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8/8/2019 Financial modelling final
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Financial Modeling:
PRESENTED BY
SMITA GUPTA
RAJVI SINGHI
SNEHA RAJARAM
SMRITI JAIN
SHUBHAM AGARWAL
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Introduction
Financial modeling is the task of building an abstractrepresentation (a model) of a financial decision makingsituation.
[1] This is a mathematical model designed to represent (asimplified version of) the performance of a financialasset or a portfolio, of a business, a project, or anyother investment
[2] financial modeling is synonymous with cash flowforecasting.
[3] This usually involves the preparation of large, detailedmodels, which are used for management decisionmaking
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Contd.
Application Include:
Business valuation, especiallydiscounted cash flow, but includingother valuation problems
Capital budgeting
Cost of capital or WACC
Financial statement analysisProject finance
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Process Of Financial Modeling
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Steps in Financial Modeling
Feasibility Study
Model construction
Compatibility of the model with the tools used Model validation
Model implementation
Model review and update
Documentation
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Validating Financial Models
Create a Framework for Ensuring theDevelopment of Valid Financial Models
Decompose Financial Model Validity into Selected
Components in Order to Facilitate Better ModelDevelopment
Consider How You Can Build More Valid Models
Apply Spreadsheet Auditor Software Capability to
Your Existing Model Explore How Colleagues in Other Organizations
Validate Their Financial Models
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Financial decisions - Leverage
Break Even Analysis :
Break even sales is also referred to as a point where total revenue and
total cost coincides & after this point profit starts occurring.
Variable costs are expected to change at the same rate as the firms
level of sales.
VC are constant per unit, so as more units are sold the total variable
cost also rises. E.g.: Sales commission, costs of raw materials etc
Fixed costs are those costs that are constant regardless of the quantity
produced, over some relevant change of production.
Total FC per unit will decline as the no. of units increases. E.g.: rent,
salaries etc
Mathematically,
BEP = Fixed Costs
Sales- Variable costs
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Limitations ofBreak even Analysis:
Costs Segregation
Assumption with regard to consistency in Fixed costs
Assumption with regards to consistency in Revenue and Variablecosts.
Assumptions with regard to a multi- product firm
Financial Break even point
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Types of Leverage
Operating Leverage:
Operating leverage refers to the use of fixed cost in the operation
of a firm and it increases or decreases the firms operating profit
(EBIT) with the change in sales.
Mathematically, it can be given as;
DOL = % change in Operating Profit
% change in sales
OR
DOL = Contribution
EBIT
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Financial Leverage:
The use of fixed charges such as debt and preference capital along
with the owners equity in the capital structure, is described as
financial leverage. The financial leverage employed by the company is intended to
earn more on the fixed charges funds than their costs.
It can be defined as a measure to gauge the changes in EPS
because of the change in EBIT due to fixed financial interest charge.
A company can raise funds from various sources which can becategorized as:
Those sources which involve fixed interest charge
Those sources which do not involve fixed interest charge
Mathematically, its given as;
DFL = % change in EPS
% change in EBIT
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Combined Leverage:
The degrees of operating and financial leverages can be combined
to calculate the effect of total leverage on EPS associated with a
given change in sales. The degree of combined leverage (DCL) is given by the following
equation:
DCL = % change in EPS
% change in sales
Illustration:A company known as Vikas Limited planned to invest 8 lakhs. It
expected a sales of 20 lakhs. The selling price p.u. of a product was
Rs. 10 and the variable cost p.u. was Rs. 5. The fixed cost of the
company for the year is expected to be around 5 lakhs. The
companys D/E ratio is 40:60. The interest on debt is at 10%. Themanagement of the company wants to know the resultant affect of
25% increase in sales on the EPS of the company. Each share of the
company has a face value of Rs. 100. Tax rate is 35%
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Base Increase of 25% in sales
Total capital employed 800000 800000
Ratio of debt in capital structure 40% 40%
Debt 320000 320000
Equity 480000 480000Sales in unit 200000 250000
Selling price per unit 10 10
Variable cost per unit 5 5
Revenue 2000000 2500000
Variable cost 1000000 1250000
Fixed cost 500000 500001
EBIT 500000 749999Interest on debenture 32000 32000
EBT 468000 717999
Tax 163800 251299.65
Earning after taxes/PAT 304200 466699.35
No. of shareholder 4800 4800
EPS 63.375 97.22903125
% change is sales 0.25% change in EBIT 0.499998
% change in EPS 0.534185897
Degree of FL 1.068376068
Degree of OL 1.999992
Combined leverage 2.13674359
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Leverage and Risks:
Leverage magnifies the EPS and also tends to increase its variability
which leads to two types of risks:
1. Operating Risks:
a) Defined as variability of EBIT which results from changes in the
environment which are beyond ones control
b) A firm with high fixed costs will be largely affected than the
firm which has less fixed costs and high variable costs
c) It is an unavoidable risks
2. Financial Risks:
a) The variability of EPS because of the use of financial leverage is
called financial risks
b) It is an avoidable risks - by not employing any debt or external
finance in the companys capital structure
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Financing Decisions
Capital Structure
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Flow Of Discussion
Meaning OfCapital Structure
EBIT-EPS Analysis Significance of Leveraging
Calculation Of Indifference point
Capital Structure Theories
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Capital Structure
Relates to a firms decision to divide its cash flows into two
broad components:
-Debt
-Equity
Influences Shareholders Return and Risk
Helps management in deciding the optimum financing mix
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EBIT-EPS Analysis (Using Excel)
Using Financial Leverage Increases the EPS when the
Economic Conditions are very good.
Also using high debt percentage when the economicconditions are very poor erodes shareholders wealth each
year. (E.g. Plan 4 with 75% debt)
Option of No Debt is the best if not sure of future economicconditions
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Indifference Points
A point where EPS of two Financing Plans remains the same
despite differences in their capital structure composition
The Formula to find the Break even level of EBIT (withdifferent compositions):
(1-T)EBIT = (1-T)(EBIT-Interest)No of shares (N1) No of Shares in plan 2
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Capital Structure Theories
Net Income Approach
Net Operating Income Approach
Modigliani-Miller Approach
Traditional Approach
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Working capital Management
To run day-to-day business activities
Determinants
1. Nature of business2. Production cycle
3. Business fluctuation
4. Credit availability
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Case Study on Cash Budgeting
Cash budgting.xls
CASE STUDY FM.docx
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Cash Management Strategies
Decrease cash conversion cycle
Stretching accounts Payable
High Inventory turnover
Decentralize Collection system
Lock box system