Using Financial Statement Models for Valuation

MGT 4850

Spring 2008

University of Lethbridge

Corporate Valuation

• Building Pro forma model

• Calculating the relevant free cash flows

• Calculating the cost of capital for the free cash flows

• Determining the terminal value of the firm

• Properly discounting the free cash flows

• Sensitivity analysis

Farmers Bagels Inc.

• Balance sheets and Income Statements for 1995 and 1996 (p.90)

• Ratio analysis (p. 91)

• Sales predictions (2001)→ terminal value

Model Assumptions

• Drop the distinction between product sales and other income

• Cost of goods sold -40%

• Selling, general and administrative expenses (-1%/y)

• Income tax rate 41.5%

• Cash cushion-declining proportion of sales

• Accounts receivable – 22% of sales

Model Assumptions II

• Inventory 5% of sales• Property and equipment at cost 70% in ‘96 to

40% in 2001.• Straight line deprec. at 10% of prop. Cost• Accounts payable and accrued expenses +1%/y

till 20%• Income tax payable 25%• Other curr. liabilities 1% of sales• No dividends, no new equity (debt is the plug).

MODEL

INCOME STATEMENT

Balance Sheet

Negative Debt

• If total value of minimum cash balance plus all other assets is greater than current liabilities the company needs debt.

• [Cash ratio]*Sales+Acc. Rec. + Inventory + Prepaid exp. + Net property and equipm. – Curr. Liab. – Com. Stock – Ret. Earn. < 0

then debt is set at 0

p.94 pro forma model

Deriving the FCF (p.90)

• Positive profit, negative cashflows

Projected FCF

• 1999 first positive cash flow (p.97)

Proposition one

Agency costs

As

WACC

• WACC= E/(E+D)*re + D/(E+D)* rD(1-Tc )

• CAPM based averages for the industry

Industry Average WACC 20.43% and terminal value

Sensitivity Analysis

• Value as a function of WACC (row) and terminal growth rate (column)

Sensitivity Analysis

• Share price is calculated as a unction of two variables

Terminal Value Proxies