Equity Val - Industry & Competition Flashcards
What is top down and Bottoms approach in financial modeling
Most logical place to start fianancial modeling is from income statement.
IFRS / GAAP require for a firm too provide notes about any item that contributes more than 10% revenue/ op cost and assets.
It is also required to provide info about segments, geographic spread
The company can choose to phprovide segment info according to business or by product line. if the company has a small number of products then product line would be a better option.
Top Down Approach would be Economy - Sector - market - Company
Bottoms up Approach would be Product LIne - Locations - Company
Top Down Approach Types
1) Growth Relative to GDP; Estimate Nominal GDP +/- percantage inc in bps.
2) Market Growth / Market Share Approach: Forcast Growth in Market (with respect to GDP) and calculate how the market share will change
Bottom Up Approach Types
Time Series: Simplest Approach - Projected Trends
Return on Invested Capital
Capacity Based
Hybrid Approach Types
It is the most commonly used apprach
calculate market growth for each segment and sum them up for total sales.
Economies of Scale
We would like to model cost seperatly for each reported segment (geo / Bus Seg / Product).
Try to differenciate between fixed and variable costs.
If margins start increasing along with increase in sales then the company is witnessing Economies of Scale.
If the GM are inc with Sales growth then it captures economies of scale with suppliers
If the Operating Margins are in with Sales growth then it is capturing operating economies of scale
Absorbtion Costing
used for manufacutring companies. - All costs associated with the manufacutring of the product is included in the product cost.
Forecasting Costs
Historical relationships provide a good starting point. Cost Drivers (Size, Competative Forces, Changing Ind, Strategy Choices/ input costs)
For SG&A costs there is a less direct relationship with revenues. There are some components are more variable than others.
Selling Expenses are more variable than Admin costs.
Non Operating Costs:
Interest Income: Depends on Cash / Investments on BS
Intterest Exp: Level of Debt
Taxes: Depends on Jurisdiction and nature of business.
Dividend Policy: Remain as a constant percentage of Income
Minority Interest: for companies where we hold greater than 50% shareholding then it has to be reported as consoliated less the income that does not belong to the company. for companies that has less tahn 50% shareholding we donot cosolodate but add the percentage of income that belongs to us.
Sharecount. Be aware of changes in share count - Dilution, Share Issuance, and Share Repurchase.
Unusual Costs: hard to predict and therefore excluded from forcasts.
Cost Drivers
Size Competative forces Changing Industry Structure Strategy Choice Flucutuating input costs. / hedging policies
Low Cost Vs Differenctiation Strategy
Differenciation Strategy would have higher margins.
Cost Pass Through Vs hedging
Compay A Sale of USD 100 and COGS of USD 75 - GP of USD 25
If the company is able to transfer its cost and the COGS increases to 100 then it would report sales of 125 (Additional sales of USD 25 passed to the cutomer). GP is USD 25. However the margins of the company dropped. (i.e 25% margin to 20%). Hence we will have margin detriotion even though we dont have profit detriotion.
However if the company hedges the cost then it would be able to report COGS of 75 even though the price has increased and sell it at USD 125. The company would therefore be able to report GP of USD 50 and show a higher GPM (i.e 40% as compared to 25%)
The same structure cuts both ways if the prices drop then the cost pass through compay would be able to report higher margins whereas the hedger would report lower margins.
Forcasting Tax Rates
Statutory Tax Rate - Tax rate applicable to company’s domestic tax base. We may need to make some adjustments to that in the form of Tax Credits (R&D has Tax credit options), non deductiable expenses (Alcohol with dining with customer is non deductible item), Div withholdings (Withholding tax paid to other countries result in tax credit/ deductibles) and adj to prior years.
Effective Tax Rate - used to forcast Tax Exp - calculated as reported Tax / pre-tax Income - it is a weighted average of tax rate for different jurisdictions. Effective Tax rate does not refer to cash that we pay to the authorities due to Deffered Tax Asset (DTA) & Deferred Tax Liabilities (DTL)
Cash Tax Rate- Used to forcast Cash Flows- calculated as Tax actually paid / Pre-Tax Income
Balance Sheet Modeling
CA & CL - Use efficiency Ratios
Non-Curr Assets = Chg in NCA = CAPEX - Dep
Non-Curr Liab = Use Capital Strucutre - Use Leverage Ratios
Equity - Use RE from Income Statement.
For CAPEX there are two components that need to be looked at Maintainence CAPEX (to maintain - should be higher than Deprecation due to inflation) and Growth CAPEX.
Check Historical Trend for Capital Strucutre.
What are Efficiency Ratios & Leverage Ratios
Inventory Turnover / Days of Inventory on hand
Receivables Turnover / Days Sales Outstanding
Payable Turnover / Days Payable Outstanding
WC turnover.
Leverage Ratios
Debt to Capital
Debt to Equity
Debt to EBITDA
Scenrio Analysis Vs Sensitivity Analsysi
Scenrion Analsysi = change multiple variatbles
Sensitivity Analysis = Change single Variaable.
