office Office

Major business business Major
Land Land Raw Raw material material Fuel Fuel and and utility utility Overhead Overhead D&A D&A Others Others Others Others Others Others
Overhead Overhead Marketing Marketing Trip Trip & & entertain entertain Office Office rental rental & & equip. equip. D&A D&A Others Others Others Others Others Others
Hotel Hotel Shopping Shopping mall mall Restaurant/ Restaurant/ SPA/Theater SPA/Theater Parking lot Parking lot Others Others Others Others
EBIT EBIT
- Interest Interest -
Tax Tax Net Net Income Income
Other operation operation Other
Other Other operating operating income income
41
Generating Balance Sheet

Remember, we have forecasted income (=Revenue COGS expenses taxes) in the income statements, we can use those items and major operation assumption to drive the balance sheet forecast. Current assets and current liabilities are items that caused by operating activities, such as procurement, credit sales, short term borrowing, etc. Items are forecasted by using inventory turnover days, account receivable turnover days, account payable turnover days 1. Inventory = COGS (excl. D&A) x inventory turnover days / 365 days 2. Account receivable = Revenue x account receivable turnover days / 365 days 3. Account Payable = COGS (excl. D&A) x account payable turnover days /365 days 4. Other account receivables/payables: use different assumption according to business nature of these items, could be inter-company lending, payable to construction contractors The assumption of turnover days shall be consistent with target company historical operation data and industrial average. Due to tighten credit policy and better/worse inventory control, these assumptions might change over time. Model shall reflect the trend in our assumptions.
42
Elaboration On Depreciation & Amortization Schedule

CAPEX and Depreciation schedule
2008A Property & Equipment Property & Equipment Cost Value Factory building and land Production equipment Transportation equipment Office equipment Total Property & Equipment Cost Value Capex Factory building and land Production equipment Transportation equipment Office equipment Total Capex Accumulated depreciation 30,561,806 32,854,946 857,946 711,650 64,986,347 30,703,135 33,321,718 857,946 794,050 65,676,849 30,703,135 33,321,718 857,946 794,050 65,676,849 30,703,135 33,321,718 857,946 794,050 65,676,849 30,703,135 34,321,718 857,946 794,050 66,676,849 30,703,135 35,321,718 857,946 794,050 67,676,849 30,703,135 36,321,718 857,946 794,050 68,676,849 2009P Fiscal Year Ending December 31st 2010P 2011P 2012P 2013P 2014P
1. 1.
Divide Divide current current fixed/intangible fixed/intangible assets assets into into different different categories, categories, some belong to COGS, some belong to COGS, some some belong belong to to sales sales and and adm., adm., each each will be depreciated at different will be depreciated at different pace pace with with different different salvage salvage value. value. New New capex capex shall shall be be grouped grouped into into the the same same categories categories and and depreciated depreciated separately. separately. Some Some items items might might goes goes into into construction in progress and construction in progress and wont wont start start depreciation depreciation until until goes goes into into fixed fixed assets. assets. Besides Besides the the capex capex during during the the early early years of operation for a new years of operation for a new project, project, there there will will be be a a maintenance capex to maintenance capex to replace replace and and upgrade upgrade the the current current production production facility. facility. The The level level of of such such capex capex investment shall be subject investment shall be subject to to industrial industrial level level and and company company specific specific needs. needs. At At the the left left bottom bottom is is an an imaginary imaginary example example of of depreciation depreciation schedule schedule of of new new capex capex in in production production equipment equipment
141,329 466,772 82,400 690,501
1,000,000 1,000,000
1,000,000 1,000,000
1,000,000 1,000,000
1,000,000 1,000,000
2. 2.
Factory building and land Production equipment Transportation equipment Office equipment Total Accumulated Depreciation Ending balance Factory building and land Production equipment Transportation equipment Office equipment Total PP&E (net)
5,259,997 11,768,866 640,611 549,321 18,218,795
6,641,638 14,767,821 737,130 692,250 22,838,838
25,443,138 21,552,851 217,335 244,730 47,458,054
24,061,497 18,553,897 120,816 101,801 42,838,011
e l p m a s
8,023,279 9,404,920 17,766,775 20,765,730 833,649 726,482 857,946 741,314 27,350,186 31,769,910 22,679,856 21,298,215 15,554,942 13,555,988 24,297 67,568 52,736 38,326,663 34,906,939
Depreciation schedule of P&E - existing + new capex Factory plant - depreciated at 20 years Production equipment - depreciated at 10 years Transportation equipment - depreciated at 8 years Office equipment - depreciated at 5 years Total Depreciation
% total revenue
10,786,561 857,946 756,146
12,168,202 27,033,639 857,946 770,978 40,830,766
13,549,843 30,302,594 857,946 779,218 45,489,601
23,854,685
3. 3.
36,255,338
19,916,574 11,467,033 37,904
18,534,933 9,288,078 23,072 27,846,083
17,153,292 7,019,124 14,832 24,187,248
4. 4.
31,421,511
1,254,243 2,808,005 183,549 252,718 4,498,515
1,381,641 2,998,955 96,519 142,929 4,620,044
1,381,641 2,998,955 96,519 34,233 4,511,347
1,381,641 2,998,955 24,297 14,832 4,419,725
1,381,641 2,998,955 14,832 4,395,428
1,381,641 2,998,955 14,832 4,395,428
1,381,641 2,998,955 8,240 4,388,836
Existing P&E Depreciation Factory plant and land Production equipment Transportation equipment Office equipment
Production equipment 2009 2010 2011 2012 2013 2014 Total - New production equipment
4,498,514.81 1,254,243 2,808,005 183,549 252,718 1,375,281 2,956,945 96,519 128,097 1,375,281 2,956,945 96,519 19,401 1,375,281 2,956,945 24,297 1,375,281 2,956,945 1,375,281 2,956,945 1,375,281 2,956,945 -
42,009
42,009 -
42,009 -
42,009 90,000
42,009 90,000 90,000 222,009
42,009 90,000 90,000 90,000 312,009
5. 5.
42,009
42,009
42,009
132,009
43
Cash Flow In A Real Company

