Financial Forecasting and Modeling

Question 0

What are the valuation techniques?

Answer 0

Dividend discount model
Free Cash Flow technique
Relative valuation using 
  Earnings
  EBIT
  EBITDA
  Sales etc

Question 1

What are the basic measure in valuing firm?

Answer 1

P is the market cap or Market value of equity

V is the Enterprise value (value of the firm) =market cap+debt-cash

Question 2

How FCF is calculated?

Answer 2

=EBIT(1-t) - additions to NWC - (Capex - depreciation)

Question 3

How do you condense income statement and balance sheet for basic financial model?

Answer 3

IS down to 3 categories 
 1. Revenue
 2. EBIT(1-t)
 3. Net income or EPS
B/S down to 3 key categories
 1. NWC
 2. NFA
 3. Net Debt

Question 4

What are the steps to build basic forecast model?

Answer 4

Step 1 - build a revenue model

Step 2 - carry on your revenue forecasts for the next few years

Step 3 - calculate historical
EBIT(1-t) Margins

Step 4 - decide EBIT(1-t) margin forecasts (profitability)

Step 5 - apply the this year’s EBIT(1-t) forecasts to this year’s revenue forecast

(Beginning Net Debt is calculated and estimate in condensed B/S)

Step 6 - calculate Net After Tax Interest

Step 7 - extrapolate this interest rate in condensed IS

Step 8 - apply the rate for the (remember this is beginning net debt figures for the year) Net Debt estimates in future years

IS is forecasted!!!!

Question 5

How do you condense balance sheet?

Answer 5

Step 1 - calculate historical NWC (remember beginning accounts must be used for this year)

NWC=(Receivables + Inventory + Other current assets) - (payables + Other current liabilities)

Step 2 - calculate historical Net Debt (Remember beginning accounts ie last years closing accounts must be used for this year)

Net Debt=Debt(short & long)-Cash

Step 3 - calculate historical NFA
(Remember beginning accounts ie last year’s closing accounts must be used for this year)

NFA=remaining assets - remaining liabilities

Step 4 - figure out Shareholder equity from this condensed B/S
=NWC+NFA- Net Debt

Step 5 - calculate historical NWC ratio = NWC/Sales

Step 6 - decide NWC/Sales ratio figures in to the future

Step 7 - apply the ratio to calculate beginning NWC for each year

Step 8 - calculate the historical NFA/Sales ratios

Step 9 - decide what values will have NFA/Sales ratio in to the future

Step 10 - apply the ratio to calculate beginning NFA for each year

Step 11 - total up the NOA and Net Capital

Step 12 - calculate historical
Net Debt/Net Capital ratios

Step 13 - decide the values for this ratios into the future

Step 14 - apply the ratio to calculate the beginning Net Debt for each year

Step 15 - calculate future Shareholder’s Equity

BS is forecasted!!!!

Question 6

How do you check your model’s ROIC and WACC? Shouldn’t they be ROIC ~ WACC?
Revenue growth assumption important? Or EBIT(1-t) margin steady state figure is important?

Answer 6

When firm is expected steady state revenue growth of whatever rate, $1000 incremental sale produces an incremental profit (EBIT(1-t)) margin of say 7% or $70.
The investment required to generate extra $1000 in the first place is
$1000 • 22,5% (NWC ratio)=$225
$1000 • 50% (NFA ratio) =$500
Net investment is therefore=$725

So the ROIC=$70/$725=9,66%

We can get WACC figures
We have Net Debt/ Capital ratio
Cost of equity is found using CAPM

So we can get WACC (don’t double count the tax here)

This WACC figure is cost of capital and it should be roughly equal to ROIC

The point is EBIT(1-t) margin assumption is crucial not revenue growth

Question 7

Basically what do you assume in the forecast model? How many assumptions?

Answer 7

Only 5 assumptions

1. Revenue growth
2. EBIT(1-t) margin
3. NWC/sales
4. NFA/sales
5. Net Debt / capital

Also remember we implied constant capital structure assumption