MBA-VI-Finance-Financial Modelling For Corporate Valuation

FINANCIAL MODELING
FOR
CORPORATE VALUATION
Prepared by
VIJAY MAHAWAR
14PGGMS071
Presented to
Sri Sri University, Cuttack, Odisha

2014-2016 BATCH

2
FINANCIAL MODEING FOR CORPORATE VALUATION
DECLARATION BY THE LEARNER
This is to declare that I have carried out this project work myself in part fulfillment of the
Trimester VI of MBA program in General Management from Sri Sri University, Cuttack,
Odisha.
The work is original, has not been copied from anywhere else and has not been submitted to
any other University/Institute for an award of any degree/diploma.
Date: 28th March, 2016 Signature:

(VIJAY MAHAWAR)
Place: Sri Sri University, Cuttack, Odisha

CAPSTONE Project Report
Prepared by VIJAY MAHAWAR (14PGGMS071)
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TABLE OF CONTENTS

CHAPTER 1: INTRODUCTION ........................................................................................................ 6

CHAPTER 2: EXCEL AS A MODELING TOOL .............................................................................. 7
CHAPTER 3: BLOOMBERG MARKET CONCEPTS ...................................................................... 8
CHAPTER 4: ABSOLUTE VALUATION ......................................................................................... 9
Step 1: Estimate long-term future cashflows based on assumptions .............................................. 9
Step 2: Estimate discount rate aka “WACC” .................................................................................. 10
Step 3: Discount the estimated future cashflows by “WACC” ....................................................... 11
Step 4: Take total firm value and derive Market Capitalization ..................................................... 11
Step 5: Calculate the share price. ................................................................................................... 12
CHAPTER 5: RELATIVE VALUATION ........................................................................................ 13
CHAPTER 6: ABSOLUTE VALUATION VS RELATIVE VALUATION .................................... 14
CASE STUDY: FMCG SECTOR ..................................................................................................... 14
Exhibit: Balance Sheet Assumption ............................................................................................ 23
Exhibit: Revenue Assumption .................................................................................................... 24
Exhibit: Asset Schedule Assumption .......................................................................................... 26
Exhibit: Financing Assumption ................................................................................................... 26
Exhibit: Tax and Valuation Assumption ...................................................................................... 26
Exhibit: Revenue Build Up .......................................................................................................... 27
Exhibit: Cost Build Up ................................................................................................................. 28
Exhibit: Debt Schedule ............................................................................................................... 29
Exhibit: Asset Schedule .............................................................................................................. 30
Exhibit: Balance Sheet ................................................................................................................ 31
Exhibit: Profit & Loss .................................................................................................................. 32
Exhibit: Cash Flow ...................................................................................................................... 33
Exhibit: Ratio Analysis ................................................................................................................ 34
Exhibit: Valuation ....................................................................................................................... 35
Exhibit: Comps ........................................................................................................................... 36
APPENDIX I: REFERENCES .......................................................................................................... 37
APPENDIX II: BLOOMBERG TERMINAL CODES ...................................................................... 38

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CHAPTER 1: INTRODUCTION
Financial modeling is the task of building an abstract representation (a

model) of a real world financial situation. This is a mathematical model
designed to represent (a simplified version of) the performance of a financial
asset or portfolio of a business, project, or any other investment.
The process by which a firm constructs a financial representation of some, or

all, aspects of the firm or given security. The model is usually characterized by
performing calculations, and makes recommendations based on that
information. The model may also summarize particular events for the end user
and provide direction regarding possible actions or alternatives.
Financial models can be constructed in many ways, either by the use of

computer software, or with a pen and paper. What's most important, however,
is not the kind of user interface used, but the underlying logic that
encompasses the model. A model, for example, can summarize investment
management returns, such as the Sortino ratio, or it may help estimate market
direction, such as the Fed model.
In corporate finance, investment banking, and the accounting profession

financial modeling is largely synonymous with financial statement forecasting.
This usually involves the preparation of detailed company specific models
used for decision making purposes and financial analysis.
Applications include:
• Business valuation, especially discounted cash flow, but including other

valuation problems
• Scenario planning and management decision making ("what is"; "what if";
"what has to be done")
• Capital budgeting
• Cost of capital (i.e. WACC) calculations
• Financial statement analysis (including of operating- and finance leases, and
R&D)
• Project finance
• Mergers and Acquisitions (i.e. estimating the future performance of
combined entities)

