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CFA Challenge Seminar Worksheet Fundamental Analysis

I am with group ________ today. The group members are: 1) _______________________________ 2) _______________________________ 3) _______________________________ 4) _______________________________ 5) _______________________________ 6) _______________________________

Learning Objective
This series of activities brings the group through building a pro forma for a company based on different assumptions.

The Discovery Methodology


Students are to sit in their groups and attempt each program together. Students are free to discuss among themselves during the activity. Students may choose to have a single person programming while the rest watch and contribute ideas, or have at most 2 persons programming and then compare their approaches. Please ensure that everyone in the group understand the solution of their group before proceeding to the next program. At regular time intervals, groups will be elected to share their solution with the rest of the class. Why the discovery methodology: the discovery methodology enhances understanding and provides the student with concurrent hands-on practice. It also builds team work which gives a more involved and enjoyable learning experience.

Pre Activity Setup


For this exercise, you shall need to activate your iteration. Here is how you can set it up if it is not already done. Click on the main button of the Excel and click on the "Excel Options" button.

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CFA Institute Research Challenge Seminar

Go to the "Formulas" section and ensure that the checkbox for "Enable iterative calculations" is checked. Also ensure that "Workbook Calculation" is set to "Automatic". *Note: you can also set to "Manual" instead of "Automatic", but you will need to press F9 every time for the worksheet to recompute all the cells after you have input new numbers/formulas into the worksheet.

Activity 0: Circular Reference in Excel


Suppose we would like to solve:

y x 2 7 x y0 3

We rewrite into:

y x 7 2 x y 3

Let x be cell A1 and y be cell A2. Program the respective formulas into the cells. That is, "=7-A2/2" in cell A1 and "=A1/3" in cell A2. Do you get the answer: A1 = 6 and A2 = 2?

A 1 2

B 6 <-- 7-A2/2 2 <-- A1/3

This is called circular reference in Excel. Cell A1 refers to Cell A2 in its formula and Cell A2 refers to Cell A1 in its formula. What happens next is a series of iterations: 1) first the value of cell A2 is used to compute the value of cell A1 as we type the formula into cell A1. 2) second, the value of cell A1 is used to compute the value of cell A2 as we type the formula into cell A2. 3) third, the value of cell A1 is recomputed if value of cell A2 is changed. 4) fourth, the value of cell A2 is recomputed if value of cell A1 is changed.

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CFA Institute Research Challenge Seminar 5) the process goes on until a) the value of cell A1 and cell A2 do not change any more, or b) the maximum number of iterations specified in the Excel Options|Formulas|Maximum Iterations is reached. In this case, case (a) occurs. We say that there is a convergence. Cells A1 and A2 yield the solution to the simultaneous equation. If case (b) occurs, we say that there is no convergence. There will still be values in cells A1 and A2, but at least one of the value will formula its formula. That is, either cell A1 or cell A2 will have the "wrong answer"! Now try: Suppose we would like to solve: We rewrite into:

y 2 x 1 x y 3

x y 2 1 y 3 x

Let x by cell A1 and y be cell A2. Program the respective formulas into the cells. Do you get the answer: A1 = 5 and A2 = -2? Finally try: Suppose we would like to solve: We rewrite into:

x y 1 x y 0

x 1 y y x

Let x by cell A1 and y be cell A2. Program the respective formulas into the cells. What answer do you get? Is this the correct answer? Explain how this answer comes about.

Activity 1: Cash as Plug


Given: Sales growth, Gross margin, SAC/Sales, Receivables Turnover, Inventory Turnover, Current liabilities/Sales, Fixed Asset Turnover, Depreciation rate, Interest rate on debt, Interest paid on cash and marketable securities, Tax rate, and Dividend payout ratio. Use cash as the plug. Find:

The pro forma for the next 5 years.