ROIC
ROIC = Return on Invested Capital = NOPLAT / OA - OL
= net operating profit less adjusted taxes / (Operating Assets - Operating liabilities) = earning available to pay both equity and debt holders/ net operating assets = EBIT x (1- Tax Rate) / OA - OL
it is not affected by degree of leverage
It can be measured as the beg period or average period
Operating Assets donot include any assets that generate intrerst such as markatable security. Any assets that are not used for operations such as assets held for sale. Non Cash assets that are held for investment.
Net Operating Assets = Current Assets - Current Liabilities - Financial / Non Core Current Assets + Financial / Non Core Current Liabilities
Sustainable high ROIC is a sign of competative Advantage - it implies higher earnings or lower invested capital.
Return on Capital Employed
not as good as ROIC = NOP or EBIT / (Debt + Equity)
It is useful for comparing among companies across different tax jurisdictions.
But it is good only if the two companies are of the same age or their net assets are of the same age. becuase it includes the effect of deprecation.
Older companies will have lower denominator resulting in higher ROCE.
problem: D/E = 40% . Company is profitable but earnings are expected to decline 2% a year for nxt 5 years. All earnings are expecteed to be retained. What will happen to total debt.
A) Total Debt will increase
B) Total Debt will decrease
C) Total Debt wil remain the same
D/E = 40%
if earnings are expected to decline by 2% and all earnings are to be retained.
E1 = E0 + NI (1-0.02). This suggests that Equity for year 1 will be higher than Equity at year 0. If Equity increases and D/E needs to be maintained then Debt must also be increased.
Hence A is correct as Debt will increase
Problem: WC and PPE account for all of company’s assets. you believe that the depreciation schedule is too aggressive and expect PPE to last twice as long as what is implied in the schedule. you project CAPEX to be significantly less than Deprecition for the next 5 years. Both earnings and WC will grow at a low single digit rate during this time. What does this most likely imply for ROIC during the next 5 years.
A) ROIC will increase
B) ROIC will decrease
C) ROIC will remain the same
ROIC = NOPLAT / Net OA
The problem states that earnings will grow at a low single digit rate. Hence NOPLAT will increase at low rate
WC assets will also increase at low rate. Net OA = Operating WC asset + Net Non Current Assets
Net Non Curr Assets = CAPEX - Dep. Since CAPEX will be signifiantly less than Dep therefore Net Non Curr Assets will be negative.
Hence Numerator of ROIC will increase at a low rate but the denominator will decrease. hence ROIC will increase.
Hence A is the correct answer.
5 Forces - Prices - Costs
Downward Price Pressure comes from A) Low Barriers to Entry B) Buyer Power C) Intense Rivalry (High FC, Freagmented, low Growth) D) Substitutes
Higher Cost Pressure comes from A) Higher Buyer Power (require improved quality) and B) Supplier Power C) Rivalry (Increased advertising cost)
Current industry structure is already in the current margins. Future margins willl be affected by future structural pressures on prices and cost.
Problem:
In 2011 Volume: 38.6 Net Revenue per Hl: 2326 Revenue: 89795 Cost of Sales: 42116 Gross Profit: 47679 Gross Margin: 53.1% Selling Exp: 23752 Admin Exp: 2439 Op Profit: 21488 Op Margin: 23.9%
Cost of Sales (Fixed): 21058
Cost of Sales (Variable) 21058
Cost of Sales (Var)/ hl : 546
Selling Expenses as % of Sales: 26.5%
Assumptions
1. Prices will increase 10% in 2017 due to an increase in the excise tax. Fully passed on without affecting net sales prices
2. 50% of Cos Fixed /hl
3. 50% variable based on volume
4. Selling exp stable as percentage of sales
5. Admin Exp Fixed
A) Price Elasticity = 0.8
B) Price Elasticity = 0.5
What is the Operating profit and Operating Margin in 2012
Price Ealsticity of 0.8 = chg in volume / chng in price
therefore for A change in volume = 0.838.6 = 35.5 and for B change in volume = 0.538.6=36.7
Net Revenue Per Hl: Since price remain unaffected with the change in volume therefore net revenue per hl = 2326
Total Revenues = 8264 and 85305 ( Rev * Vol)
Cost of sales is broken down into fixed and variables. 50% of the cost is fixed. Therefore fixed cost will remain the same 21058 whereas variable cost is based on volume. therefore variable cost = 19373 and 20005n (i.e 546* 35.5 and 546*38.6)
Total Cost = 40431 and 41063
Gross Profit = 42180 and 44242
Gross Margin = 51.1% and 51.9%
Selling expenses is a percentage of sales. therefore calculate the existing selling exp percantage and multiply with new sales. 21852 and 22564
Admin cost is fixed= 2439 and 2439
Operating profit = 17889 and 19239
Operating profit % = 21.7% and 22.6%