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CHAPTER 2: EXCEL AS A MODELING TOOL

• Excel is one of the most widely used tools in financial industry
– Easy to use
– High reach & access to software across geographies
– Flexibility
– Robustness
– Inbuilt features (Most people would not even be using 95% of the
features) & Extendibility
– Modular and Object Oriented Architecture
• Excel as a data-store
– Easy to store and retrieve information
– Flexibility to put many data-types in the same sheet
• Functions and a range of features
– Excel is easily extendible to be used as a Modeling tool
• Modeling Context
– Understand the industry models being used
– Create your own models Rather than just using them
– Improve & enhance productivity in work
– Extend these models for your use
– Debug Problems

8
CHAPTER 3: BLOOMBERG MARKET CONCEPTS
AN INTRODUCTION TO FINANCE FROM BLOOMBERG.
Bloomberg Market Concepts (BMC) is an 8 hours self-paced e-learning course

that provides a visual introduction to the financial markets. BMC consists of 4
modules –
1. Economics,
2. Currencies,
3. Fixed Income and
4. Equities
The modules are woven together from Bloomberg data, news, analytics and
television.

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CHAPTER 4: ABSOLUTE VALUATION

An absolute value is a business valuation method that uses discounted cash
flow analysis to determine a company's financial worth. The absolute value
method differs from the relative value models that examine what a company is
worth compared to its competitors. Absolute value models try to determine a
company's intrinsic worth based on its projected cash flows.
• Absolute valuation involves the discounting of future cashflows.

• The discount rate is higher for long-term cashflows and for riskier firms.
• Good financial models balance simplicity with insights.
• Absolute valuation is theoretically perfect.
• Absolute valuations are usually precisely wrong.
The five steps involved in valuation using Absolute valuation are:
Step 1: Estimate long-term future cashflows based on assumptions

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Step 2: Estimate discount rate aka “WACC”

11
Step 3: Discount the estimated future cashflows by “WACC”
Step 4: Take total firm value and derive Market Capitalization

12
Step 5: Calculate the share price.
5 steps process in valuation summarized.

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CHAPTER 5: RELATIVE VALUATION

A relative valuation model is a business valuation method that compares a
firm's value to that of its competitors to determine the firm's financial worth.
Relative valuation models are an alternative to absolute value models, which
try to determine a company's intrinsic worth based on its estimated future free
cash flows discounted to their present value. Like absolute value models,
investors may use relative valuation models when determining whether a
company's stock is a good buy.
P/E Ration Benchmarking:
1. Itself
2. Its Peers
3. The Market
• Relative valuation is the quick and easy comparison of one valuation to

another
• The risk of relative valuation is being led astray by unrealistic reference
points
• Earnings and multiples are used to estimate fair share prices
• Fast growing companies warrant high multiples and vice versa.
• The state of the economy is a key driver of relative valuation.

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CHAPTER 6: ABSOLUTE VALUATION VS RELATIVE VALUATION
CASE STUDY: FMCG SECTOR

Looking through the window of his office, Akshay was wondering how quickly time has
passed by. The day was pleasant with bright sunshine outside. With a mug of coffee in his
hand, he was looking at the day to day activities in the premises of Renuka Consumer
Products Limited (“RCPL”).
Akshay had just completed his MBA when his father expired in late 2004. Since then he had
taken control of RCPL, a company started by his father and named after his mother Mrs.
Renuka Devi.
RCPL, a popular name in one of the western states of India, operates in fast moving
consumer products segments. It manufactures and sells three products:
• Soaps in packets of 100 gms

• Hair colour in bottles of 250 ml
• Liquid Detergents in the bottles of 500 ml
Since the time Akshay took control of the operations at RCPL, the company has grown leaps
and bounds. The volumes sold across each of the three categories of products have shown
significant growth over last five years.