Dividend Interest
Shareholder
Financing Capital injection Net borrowing
Debt holder
Company fund
tax Payment Collection
Account payable
Account receivable
Cash sales
Government
Operation Investment
Production
Inventory
Depreciation Investment
Fixed assets
44
Generate Cash Flow Statement Indirect Method

Method Method Based on the accounting principle, cash flow statement can be generated by using last year & current year balance sheet, and income statement Step 1. Start from net income from income statement Step 2. Add back depreciation and amortization, and other non-cash cost items (such as bad accounts provision, capitalized expenses, etc.) Step 3. Deduct increase in current assets (excl. cash), add increase in current liabilities. The 2 actions in net, deduct the working capital investment Step 4. Deduct capex Step 5. Add net funds from equity/bonds raise and net new bank borrowing Step 6. Add year BGN cash to get year END cash balance.
e l p m a s
45
General Modeling Methods And Skills Linking Everything Together

Income statement
Starting from income statements, net income = Revenue COGS expenses - taxes 1. Interest income = saving rate x average of cash balance of year BGN and END 2. Interest expense 2 items 1) Interest expense of loan = interest rate x loan balance at year BGN; 2) Interest expense of necessary to finance = interest rate x average of necessary to finance at year BGN and END 3. necessary to finance a transition item used to balance the balance sheet, basically is of shortterm financing in nature and shall be zero after the balance sheet is balanced 4. Necessary to finance (its included in current liability in the B/S, not included in C/F, but as a calculation outcome of C/F), defined as shortage (if any) of cash balance compared with minimum cash requirements.
46
Linking Everything Together (Cont)

Balance sheet & cash flow statement forecasts and Iteration
Secondly, use the forecasted ratio and various schedules to complete the balance sheet, with cash balance to be linked with cash flow statements The link causes circular calculation Solution: under Excel spreadsheet tool bar, choose Tools tick Iteration enter 100 (shall be enough) Options Calculation tab
Finally, cash flow statement (slightly different from what you commonly see). Start from net income, adjusted for non-cash gain/loss, such as D&A, gain/loss on assets, etc. Adjust for working capital changes, such as AR, inventory, AP, tax payable, etc. Adjust for financing cash flows (borrowings & pay back, and equity injection) and investment cash flows (Capex) Arrives at cash balance at year end (or year beginning of next year), which will be linked to B/S
47
Table Of Contents
New Format for Executive Summary (Investment Proposal)

