This tutorial explains all the steps of the McKinsey valuation model, also referred toas the discounted cash ﬂow model and described in Tom Copeland, Tim Koller, and JackMurrin:
Valuation: Measuring and Managing the Value of Companies
(Wiley, New York;1st ed. 1990, 2nd ed. 1994, 3rd ed. 2000). The purpose is to enable the reader to set up acomplete valuation model of his/her own, at least for a company with a simple structure(e. g., a company that does not consist of several business units and is not involved inextensive foreign operations). The discussion proceeds by means of an extended valuationexample. The company that is subject to the valuation exercise is the McKay company.The McKay example in this tutorial is somewhat similar to the Preston example (con-cerning a trucking company) in Copeland et al. 1990, Copeland et al. 1994. However,certain simpliﬁcations have been made, for easier understanding of the model. In par-ticular, the capital structure of McKay is composed only of equity and debt (i. e., noconvertible bonds, etc.). The purpose of the McKay example is merely to present allessential aspects of the McKinsey model as simply as possible. Some of the historicalincome statement and balance sheet data have been taken from the Preston example.However, the forecasted income statements and balance sheets are totally diﬀerent fromPreston’s. All monetary units are unspeciﬁed in this tutorial (in the Preston example inCopeland et al. 1990, Copeland et al. 1994, they are millions of US dollars).This tutorial is intended as a guided tour through one particular implementation of the McKinsey model and should therefore be viewed only as exemplifying: This is one wayto set up a valuation model. Some modelling choices that have been made will be pointedout later on. However, it should be noted right away that the speciﬁcation given belowof net Property, Plant, and Equipment (PPE) as driven by revenues is actually takenfrom Copeland et al. 2000. The previous editions of this book contain two alternativemodel speciﬁcations relating to investment in PPE (cf. Section 15 below; cf. also Levinand Olsson 1995).In one respect, this tutorial is an extension of Copeland et al. 2000: It contains a moredetailed discussion of capital expenditures, i. e., the mechanism whereby cash is absorbedby investments in PPE. This mechanism centers on two particular forecast assumptions,[this year’s net PPE/revenues] and [depreciation/last year’s net PPE].
It is explainedbelow how those assumptions can be speciﬁed at least somewhat consistently. On arelated note, the treatment of deferred income taxes is somewhat diﬀerent, and also moredetailed, compared to Copeland et al. 2000. In particular, deferred income taxes arerelated to a forecast ratio [timing diﬀerences/this year’s net PPE], and it is suggestedhow to set that ratio.
Square brackets are used to indicate speciﬁc ratios that appear in tables in the spreadsheet ﬁle.
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