Implementation 1: the base model


Suppose given: Sales growth Gross margin SAC/Sales Receivables Turnover Inventory Turnover Current liabilities/Sales Fixed Asset Turnover 10% 30% 9% 10 6 8% 1.3 Page 3 of 14

CFA Institute Research Challenge Seminar Depreciation rate 10% Interest rate on debt 10.00% Interest paid on cash and marketable securities 8.00% Tax rate 40% Dividend payout ratio 40% Output: The pro forma for the next 5 years. Refer to the CashPlug worksheet in CFASeminar.xls. Steps: 1) Use the following formulas to find the pro forma in year 1: Sales = prev Sales * (1+Sales growth) Gross profit = Gross margin * Sales COGS = -(Sales Gross profit) Staff and admin cost = - SAC/Sales * Sales EBITDA = Gross profit + Staff and admin cost Depr = -Depr rate * (prev FA at cost + FA at cost)/2 EBIT = EBITDA + Depr Int (debt) = -debt rate * (prev debt + debt)/2 Int (cash) = cash rate * (prev cash + cash)/2 EBT = EBIT + int(debt) + int(cash) Tax = -tax rate * EBT NI = EBT + tax Div = -Payout ratio * NI RE = NI + Div

A 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47
Year Income statement

B
0

Sales 1,000 Costs of goods sold (700) Gross profit 300 Staff and admin cost (90) EBITDA 210 Depreciation (100) EBIT 110 Interest payments on debt (39) Interest earned on cash and marketable securities 6 EBT 78 Taxes (31) Net Income 47 Dividends (19) Retained earnings 28
Balance sheet Cash and marketable securities Receivables Inventory

Receivables = Sales / Receivables Turnover Inventory = -COGS / Inventory Turnover Total assets CA = Cash + Receivables + Inventory Cumu Depr = prev cumu Depr + Depr Current liabilities Net FA = Sales / Fixed Asset Turnover FA at cost = Net FA Cumu Depr Debt Total Assets = CA + Net FA Stock CL = CL/Sales * Sales Accumulated retained earnings Debt and Stock remain constant Total liabilities and equity Accum RE = prev Accum RE + RE TLE = CL + Debt + Stock + Accum RE **Cash = TLE Receivables Inventory Net FA Note that there is circular referencing in the formulas. Can you find the 2 set of circular referencing? If we do not want circular referencing (to avoid wrong answer or slowing down/crashing of excel) what are 2 methods we can use? 2) Make sure any reference to the given parameters are fixed to the respective cells using $, e.g. $B$2. Drag the column for year 1 and extend to year 5. You should obtain the following answers.

Current assets Fixed assets At cost Cummulative Depreciation Net fixed assets

80 100 117 297 1,069 (300) 769 1,066 80 386 450 150 1,066

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CFA Institute Research Challenge Seminar


A 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47
Year Income statement

B
0

C
1

D
2

E
3

F
4

G
5

Sales 1,000 1,100 1,210 1,331 Costs of goods sold (700) (770) (847) (932) Gross profit 300 330 363 399 Staff and admin cost (90) (99) (109) (120) EBITDA 210 231 254 280 Depreciation (100) (117) (137) (161) EBIT 110 114 117 118 Interest payments on debt (39) (39) (39) (39) Interest earned on cash and marketable securities 6 4 (1) (8) EBT 78 80 77 72 Taxes (31) (32) (31) (29) Net Income 47 48 46 43 Dividends (19) (19) (18) (17) Retained earnings 28 29 28 26
Balance sheet Cash and marketable securities Receivables Inventory

1,464 (1,025) 439 (132) 307 (188) 119 (39) (15) 66 (26) 39 (16) 24

1,611 (1,127) 483 (145) 338 (220) 119 (39) (23) 57 (23) 34 (14) 20

<-- =F17*(1+$B$2) <-- =G19-G17 <-- =G17*$B$3 <-- =-G17*$B$4 <-- =G19+G20 <-- =-$B$9*(G38+F38)/2 <-- =G21+G22 <-- =-$B$10*(F44+G44)/2 <-- =$B$11*(F33+G33)/2 <-- =G23+G24+G25 <-- =-G26*$B$12 <-- =G27+G26 <-- =-$B$13*G28 <-- =G29+G28