15
Exhibit 1: Volumes sold over FY05 – FY09
Besides, RCPL has also managed to consistently increase the sale prices of its products
primarily because of lack of competition in the areas where it has achieved good
marketability.
Exhibit 2: Sales Price Movement
However, Akshay knows that things are no longer going to be as comfortable as they are
right now. Specially, in a situation when a leading listed player in the consumer products
area has announced plans to expand in the geographies where RCPL operates. Given the
changing dynamics of the business, Akshay was thinking through the potential course of
actions he can take to counter the increasing competition. As a first step he decided to take
stock of the situation. He asked the chartered account for the historical financial statements
of the company.
Exhibit 3: Historical P&L Statement of RCPL

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Exhibit 4: Historical Balance Sheet of RCPL

18
While the past performance looked phenomenal, he knew that he along-with his
management team has to constantly improve and think ahead of curve lest RCPL should be
eaten by the competition. He was well aware of the fact that however good his team might
be, past performances may not be sustained in future unless he does plan well in advance.
He quickly summoned his Sales and Marketing team to seek their inputs on the future sale
price points for the various products RCPL manufacture.
Excerpts from the discussion he had with his Sales & Marketing team:
“....Soap segment has seen a high growth phase so far, but due to enhanced penetration in
the rural markets, this segment will see a tapering growth rate from the expected 15% in
FY10 to 12% in five years time. Due to lack of fashion consciousness in the villages, hair
colour segment will, at the best see a CAGR of 0.5% less than historical CAGR over a five
period time frame. ..Liquid detergents have gained popularity in the rural markets and will
continue to display a growth rate of 5% - 6% over the same time frame, very much in line
with its growth rate last year...”
“....While RCPL has so far controlled the sale prices of these products at its will, the same
may not happen in future. It will be almost impossible to increase the prices of soaps and
detergents for the next two years and even beyond that, the increase will be limited to 2% to
3%. Hair colour segment still has a possibility of seeing a price CAGR growth rate same at
historical levels...”
Akshay quickly realized that in the competitive world, revenue growth alone may not fetch
the desired shareholders’ value creation. He quickly turned his attention to the key cost
elements in the P&L statement. He knew that raw material was the key constituent of the
total cost base. There were just four categories of raw materials required for the operations
of RCPL.
Exhibit 5: Raw materials requirement of key products of RCPL
Acids were the single primary key raw material in terms of quantum of consumption.
Specialty chemicals were added to achieve the desired colour and perfumes were added for
fragrance. Akshay quickly noticed the raw materials price trend from the exhibit overleaf
provided to him by the Materials Department

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Exhibit 6: Raw Materials Price movement
He quickly invited Mr. Rao, Head of Materials Department for a discussion on the prices of
the raw materials.
Excerpts from the discussion he had with Mr. Rao
“...For the acids, RCPL has entered into a long term contract with the leading supplier in
the region. Under the terms of the contract, acids will see a price escalation of constant 5%
every year for the next five years. For specialty chemicals, he has multiple vendors and due
to high bargaining power RCPL enjoys with the suppliers, the price rise in this segment will
be restricted to 5% every year. Ordinary chemicals will display a price rise of 15% to 16%
over the same time horizon while perfumes will display the historical CAGR in terms of its
price growth...Power cost will display a growth rate in the range of 10% – 11%...”
As soon as the discussion was concluded and Mr. Rao left the room; a very commanding
and authoritative female voice shouted at him, “You never seem to keep track of time. It’s
lunch time, where had you been?”
From the authority and power in the voice, it was evident that the voice was of none other
than Raveena, Akshay’s wife. Raveena was Akshay’s childhood friend and was also his
father’s choice as his wife. The two got married in early 2005 when Akshay took control of
RCPL and Raveena of Akshay. A wife’s entry into the scene need not always be welcome
when one is thinking about the future, however this time Raveena’s entry was perfect in
time. Raveena, besides being Akshay’s wife, was also the HR head of RCPL. Over lunch,
Akshay figured out that his HR department had been quite cautious in growing the
manpower in the organization.
Exhibit 7: Manpower in RCPL
Raveena told him that manpower count will remain the same for this year while she had
budgeted a headcount increase of 5% beyond. Knowing that he must be thinking of the cost
control, she anticipated his next question, thus displaying a quality rare in HR and provided
information on the monthly salary figures of the employees in different categories.

