other financial institutions to carry out a variety of financial transactions via the website of the financial institution. Notary services - Legal documents must be verified, authenticated, certified, or attested by a notary. Stock Broking - Retail and institutional investors can purchase and sell stocks using the stockbroking service. 4.8 Learning activity 1. What features does conventional bank has? 2. Name any10 private sector banks which were granted licences by the RBI in Liberalization period. 4.9UNIT END QUESTIONS Descriptive questions A. Short questions 1. What is the meaning of traditional banking? 2. Explain the definition of bank. 3.Which features do conventional traditional banks usually have? 4.How do to interact personally in a bank? 5. What do you mean by investment banking? 51
Long questions 1. What more services do Traditional Banks provide? 2. Explain the differentiate investment banking from traditional banking. 3. Explain the features of Traditional bank. 4. What are the limitation of Traditional bank? 5. Write in briefly traditional bank. B. Multiple choice questions 1. Traditional banking commissions are ______________due to their high operating expenses. a. lower b. higher c. general d. reasonable 2. ______________has substantial operating costs because in addition to having administrative offices. a. Investment banking b. Online banking c. Commercial banking d. Traditional banking 3. Which services can traditional bankers supply, such as witnessing a document's signature and confirming the person signing's identity? 52
a. Notary b. Discounting c. Commission d. Interest rate 4. ____________- banking cannot provide notary service. a. Mobile b. Online c. Traditional d. Investment 5. Ifthere is a low saving stimulus since traditional banks often pay their savings customers a ___________ interest rate. a. low b. high c. reasonable d. too low Answers: b,2- d,3-a ,4-b ,5-a 4.10 SUGGESTED READING AND E- RESOURCES PunithavathyPandian, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, Vikas Publications Pvt. Ltd, New Delhi. 2001. Kevin.S, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, PHI, Delhi, 2011 YogeshMaheswari, INVESTMENT MANAGEMENT, PHI, Delhi, 2011 Bhalla V K, INVESTMENT MANAGEMENT: SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, S Chand, New Delhi, 2009 Prasanna Chandra, PORTFOLIO MANAGEMET, Tata McGraw Hill, New Delhi, 200 53
UNIT - 5 FINANCING 5.0 Unit Objective 5.1 Introduction 5.2 Financing alternatives including international financing, 5.3 Summary 5.4 Keywords 5.5 Unit end questions 5.6 Learning activity 5.7 Suggested Reading and E- Resources 5.0 UNIT OBJECTIVES To understand the concept of Financing To discuss Financing alternatives including international financing, 5.1 INTRODUCTION Financing is the process of providing funds for business activities, making purchases, or investing. Financial organisations like banks are in the business of lending money to individuals, businesses, and investors so they can fulfil their objectives. Any economic system that makes use of financing is essential because it enables businesses to buy goods that are out of their immediate price range. To put it another way, financing is a means to use the temporal value of money (TVM) to employ predicted future cash flows for initiatives that are started today. In order to create a market for money, financing also benefits from the fact that some people in an economy will have extra cash that they want to invest in order to earn returns, while others will need money in order to make investments (also in the aim of earning returns). 5.2 CONCEPT OF FINANCINGS The practise of raising money or capital for any form of spending is known as finance. In order to finance their operations, consumers, businesses, and governments frequently lack the cash on hand to spend, settle debt, or carry out other activities. As a result, they must borrow money or 54
sell shares. On the other side, investors and savers build up money that, if used wisely, could provide interest or dividends. These savings may build up as savings deposits, savings and loan shares, pension and insurance claims, or any combination thereof; when lent out at interest or invested in equity shares, they serve as a source of investment capital. Finance is the process of directing these resources in the form of credit, loans, or invested capital to those businesses that can use them most effectively or have the greatest need for them. Financial intermediaries are the organisations that transfer money from savings to consumers. They consist of financial institutions like commercial banks, savings banks, savings and loan organisations, as well as nonbank ones like credit unions, insurance firms, pension funds, investment firms, and finance firms.Business finance, personal finance, and public finance are three main sectors of finance that have established specialised organisations, practises, standards, and objectives. In industrialised countries, there is a complex network of financial markets and