Current assets Fixed assets At cost Cummulative Depreciation Net fixed assets
Total assets

80 100 117 297

18 110 128 256

(54) 121 141 208

(138) 133 155 151

(235) 146 171 83 2,030 (904) 1,126 1,209 117 386 450 256 1,209

(347) 161 188 2 2,362 (1,123) 1,239 1,241 129 386 450 276 1,241

<-- =G47-G40-G34-G35 <-- =G17/$B$5 <-- =-G18/$B$6 <-- =G33+G34+G35 <-- =G40-G39 <-- =F39+G22 <-- =G17/$B$8 <-- =G40+G36 <-- =G17*$B$7 <-- =F44 <-- =F45 <-- =F46+G30 <-- =SUM(G43:G46)

1,069 1,263 1,485 1,739 (300) (417) (554) (715) 769 846 931 1,024 1,066 1,103 1,139 1,175 80 386 450 150 1,066 88 386 450 179 1,103 97 386 450 206 1,139 106 386 450 232 1,175

Current liabilities Debt Stock Accumulated retained earnings


Total liabilities and equity

Further Explore: Note that the cash turned negative in the 5th year. Does it help if the sales growth rate is higher? Try for the case that sales growth rate = 20% and 50%, What about the case that sales growth rate = 3%? Why do you think that the cash balance turns negative for the high sales growth rate?

Activity 2: Cash and Debt as Plug


Given: Sales growth, Gross margin, SAC/Sales, Receivables Turnover, Inventory Turnover, Current liabilities/Sales, Fixed Asset Turnover, Depreciation rate, Interest rate on debt, Interest paid on cash and marketable securities, Tax rate, and Dividend payout ratio. Use cash and debt as the plug. Find:

The pro forma for the next 5 years.

Implementation 1: the base model


Refer to the DebtPlug worksheet in CFASeminar.xls. Page 5 of 14

CFA Institute Research Challenge Seminar Now suppose given: The same parameters as in Activity 1. Require that the cash balance be at least $10 per year. Output: The pro forma for the next 5 years. Steps: 1) Change the formula for debt to become: Debt = MAX(Receivables+Inventory+Cash buffer+Net FA-CL-Stock-Accumu RE, prev Debt) where cash buffer is given in cell B14. Find the pro forma for year 1. 2) Drag the column for year 1 and extend to year 5. You should obtain the following answers. 3) Compute the debt ratio for year 0 to year 5. Hint: Debt ratio = (Current liabilities + debt) / Total liabilities and equity.
A 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 33 34 35 36 37 38 39 40 41 42 44 45 46 47 48 49 50 51
Year Income statement

B
0

C
1

D
2

E
3

F
4

G
5

Sales 1,000 1,100 1,210 1,331 Costs of goods sold (700) (770) (847) (932) Gross profit 300 330 363 399 Staff and admin cost (90) (99) (109) (120) EBITDA 210 231 254 280 Depreciation (100) (117) (137) (161) EBIT 110 114 117 118 Interest payments on debt (39) (39) (42) (49) Interest earned on cash and marketable securities 6 4 1 1 EBT 78 80 76 70 Taxes (31) (32) (30) (28) Net Income 47 48 46 42 Dividends (19) (19) (18) (17) Retained earnings 28 29 27 25
Balance sheet Cash and marketable securities Receivables Inventory

1,464 (1,025) 439 (132) 307 (188) 119 (58) 1 61 (25) 37 (15) 22 10 146 171 327 2,030 (904) 1,126 1,453 117 633 450 253 1,453

1,611 (1,127) 483 (145) 338 (220) 119 (69) 1 50 (20) 30 (12) 18 10 161 188 359 2,362 (1,123) 1,239 1,598 129 747 450 272 1,598