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Exhibit 8: Average monthly salary
She also indicated that the employees have not received any salary hike this year; however
she had budgeted for 5% hike year on year for the next five years. The firm will continue to
pay 15% of the salary as bonus in the years to come unless something unforeseen happens.
The two had finished lunch, post which she left the room without any debate; something you
won’t expect at least from an HR professional who has been queried about the “resources”.
Post lunch, it was time for a quick walk and he was joined by none other than Mr.
Tibrewala, the guy behind the operations of RCPL. Akshay was aware that the packaging of
the end products of RCPL was outsourced to another firm through a long term contract.
Mr. Tibrewala clarified that packaging cost will see a meager rise of 2% after remaining
constant this year (with respect to FY09). Besides, he promised to mail Akshay the
historical packaging rates.
At times, our mailbox is so flooded with mails that we simply keep staring at it without
knowing which ones to open first. But Akshay was quite clear in his mind and he clicked
open the mail from Mr. Tibrewala as soon as he reached his office after the walk.
Exhibit 9: Packaging cost per unit
Akshay knew that RCPL had not been an aggressive advertiser so far. However, in order to
increase penetration of the products and reach wider markets, advertisement-spend had to
increase. He has increased the budgetary allocation of advertising spend to 10% of sales
this year and he decided to raise it to ~ 14% gradually over next few years. Besides to
prevent the retailers and salesman from partnering with any new player in the area, he
knew he would have to gradually increase their commission to 7% from the current levels of
5%.
Having been through key items of revenues and growth, it was now time to interact with
Corporate Finance department about the future capital expenditure and their funding plans.
The firm had raised a debt of Rs. 500 Lakhs at an interest rate of 12% in FY05 to be repaid
in 20 equal installments beginning FY06. The capital expenditure plans for the firm was as
follows

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Exhibit 10: Capital expenditure plans
The firm depreciated all capex items using a straight line method over a period of 10 years.
Knowing the cash balance available with RCPL and good results so far in FY10, he
realized that no additional external funding will be required in order to carry out the
planned expansion.
Having assimilated all the information now, Akshay was now wondering how to make use of
them to figure out the cash position of the company, its financial health and projected
performance. He was also thinking of a possible way of arriving at the valuation of the
company his father had created. He knew that he had a tough task in his hand. He was
reminded of an investment banker, Christopher, his batch mate from his MBA College.
However, he did not want to employ his services as he feared the magnitude of the fees.
Eventually, he called him to seek information on trading multiples of the listed companies in
this sector and also an update on the recent M&A or PE transactions that might have
happened.
Gone are the days when investment bankers used to be working 100 hours a week. Thanks
to the recent downturn, bankers now enjoy some free evenings with their loved ones.
However, greed for fees never leaves them. Within minutes of the call, Akshay saw a mail
from Christopher who has concisely compiled the data he was looking for.
Exhibit 11: Trading multiples of the listed companies in FMCG sector
Note: *EV and M Cap in Rs. Lakhs

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Exhibit 12: Transaction Multiples
Akshay has a voluminous and strenuous task at hand to determine the value of his firm.
However, he had been quick to break a big problem into a series of smaller problems to
facilitate his task.
Step 1:
As a first step, prepare cash flow statements from the historical P&L and Balance sheet
statements for the period of FY05 to FY09
Step 2:
Identify key drivers of the revenue and cost. Prepare projected financial statements based
on the historical trends and the inputs gathered from various departments.
Step 3:
Based on projected financial statements, build a DCF model to arrive at an approximate

equity value of the firm. Examine this valuation with respect to the trading multiples and
transaction multiples in the industry.