Example UTLC/UTWC Warehouse Reconstruction
1. EXECUTIVE SUMMARY
Deal Evaluation:
Scenario
Worst Case
Lost all customers from fire accident w/o replacement 30%
Base Case
Retain major customers Sojitz & Polyplastics 50%
Best Case
Retain major customers with partial replacement of lost customers 20%
Project:
UTLC/UTWC warehouse reconstruction at Bangna Km23
GIC Decision Sought:
Approval for IMC to invest $1.7m* being its 59% pro-rata portion to rebuild UTLC/UTW C warehouse at Bangna Km23 [at a total cost of $2.9m] * Fully funded from insurance claim proceeds from Wellgrow warehouse fire
Probability Op Cash Flow (US$000) Year 1 Year 2 Year 3 Year 4 Year 5 Cash-on-cash Payback Equity Payback Project IRR Equity IRR Project NPV 10.5% Teams Discount Rate 8% DR 12% DR 16% DR
Rationale:
To replace lost capacity from fire accident on Warehouse 1 at Wellgro in May 2008 To maximize insurance claim amount ($3.7m vs. $1.4m if no rebuild). Construction needs to be started within 1 year of fire accident
To re-build at Km23 instead of Wellgrow in order to consolidate operation in one location, leverage on Km23s more strategic location and potentially release value from future sales of Wellgrow assets
Deal Size: Exchange Rate: Shareholding:
$2.9m CAPEX
Bht35 to US$1
e d i l s c le o d p C am I G s
Forecast Forecast period period is is long long enough enough until until stable stable years years Firm Firm value, value, need need comparable comparable analysis analysis to to justify justify 5 5 times times of of EBITDA EBITDA
$xxx $xxx $xxx $xxx $xxx 8.8 yrs x.x yrs 11.1% xx.x%
$293 $394 $413 $423 $432 7.7 yrs x.x yrs 13.4% xx.x%
$xxx $xxx $xxx $xxx $xxx 6.9 yrs x.x yrs 15.5% xx.x%
$0.15m
$0.67m
$1.19m
IMC/Unithai 58.6%
$x.xxm $x.xxm $x.xxm $x.xxm
Proposed IMC Investment Amount:
No additional funding from IMC required (to be fully funded from insurance proceeds) IMC/Unithai CAPEX portion $1.7m
Equity NPV Key Assumptions Revenue
Usage of Capital:
Warehouse $2.57m Rack $0.14m Machine and Equipment $0.09m Engineering Supervision $0.13m Total $2.93 m (Foundation already completed at Km23) Approval from the insurers, IAG and QBE to rebuild at Bangna Km23 instead of at Wellgrow
-15% vs. Base
Base
+15% vs. Base
Common assumptions across all 3 cases: Forecast Period: 15 years (starting from 1 Jan 2010) Terminal Value: 5 x EBITDA Revenue growth: 5% p.a. (2010-12) and 3% p.a. (>2012) Direct operating cost 30% of Rev, Operating overhead 20% of Rev, no increase in SG&A at Km23
Conditions Precedent:
Target Closing Date:
Construction complete by November 2009
Forecast Forecast assumptions assumptions need need justification justification

49
Sample Deal Evaluation Financial Modeling

(inUS$millions)
DealEvaluationbasedonUngearedCashFlow Year EBITDA Tax(basedonprojecttaxrate) ChangeinWorkingCapital CashFlowfromOperations Capex TerminalValue CashFlowfromInvestment FreeCashFlow(ungeared) CashoncashPayback ProjectIRR(ungeared) ProjectNPV 0 1 2 3 4 5 30 30 30 30 30 (1.4) (1.4) (1.4) (1.4) (1.4) 0 28.6 28.6 28.6 28.6 28.6 20 20 29 49
(100) (100)
(100) 29 29 29 3.5 years Team's Discount 17.3% Rate DiscountRate 10% 12% 16% 8% $27.8 $20.8 $14.4 $3.2
C I G
m a s c o d
e l p
DealEvaluationbasedonGearedCashFlow Year EBITDA Interest(basedonprojectfinancingrate) Tax(basedonprojecttaxrate) ChangeinWorkingCapital CashFlowfromOperations Capex TerminalValue CashFlowfromInvestment BankLoans PrincipalRepayment CashFlowfromFinancing RemainingBackLoan FreeCashFlow(geared) EquityPayback EquityIRR(geared) EquityNPV
0 (100)
1 30 (1.3) (1.3) 27.5
2 30 (1.0) (1.3) 27.7
3 30 (0.8) (1.3) 27.9
4 30 (0.5) (1.3) 28.1
5 30 (0.3) (1.4) 28.4
KeyAssumptions ProjectInterestRate ProjectDebtRatio ProjectIncomeTaxRate
2.5% 50% 10%
(100) 50
20 20
Generally Generally not not the the same, unless no same, unless no liabilities liabilities
(9.5) (9.8) (10.0) (10.2) (10.5) 50 (9.5) (9.8) (10.0) (10.2) (10.5) 50 40.5 30.7 20.7 10.5 (0.0) (50) 2.8 years 29.1% $17.0 m 18 18 18 18 38
50
Investment Paper Supports Assumptions Used In The Model