<-- =F18*(1+$B$2) <-- =G20-G18 <-- =G18*$B$3 <-- =-G18*$B$4 <-- =G20+G21 <-- =-$B$9*(G39+F39)/2 <-- =G22+G23 <-- =-$B$10*(F45+G45)/2 <-- =$B$11*(F34+G34)/2 <-- =G24+G25+G26 <-- =-G27*$B$12 <-- =G28+G27 <-- =-$B$13*G29 <-- =G30+G29 <-- =G48-G41-G35-G36 <-- =G18/$B$5 <-- =-G19/$B$6 <-- =G34+G35+G36 <-- =G41-G40 <-- =F40+G23 <-- =G18/$B$8 <-- =G41+G37 <-- =G18*$B$7 <-- =MAX(G35+G36+$B$14+G41-G44-G46-G47,F45) <-- =F46 <-- =F47+G31 <-- =SUM(G44:G47)

Current assets Fixed assets At cost Cummulative Depreciation Net fixed assets
Total assets

80 100 117 297

18 110 128 256

10 121 141 272

10 133 155 298 1,739 (715) 1,024 1,322 106 535 450 231 1,322

Current liabilities Debt Stock Accumulated retained earnings


Total liabilities and equity

1,069 1,263 1,485 (300) (417) (554) 769 846 931 1,066 1,103 1,203 80 88 97 386 386 450 450 450 450 150 179 206 1,066 1,103 1,203

Debt Ratio

43.71% 42.98% 45.46% 48.48% 51.61% 54.84% <-- =(B45+B44)/B48

Discuss: Explain the formula for the debt. Why does it work? What trend do you see for the debt ratio? Why do you think this happened?

Activity 3: Cash, Debt and Stock as Plug with constant Debt Ratio
Given: Sales growth, Gross margin, SAC/Sales, Receivables Turnover, Inventory Turnover, Current liabilities/Sales, Fixed Asset Turnover, Depreciation rate, Interest rate on debt, Interest paid on cash and marketable securities, Tax rate, and Dividend payout ratio. Use cash, debt, and stock as the plug with constant debt ratio. Page 6 of 14

CFA Institute Research Challenge Seminar Find:

The pro forma for the next 5 years.

Implementation 1: the base model


Refer to the ConstantDebtR worksheet in CFASeminar.xls. Now suppose given: The same parameters as in Activity 2. Require that the cash balance be at least $10 per year, and the debt ratio be constant at 43.71% Output: The pro forma for the next 5 years. Steps: 1) Leave the cash and debt formulas as in activity 2. Change the formula for stock to become: Stock = (1-Debt Ratio) * Total Assets Accum RE where debt ratio is given in cell B15. Find the pro forma for year 1. 2) Drag the column for year 1 and extend to year 5. You should obtain the following answers. 3) Compute the debt ratio and current ratio for year 0 to year 5. Note: the cell for Depreciation rate and Fixed Assets Turnover have changed. Make sure your formulas refer to the correct cell.
A 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52
Year Income statement

B
0

C
1

D
2

E
3

F
4

G
5

Sales Costs of goods sold EBITDA Staff and admin cost EBITDA Depreciation EBIT Interest payments on debt Interest earned on cash and marketable securities EBT Taxes Net Income Dividends Retained earnings
Balance sheet Cash and marketable securities Receivables Inventory

1,000 (700) 300 (90) 210 (100) 110 (39) 6 78 (31) 47 (19) 28

1,100 (770) 330 (99) 231 (117) 114 (39) 4 79 (32) 48 (19) 29

1,210 (847) 363 (109) 254 (137) 117 (41) 1 77 (31) 46 (18) 28

1,331 (932) 399 (120) 280 (161) 118 (45) 1 74 (30) 44 (18) 27

1,464 (1,025) 439 (132) 307 (188) 119 (49) 1 70 (28) 42 (17) 25

1,611 (1,127) 483 (145) 338 (220) 119 (54) 1 65 (26) 39 (16) 23

<-- =F19*(1+$B$2) <-- =G21-G19 <-- =G19*$B$3 <-- =-G19*$B$4 <-- =G21+G22 <-- =-$B$9*(G40+F40)/2 <-- =G23+G24 <-- =-$B$10*(F46+G46)/2 <-- =$B$11*(F35+G35)/2 <-- =G25+G26+G27 <-- =-G28*$B$12 <-- =G29+G28 <-- =-$B$13*G30 <-- =G31+G30