23
Exhibit: Balance Sheet Assumption

24
Exhibit: Revenue Assumption

25
Exhibit: Cost Assumption

26
Exhibit: Asset Schedule Assumption
Exhibit: Financing Assumption
Exhibit: Tax and Valuation Assumption

27
Exhibit: Revenue Build Up

28
Exhibit: Cost Build Up

29
Exhibit: Debt Schedule

30
Exhibit: Asset Schedule

31
Exhibit: Balance Sheet

32
Exhibit: Profit & Loss

33
Exhibit: Cash Flow

34
Exhibit: Ratio Analysis

35
Exhibit: Valuation

36
Exhibit: Comps

37
APPENDIX I: REFERENCES
1. Financial Modeling definition: https://en.wikipedia.org/wiki/Financial_modeling
2. URL (video): https://vimeo.com/133348600
3. URL (About BMC): http://about.bloomberginstitute.com/bloomberg-market-
concepts/
4. Financial Modeling material (case study) from Pristine –
http://www.edupristine.com

38
APPENDIX II: BLOOMBERG TERMINAL CODES

39


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FINANCIAL MODELING

Sri Sri University, Cuttack, Odisha

DECLARATION BY THE LEARNER

Date: 28th March, 2016 Signature:

CHAPTER 1: INTRODUCTION ........................................................................................................ 6

Financial modeling is the task of building an abstract representation (a

The process by which a firm constructs a financial representation of some, or

Financial models can be constructed in many ways, either by the use of

In corporate finance, investment banking, and the accounting profession

• Business valuation, especially discounted cash flow, but including other

CHAPTER 2: EXCEL AS A MODELING TOOL

• Excel is one of the most widely used tools in financial industry

– High reach & access to software across geographies

– Modular and Object Oriented Architecture

– Easy to store and retrieve information

– Flexibility to put many data-types in the same sheet

• Functions and a range of features

– Excel is easily extendible to be used as a Modeling tool

– Understand the industry models being used

– Create your own models Rather than just using them

– Improve & enhance productivity in work

– Extend these models for your use

CHAPTER 3: BLOOMBERG MARKET CONCEPTS

AN INTRODUCTION TO FINANCE FROM BLOOMBERG.

Bloomberg Market Concepts (BMC) is an 8 hours self-paced e-learning course

CHAPTER 4: ABSOLUTE VALUATION

• Absolute valuation involves the discounting of future cashflows.

The five steps involved in valuation using Absolute valuation are:

Step 1: Estimate long-term future cashflows based on assumptions

Step 2: Estimate discount rate aka “WACC”

Step 3: Discount the estimated future cashflows by “WACC”

Step 4: Take total firm value and derive Market Capitalization

Step 5: Calculate the share price.

5 steps process in valuation summarized.

CHAPTER 5: RELATIVE VALUATION

P/E Ration Benchmarking:

• Relative valuation is the quick and easy comparison of one valuation to

CHAPTER 6: ABSOLUTE VALUATION VS RELATIVE VALUATION

CASE STUDY: FMCG SECTOR

• Soaps in packets of 100 gms

Exhibit 1: Volumes sold over FY05 – FY09

Exhibit 2: Sales Price Movement

Exhibit 3: Historical P&L Statement of RCPL

Exhibit 4: Historical Balance Sheet of RCPL

Exhibit 5: Raw materials requirement of key products of RCPL

Exhibit 6: Raw Materials Price movement

Excerpts from the discussion he had with Mr. Rao

Exhibit 7: Manpower in RCPL

Exhibit 8: Average monthly salary

Exhibit 9: Packaging cost per unit

Exhibit 10: Capital expenditure plans

Exhibit 11: Trading multiples of the listed companies in FMCG sector

Note: *EV and M Cap in Rs. Lakhs

Exhibit 12: Transaction Multiples

Based on projected financial statements, build a DCF model to arrive at an approximate

Exhibit: Balance Sheet Assumption

Exhibit: Revenue Assumption

Exhibit: Cost Assumption

Exhibit: Asset Schedule Assumption

Exhibit: Financing Assumption

Exhibit: Tax and Valuation Assumption

Exhibit: Revenue Build Up