Aim: To identify the driver & risks of business, and quantify analysis to help management to make decision
1. Macro Environment

GIC IP Industrial profile
1.Macro Environment 2.Industry Market Environment 3.Product Market
Analyze the macro economy (most probably need to cover global economy and trade policies/trend) to identify variables that affect an industrys sales How do these variables affect the sales? by how much? Quantify it (for example, household disposable income vs. residential real estate investment) What is the expectation of future change of these variables?
2.
Industry Market Environment

Demand forecast (major downstream and end customer demand analysis and forecast, quantity growth assumption in the model shall be based on this forecast) Supply forecast (major upstream industry analysis. Capacity adding forecast. If oversupplied, price will go down/at least not go up in our financial model assumption, vice versa) Competition (Major competitors, their strategy and business model, market shares, industrial profitability. If the market structure is stable, if the model assumes to grab share from them/grow faster than them, sales expense could be higher than their/industrial average level)
3.
Products Market
Customer analysis (who are they type of customers, what is their purchasing behavior-what do they seek, price sensitivity, brand loyalty/cost of switch supplier, etc. Our model might be structured to forecast the sales to different customer segment) Demand and supply analysis for each product category, future trend, what is our advantage and disadvantage (to compromise our disadvantage, probably mean higher capex for better equipment to offer additional features on our product, or higher COGS due to different raw materials, or higher marketing expense, or higher R&D expense, or higher labor cost to maintain better quality of product or customer service . All these shall be reflected in our assumptions in the financial model) Substitutes (any threaten from or market share loss caused by substitute products? Any related policy issue? This will affect our long term revenue growth assumption if substitute product would not cause major threats in the short run)
51
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How to build a financial model

The Use Of Financial Models

Operation Operation Management Management

Financial Modeling Workshop Dec, 2009

Relationship Between Financial Model And Strategy

Financial Modeling Workshop Dec, 2009

Detailed Terrain Analysis Leads To Effective Strategic Planning

Indentify Indentify Potential Potential Opportunities Opportunities 4a.

Drivers Of Future Market Evolution

Construct Assessment Criteria

Overall Chemical Strategic Options Development

Financial Modeling Workshop Dec, 2009

Terrain Analysis Helps To Locate The Relative Position Of Ourselves

Strategic advantage Strategic goal Industrial

Segment Low cost Differentiation

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

Financial Modeling Workshop Dec, 2009

Financial Modeling Workshop Dec, 2009

Relationship Of Enterprise Value And Equity Value

From equity value to enterprise value

Financial Modeling Workshop Dec, 2009

Comparison Of Major Valuation Methods

Pros and Cons

Transaction comparable method

Discounted cash flow method

Financial Modeling Workshop Dec, 2009

Difference Between Equity Value And Enterprise Value

Financial Modeling Workshop Dec, 2009

Using Different Valuation Methods During The Life Span Of A Company

Trading Comparable Method

Financial Modeling Workshop Dec, 2009

Trading Comparable Analysis

Simple Example Of Trading Comparable Analysis

Closest Closest comparable comparable

Net income 248 4,160 92 820 -2 -414 820 6,231 1,624

821 27,655 1,327 6,484 62 1,052 6,484 55,683 7,359

675 12,042 778 2,569 135 2,023 2,569 31,832 4,315

Transaction Comparable Method

Financial Modeling Workshop Dec, 2009

Simple Example Of Transaction Comparable Application

27-Apr 12-May 20-May

5.9 5.0 17.3

International Finance Corporation

Suntech Power Holdings Co. Ltd. (NYSE:STP)

Selected comparable transactions

Financial Modeling Workshop Dec, 2009

Accrual Accounting* And Its Effect On Fixed Assets Depreciation

Importance Of Cash Flow

Financial Modeling Workshop Dec, 2009

Time Value Of Money And The Concept Of Discounting

Financial Modeling Workshop Dec, 2009

Simple Example Of Discounting Cash Flow (DCF)

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

Financial Modeling Workshop Dec, 2009

Flow Of Free Cash Flows

Working capital investment

Free cash flow to firm (FCFF)

Debt holder Interest payment

Net new borrowing

Financial Modeling Workshop Dec, 2009

Definition of Free Cash Flows

Free cash flow to firm