Current assets Fixed assets At cost Cummulative Depreciation Net fixed assets
Total assets

80 100 117 297 1,069 (300) 769 1,066 80 386 450 150 1,066

10 110 128 248 1,263 (417) 846 1,094 88 390 438 179 1,094

10 121 141 272 1,485 (554) 931 1,203 97 429 471 206 1,203

10 133 155 298 1,739 (715) 1,024 1,322 106 471 512 233 1,322

10 146 171 327 2,030 (904) 1,126 1,453 117 518 560 258 1,453 43.71% 2.79

10 161 188 359 2,362 (1,123) 1,239 1,598 129 570 618 281 1,598

<-- =G49-G42-G36-G37 <-- =G19/$B$5 <-- =-G20/$B$6 <-- =G35+G36+G37 <-- =G42-G41 <-- =F41+G24 <-- =G19/$B$8 <-- =G42+G38 <-- =G19*$B$7 <-- =MAX(G36+G37+$B$14+G42-G45-G47-G48,F46) <-- =(1-$B$15)*G43-G48 <-- =F48+G32 <-- =SUM(G45:G48)

Current liabilities Debt Stock Accumulated retained earnings


Total liabilities and equity

Debt Ratio Current Ratio

43.71% 43.71% 43.71% 43.71% 3.71 2.82 2.81 2.80

43.71% <-- =(G45+G46)/G49 2.79 <-- =G38/G45

Discuss: Explain the formula for the stock. Why does it work? Page 7 of 14

CFA Institute Research Challenge Seminar What trend do you see for the debt ratio and the current ratio?

Activity 4: Debt and Stock as Plug with constant Debt Ratio and Current Ratio
Given: Sales growth, Gross margin, SAC/Sales, Receivables Turnover, Inventory Turnover, Current liabilities/Sales, Fixed Asset Turnover, Depreciation rate, Interest rate on debt, Interest paid on cash and marketable securities, Tax rate, and Dividend payout ratio. Use debt and stock as the plug with constant debt ratio and current ratio. Find:

The pro forma for the next 5 years.

Implementation 1: the base model


Refer to the Activity4 worksheet in CFASeminar.xls. Now suppose given: The same parameters as in Activity 3. Require that the debt ratio be constant at 43.71% and the current ratio be constant at 3.71. Output: The pro forma for the next 5 years. Steps: 1) Leave the debt and stock formulas as in activity 3. Change the formula for CA and cash to become: CA = Current Ratio * CL Cash = CA Receivables Inventory Debt = Debt Ratio * Total Asset CL where current ratio is given in cell B15. Find the pro forma for year 1. 2) Drag the column for year 1 and extend to year 5. You should obtain the following answers. 3) Compute the debt ratio and current ratio for year 0 to year 5.

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CFA Institute Research Challenge Seminar


A 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 34 35 36 37 38 39 40 41 42 43 45 46 47 48 49 51 52
Year Income statement

B
0

C
1

D
2

E
3

F
4

G
5

Sales Costs of goods sold Gross profit Staff and admin cost EBITDA Depreciation EBIT Interest payments on debt Interest earned on cash and marketable securities EBT Taxes Net Income Dividends Retained earnings
Balance sheet Cash and marketable securities Receivables Inventory

1,000 1,100 1,210 1,331 (700) (770) (847) (932) 300 330 363 399 (90) (99) (109) (120) 210 231 254 280 (100) (117) (137) (161) 110 114 117 118 (39) (41) (45) (49) 6 7 7 8 78 81 80 77 (31) (32) (32) (31) 47 48 48 46 (19) (19) (19) (19) 28 29 29 28 80 100 117 297 1,069 (300) 769 1,066 80 386 450 150 1,066 43.71% 3.71 88 110 128 326 1,263 (417) 846 1,173 88 425 481 179 1,173 43.71% 3.71 97 121 141 359 1,485 (554) 931 1,290 97 467 518 208 1,290 43.71% 3.71 107 133 155 395

