Using Financial Statement
Models for Valuation
MGT 4850
Spring 2008
University of Lethbridge
Corporate Valuation
• Building Pro forma model
• Calculating the relevant free cash flows
• Calculating the cost of capital for the free
cash flows
• Determining the terminal value of the firm
• Properly discounting the free cash flows
• Sensitivity analysis
Farmers Bagels Inc.
• Balance sheets and Income Statements
for 1995 and 1996 (p.90)
• Ratio analysis (p. 91)
• Sales predictions (2001)→ terminal value
Model Assumptions
• Drop the distinction between product sales
and other income
• Cost of goods sold -40%
• Selling, general and administrative
expenses (-1%/y)
• Income tax rate 41.5%
• Cash cushion-declining proportion of sales
• Accounts receivable – 22% of sales
Model Assumptions II
• Inventory 5% of sales
• Property and equipment at cost 70% in ‘96 to
40% in 2001.
• Straight line deprec. at 10% of prop. Cost
• Accounts payable and accrued expenses +1%/y
till 20%
• Income tax payable 25%
• Other curr. liabilities 1% of sales
• No dividends, no new equity (debt is the plug).
MODEL
INCOME STATEMENT
Balance Sheet
Negative Debt
• If total value of minimum cash balance plus
all other assets is greater than current
liabilities the company needs debt.
• [Cash ratio]*Sales+Acc. Rec. + Inventory +
Prepaid exp. + Net property and equipm. –
Curr. Liab. – Com. Stock – Ret. Earn. < 0
then debt is set at 0
p.94 pro forma model
Deriving the FCF (p.90)
• Positive profit, negative cashflows
Projected FCF
• 1999 first positive cash flow (p.97)
Proposition one
Agency costs
As
WACC
• WACC= E/(E+D)*re + D/(E+D)* rD(1-Tc )
• CAPM based averages for the industry
Industry Average WACC 20.43%
and terminal value
Sensitivity Analysis
• Value as a function of WACC (row) and
terminal growth rate (column)
Sensitivity Analysis
• Share price is calculated as a unction of
two variables
Terminal Value Proxies