Financial Modelling and Company Valuation

A Sharing Session by Tan Heng Leng

29th August 2014

Agenda
Valuation Approaches
Free-Cash Flow Models
Weighted average cost of capital
Application: Derive Enterprise Value of Pura
Limited

What is valuation

How much money something is worth?

Why valuation?

Valuation Approaches

Determined by a
stream of
forecasted cash
flows

Benchmark
against other
comparable
companies

Based on book
values in
balance sheet

Income based approach

Strength

Weakness

Applicability

Based on discounted
future cash flows

Most complex
technique

Most technically robust

approach

Value both business

acquisitions and
disposals

Large range of
assumptions

Focus on true
economic drivers of
value

Understanding the
value of a business
and then pricing in
synergies

Prone to forecasting
error

Market based approach

Strength

Weakness

Applicability

Straightforward
technique

Readily available data

Relies wholly on
available data of
comparable
companies

To compare and
contrast the relative
values of investments
within a portfolio

Broad assumptions
made

No detailed analysis of
intrinsic drivers of
value

Provide a sense check

for business
acquisition / disposal
decisions

Difficult to apply to
privately owned entity

Benchmarking the
relative value of
organisations against
each other
Uses market based
factors instead of
analyst own estimate

Market based approach

Three (3) Steps Approach
1 Identify comparable assets and their market value
2 Convert these to a standardised statistic (Price / Earnings) which
becomes the valuation multiplier
3 Apply the valuation multiplier to the assets being valued
Example:
Value of Turquoise Ltd

: RM 1,500 mil (market capitalisation)

Current year earnings

: RM 100 mil

Earnings multiple

: 1500 100 = 15 times

Cost based approach

Strength

Weakness

Applicability

Simple and quick

Data readily available

in balance sheet

Book value does not

reflect current fair
values

May significantly
undervalue a business
(intangibles value are
often ignored)

Obtain preliminary
view of the base value
of a business
especially in a
divestment exercise

Liquidation value used

where all assets are
sold and liabilities are
repaid

Used to value excess

assets within a
business

Has an element of
certainty - based on
assets that are owned

Enterprise Value vs Equity Value

Question:
Should this
WACC be the
Acquirer WACC
or Targets
WACC?

What is Free Cash Flow?

Definition:
Cash flow available to suppliers of capital (i.e. debt holders and equity holders) after:
All operating expenses have been paid in cash
Necessary investments in working capital; and
Fixed capital have been made

What is Free Cash Flow to Equity

(FCFE)?
Example:

Free Cash Flow Valuation Framework

Main idea !
Fair value of a stock = the present value of all the cash that can be
potentially be distributed

Step-by-Step Guide
Step 1: Value the business/ operating assets
Step 2: Value the company
Step 3: Value the companys equity
Step 4: Find the fair value per share

Corporate Valuation vs Project Valuation

What is the difference between:

valuing TNB as a company
VS
valuing an IPP project?

Terminal Value
Firm in steady state

Y0

Y1

Y2

Y3

Y4

Y5

Explicit forecast period

Step 1: Calculate terminal value

Step 2: Derive present value of terminal value to Year 0
Step 3: Add Present Value of Terminal Value to Present value of
FCFs to arrive at final enterprise value

Weighted Average Cost of Capital

Definition:
Discount rate used to find the Present Value of the FCFs.
The return an investor would require for owning all the capital issued / raised

WACC = wdkd(1-t) + wprp + weke

Where:
wd,wp,we = proportion of debt, preference shares and ordinary
shares
t = corporate tax rate
kd, kp, ke= cost of debt, cost of preference shares, cost of equity

Cost of Equity
Definition:
cost of equity (ke)
= rate of return that shareholders require on their investment in an
organisation

Application:
Financial Modelling Basics Steps
Big Step

Baby Steps

1. Project income
statement

i.
ii.
iii.

2. Project balance
sheet

i.
ii.
iii.

3. Project cash flow

statement

i.
ii.
iii.

4. Balancing

i.

Understand income statement mechanics by keying in

historical data
Document assumptions
Project income statements
Understand balance sheet mechanics by keying in historical
data
Document assumptions
Project balance sheet items
Link income statement and balance sheet items to cash flow
statement
Dividends and share repurchases
Wrap up the cash flow statement
Deal with the PLUG that make the financial statements
balance!

Case Study: Pura Limited

IMD is investigating the acquisition of Pura Limited, a biscuit-manufacturing company based
in Sungai Petani, Kedah.
FCF drivers
1.Current level of sales = RM 22.1 mil per annum
2.Sales growth rate during the forecast period = 4.5% per annum
3.Operating expenses (net of interest and depreciation): remain constant at 88.8% of sales
per annum
4.Income tax rate = 30% of EBITDA
5.Fixed capital and working capital
Incremental fixed capital rate = 15.0%
Working capital investment rate = 10.0%
6.WACC = 10.0%
7.Terminal value growth rate = 1.5%
8.Market value of debt = RM10 mil

Case Study: Pura Limited

Step 1: Calculate FCF in the forecast period by applying FCF
drivers
Step 2: Calculate the terminal value using a growth rate of
1.5%
Step 3: Calculate the enterprise and equity values

Thank you