1,464 (1,025) 439 (132) 307 (188) 119 (54) 9 74 (30) 44 (18) 27 117 146 171 435

1,611 (1,127) 483 (145) 338 (220) 119 (59) 10 69 (28) 41 (17) 25 129 161 188 478

<-- =F19*(1+$B$2) <-- =G21-G19 <-- =G19*$B$3 <-- =-G19*$B$4 <-- =G21+G22 <-- =-$B$10*(G40+F40)/2 <-- =G23+G24 <-- =-$B$11*(F46+G46)/2 <-- =$B$12*(F35+G35)/2 <-- =G25+G26+G27 <-- =-G28*$B$13 <-- =G29+G28 <-- =-$B$14*G30 <-- =G31+G30 <-- =G38-G37-G36 <-- =G19/$B$5 <-- =-G20/$B$6 <-- =G45*$B$8

Current assets Fixed assets At cost Cummulative Depreciation Net fixed assets
Total assets

Current liabilities Debt Stock Accumulated retained earnings


Total liabilities and equity

Debt Ratio Current Ratio

1,739 2,030 2,362 <-- =G42-G41 (715) (904) (1,123) <-- =F41+G24 1,024 1,126 1,239 <-- =G19/$B$9 1,419 1,561 1,717 <-- =G42+G38 106 117 129 <-- =G19*$B$7 514 565 622 <-- =$B$15*G43-G45 563 616 679 <-- =(1-$B$15)*G43-G48 236 262 287 <-- =F48+G32 1,419 1,561 1,717 <-- =SUM(G45:G48) 43.71% 43.71% 43.71% <-- =(G45+G46)/G49 3.71 3.71 3.71 <-- =G38/G45

Discuss: Explain the formula for the CA and the cash. Why do they work? What trend do you see for the debt ratio and the current ratio?

Activity 5: Valuing the Stock


Given: Sales growth, Gross margin, SAC/Sales, Receivables Turnover, Inventory Turnover, Current liabilities/Sales, Fixed Asset Turnover, Depreciation rate, Interest rate on debt, Interest paid on cash and marketable securities, Tax rate, and Dividend payout ratio. Use debt and stock as the plug with constant debt ratio and current ratio. WACC, g and number of stocks. Find:

The pro forma for the next 5 years. The stock price.

Implementation 1: the base model


Refer to the Value worksheet in CFASeminar.xls. The assumptions have been changed to the following: Sales growth 3.000% Page 9 of 14

CFA Institute Research Challenge Seminar Gross margin SAC/Sales Receivables Turnover Inventory Turnover Current liabilities/Sales Fixed Asset Turnover Depreciation rate Interest rate on debt Interest paid on cash and marketable securities Tax rate Dividend payout ratio Debt Ratio Current ratio The initial values are changed to the following as well: Sales Costs of goods sold EBITDA Staff and admin cost EBITDA Depreciation EBIT Interest payments on debt Interest earned on cash and marketable securities EBT Taxes Net Income Dividends Retained earnings
Balance sheet Cash and marketable securities Receivables Inventory

40% 9% 10 6 8% 1.3 10% 10.00% 8.00% 40% 40% 43.71% 3.71

1,000 (600) 400 (90) 310 (100) 110 (37) 6 79 (32) 48 (19) 29 80 100 100 280 1,069 (300) 769 1,049 80 369 450 150

Current assets Fixed assets At cost Cummulative Depreciation Net fixed assets
Total assets

Current liabilities Debt Stock Accumulated retained earnings

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CFA Institute Research Challenge Seminar 1,049