institutions to meet both the combined and individual demands of various sectors. Corporate finance is a branch of applied economics that seeks to maximise the objectives of a corporation or other business entity by using the quantitative information provided by accounting, the instruments of statistics, and economic theory. Estimating future asset requirements and choosing the best combination of funds to acquire those assets are among the fundamental financial decisions involved. Short-term credit is used for business financing in the form of trade credit, bank loans, and commercial paper. Through the operations of national and international capital markets, long-term funds are obtained through the selling of securities (stocks and bonds) to a variety of financial institutions and people. Family budgeting, the use of credit, and personal savings are the three main topics of personal finance. For the most part, people get mortgages from commercial banks and savings and loan organisations to buy their homes, while banks and finance businesses can provide financing for the purchase of consumer durables like cars and appliances. Charge accounts and credit cards are two more significant ways that banks and companies provide consumers with short-term credit.Charge accounts and credit cards are two more significant ways that banks and companies provide consumers with short-term credit. Small cash loans are available through banks, credit unions, or finance organisations for those who urgently need to consolidate their debts or borrow money. 55
Since the Great Depression of the 1930s, public, or government, finance has grown significantly in both level and importance in Western nations. Taxation, government spending, and the level of the public debt therefore often have a far greater impact on a country's economy than they did in the past. Governments fund their expenses in a variety of ways, with taxes by far the most significant of these. However, government budgets rarely balance, forcing governments to borrow in order to cover their deficits, leading to the creation of public debt. The majority of public debt is made up of marketable securities that the government has issued and that are subject to certain payment obligations to holders at specific intervals.For businesses, debt finance and equity financing are the two primary sources of funding. Debt is a loan that must frequently be repaid with interest, but because of tax deductible considerations, it is frequently less expensive than acquiring capital. While equity does not require repayment, it does transfer ownership interests to the shareholder. Both equity and debt have benefits and drawbacks. Types of Financing Equity Financing: Another phrase for a company's ownership is \"equity.\" For instance, the proprietor of a chain of grocery stores needs to expand operations. Instead of taking on debt, the owner would like to raise $1 million by selling a 10% ownership in the business for $100,000. Because the investor assumes full risk and loses everything if the business fails, companies like to offer equity.Giving away equity also entails giving up some control. Particularly in trying times, equity investors desire a role in how the business is run and frequently have voting rights based on the number of shares they own. As a result, in exchange for ownership, a shareholder offers a business money in exchange for a claim on future profits.Some investors are content with growth in the form of rising share prices; they want the price to increase. Other investors seek principle protection as well as consistent dividend payments. Benefits of Equity Finance Getting funding for your company from investors has a number of benefits, such as the following: 56
The fact that you are not required to repay the money is the largest benefit. Your investor or investors are not considered creditors if your business declares bankruptcy. They are a portion owner in your business; thus their money is gone along with yours. There is frequently more money available for running costs because you do not have to make monthly payments. Investors are aware that starting a firm requires patience. You won't be under any pressure to have your product or company succeed in a short period of time; instead, you'll obtain the money you require. Issues with Equity Financing Similar to debt financing, equity financing has a number of drawbacks, such as the following: What are your thoughts on getting a new partner? Gaining equity funding necessitates ceding some of your company's ownership. The investor will desire a larger stake in a riskier investment. You might have to give up 50% or more of your business, and that partner will always receive 50% of your profits unless you eventually work out a contract to purchase the investor's portion. You will also have to consult with your investors before making decisions. If the investor owns more than 50% of your business, it is no longer just yours, and you now have a boss you are responsible to. Debt Financing Because they have student loans or mortgages, the majority of individuals are familiar with debt as a means of finance. Another typical method of financing for startup companies is debt. Debt finance needs to be returned, and lenders expect to be compensated with interest in return for using their funds. Some lenders demand security. Assume, for instance, that the proprietor of the grocery business also determines they require a new truck and must obtain a loan for $40,000 to do so. The grocery shop owner consents to pay 8% interest to the lender until the loan is repaid in five years, and the truck may be used as collateral against the loan. 57