Total liabilities and equity

Now suppose given: WACC = 20%, g = 5%, Total number of shares = 100. Output: The pro forma for the next 5 years. The stock price. Steps: 1) Compute the following cells:
A 51 52 53 54 55 56 57 58 59 60 61 66 67 68 69 70 71 72 73 74 75 76 77 78
Year Free cash flow calculation

B
0

C
1

D
2

E
3

F
4

G
5

Profit after tax Add back depreciation Subtract increase in current assets Add back increase in current liabilities Subtract increase in fixed assets at cost Add back after-tax interest on debt Subtract after-tax interest on cash and mkt. securities
Free cash flow Year 0 1 2 3 4 5

FCF Terminal value Total Enterprise value Add in initial (year 0) cash and mkt. securities Asset value in year 0 Subtract out value of firm's debt today Subtract out value of firm's pref shares today Equity value Total number of shares Share price

100

Note: Use the following formulas: Terminal value = CF5 * (1+g)/(WACC - g) Enterprise value = NPV(WACC, CF1 to CF5a)*(1+WACC)^0.5. The Subtract items should be in negative terms. 2) Create a vertical 1-dim data table tabulating the share price by varying gross profit margin from 32% to 48% in increments of 2%. Plot the share price versus gross profit margin. 3) Create a 2-dim data table tabulating the share price by varying (vertical) g from 0% to 16% in increments of 2%, and (horizontal) WACC from 10% to 26% in increments of 2%, You should get the following answer:

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CFA Institute Research Challenge Seminar


A 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78
Year Free cash flow calculation

B
0

C
1

D
2

E
3

F
4

G
5

Profit after tax Add back depreciation Subtract increase in current assets Add back increase in current liabilities Subtract increase in fixed assets at cost Add back after-tax interest on debt Subtract after-tax interest on cash and mkt. securities
Free cash flow

105 114 (26) 2 (137) 23 (4) 77

101 128 (9) 2 (152) 24 (5) 90

97 144 (9) 3 (169) 25 (5) 85

92 162 (10) 3 (187) 26 (5) 80

85 182 (10) 3 (208) 26 (5) 73

<-- =C30 <-- =-C24 <-- =-(C38-B38) <-- =C45-B45 <-- =-(C40-B40) <-- =-(1-$B$13)*C26 <-- =-(1-$B$13)*C27 <-- =SUM(C53:C59)

Valuing the firm using mid-year discounting


Weighted average cost of capital Long-term free cash flow growth rate Year 20% 5% <-- real growth 2% + inflation 3%? 0 1 2 3 4 5

FCF Terminal value Total Enterprise value Add in initial (year 0) cash and mkt. securities Asset value in year 0 Subtract out value of firm's debt today Subtract out value of firm's pref shares today Equity value Total number of shares Share price 493 80 573 (369) 0 204 100 2.03666

77 77

90 90

85 85

80 80

73 513 <-- =G67*(1+B64)/(B63-B64) 586

<-- =NPV(B63,C69:G69)*(1+B63)^0.5 <-- =B35 <-- =B72+B71 <-- =-B46 <-- =B73+B74 <-- =B76/B77

Discuss: Explain the formula for the Enterprise value. Further Explore: If the market stock price were $1.80, then all else the same, what sales growth rate does the market expect?

Activity 6: Variable Sales Growth and Fixed/Variable COGS


Given: Sales growth, Gross margin, SAC/Sales, Receivables Turnover, Inventory Turnover, Current liabilities/Sales, Fixed Asset Turnover, Depreciation rate, Interest rate on debt, Interest paid on cash and marketable securities, Tax rate, and Dividend payout ratio. Use debt as the plug. Find:

The pro forma for the next 5 years.

Implementation:
Refer to the VarSaleCOGS worksheet in CFASeminar.xls. Now instead of a fixed Sales growth rate, the Sales growth rates are given as: Year Sales growth 1 30% 2 35% 3 25% 4 15% 5 8%

Furthermore instead of a single COGS line, we have COGS Variable based on the given COGS Variable Rate of 50%, and COGS Fixed, which is fixed at -$200. Page 12 of 14

CFA Institute Research Challenge Seminar Derive the pro forma using the Debt as Plug model.

Activity 7: Geographical breakdown


Given: Sales growth, Gross margin, SAC/Sales, Receivables Turnover, Inventory Turnover, Current liabilities/Sales, Fixed Asset Turnover, Depreciation rate, Interest rate on debt, Interest paid on cash and marketable securities, Tax rate, and Dividend payout ratio. Use debt as the plug. Find:

The pro forma for the next 5 years.

Implementation:
Refer to the Geo1 worksheet in CFASeminar.xls. Now Sales, COGS and Fixed Assets are broken down into Singapore and Malaysia. The following tables are given:
A 15 16 17 18 19 20 21 22 23 Singapore Sales Growth Rate Sales COGS Variable COGS Fixed Gross Fixed Asset Cumu Depreciation Depreciation Net Fixed Asset B C 15% 800 -400 -160 854 -238.615385 615.384615 D 13% E 11% F 10% G 8%

A 25 26 27 28 29 30 31 32 33 34 Malaysia Sales Growth Rate Sales COGS Variable COGS Fixed Exchange Rate Gross Fixed Asset SGD Cumu Depreciation SGD Depreciation SGD Net Fixed Asset SGD

C 30%

D 35%

E 25%

F 15%

G 8%

510 -255 -101 0.395039 215 -60.0231615 154.976838

0.395

0.38

0.37

0.36

0.35

Sales = prev Sales * (1+ growth rate) COGS Variable = - Sales * COGS Variable Rate COGS Fixed = previous COGS Fixed Net Fixed Assets SGD = Sales / Fixed Asset Turnover * Exchange Rate Depreciation = - Depreciation rate * (prev Gross Fixed Asset + now Gross Fixed Asset) / 2 Cumu Depreciation = previous Cumu Depreciation + now Depreciation Gross Fixed Asset = Net Fixed Asset - Cumu Depreciation Page 13 of 14

CFA Institute Research Challenge Seminar

In the main pro forma Sales, COGS Variable, and COGS Fixed are computed as the summation from different geographical regions with the exchange rate applied. The Gross Fixed Assets, Cumulative Depreciation, Depreciation and Net Fixed Assets are computed as the summation from the different geographical regions. Derive the pro forma using the Debt as Plug model.

Activity 8: Discrete Re-capitalization


Given: Sales growth, Gross margin, SAC/Sales, Receivables Turnover, Inventory Turnover, Current liabilities/Sales, Fixed Asset Turnover, Depreciation rate, Interest rate on debt, Interest paid on cash and marketable securities, Tax rate, and Dividend payout ratio. Use debt as the plug, but allow discrete re-capitalization. Find:

The pro forma for the next 5 years.

Implementation:
Refer to the Recap worksheet in CFASeminar.xls. Copy the Geo1 solution. Manually recapitalize whenever the debt ratio > 45%. Recapitalize the Equity till the debt ratio falls back to exactly 35%. Assume that we do not return debt. First try manually and then see if you can "automate" it with excel functions.

Activity 9: Discrete Net Fixed Asset Increment


Given: Sales growth, Gross margin, SAC/Sales, Receivables Turnover, Inventory Turnover, Current liabilities/Sales, Fixed Asset Turnover, Depreciation rate, Interest rate on debt, Interest paid on cash and marketable securities, Tax rate, and Dividend payout ratio. Use debt as the plug, but allow discrete re-capitalization. Use discrete net fixed asset increments. Find:

The pro forma for the next 5 years.

Implementation:
Refer to the DiscreteFA worksheet in CFASeminar.xls. Copy the Recap solution. Gross fixed asset increase by the depreciation rate every year, preserving the net fixed asset every year. However when fixed asset turnover > 1.8, the net fixed asset is increased till the fixed asset turnover is reset back to 1.0. First try manually and then see if you can "automate" it with excel functions.

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