For small sums of money required for particular items, borrowing money is simpler, especially if the asset may be used as collateral. Even in bad circumstances, debt must be repaid, but the corporation still owns and controls its business. Debt financing benefits Debt financing has a number of benefits for your business: The lending institution has no ownership over your business and has no influence over how you run it. Your connection with the lender is terminated once you have repaid the loan. As the value of your company increases, this becomes increasingly crucial. You can deduct debt financing interest from your taxes as a business expense. You may precisely include the monthly payment and its breakdown in your forecasting models because it is a known expense. Disadvantages of Debt Financing There are some drawbacks to using debt financing for your company: The assumption made when adding a debt payment in your monthly expenses is that you will always have enough money coming in to cover all operating costs, including the debt payment. For small or emerging businesses, that is frequently far from assured. During recessions, financing to small businesses may be significantly slower. Receiving debt finance becomes more challenging when the economy is struggling, unless you are abundantly qualified. 5.3 FINANCING ALTERNATIVES INCLUDING INTERNATIONAL FINANCING A diverse collection of investments that differ typical long-only, publicly traded investments in stocks, bonds, and cash are referred to as \"alternative investments\" (often referred to as traditional investments). The phrases \"conventional\" and \"alternative\" should not be interpreted to mean that alternatives are uncommon or that they are relatively new to the world of investing. Real estate and commodities, which are probably two of the oldest types of investments, are examples of alternative investments. 58
Alternative investments also include unconventional ways to invest in specialised vehicles like hedge funds and private equity firms. These funds might enable the management to use leverage, derivatives, invest in illiquid assets, and take short positions. These vehicles may invest in both conventional assets (such as stocks, bonds, and cash) and nonconventional assets. Alternative investment management is often active. Many of the following traits are frequently found in alternative investments: Limited area of expertise among investment managers Returns have a relatively poor link to returns from traditional investments. Less transparency and less oversight than conventional investing Historical risk and return statistics are scarce. Special tax and legal considerations Higher costs, frequently including incentive or performance fees Specialised portfolios Redeeming restrictions (also known as \"lockups\" and \"gates\") Bankers’ Acceptance: Banker's acceptance (BA), which has been around for millennia, is frequently used to finance international trade. Time draughts or bills of exchange drawn on and approved by a bank are referred to as BAs. By 'accepting' the draught, the bank commits unconditionally to paying the draft's owner the agreed-upon sum when it matures.Thus, the bank substitutes a borrower's credit for its own in effect. BA is a freely tradeable negotiable instrument.The bank first purchases (discounts) the BA and pays the drawer (exporter) a sum less than the draft's face value before selling (rediscounting) the BA to a money market investor. The reduction accounts for the time worth of money.When it matures, the bank pays the investor who presents it in full. By definition, banker's draughts are time draughts with maturities of 30, 60, 90, or 180 days. The receiving bank's cost varies according on the maturity period and the borrower's creditworthiness. Discounting: 59
Exporters can \"discount\" the draught in order to turn their credit sales into cash, even if the bank does not accept it. The bank reduces the draft's face value by deducting interest and commissions. Discounting could be done either \"with\" or \"without\" recourse. In the case of \"with recourse\" discounting, the bank can collect from the exporter if the importer doesn't pay, whereas in the case of \"without recourse\" discounting, the bank is responsible for taking on the collection risk. Due mostly to the government's export promotion programmes and subsidies, discounting rates are typically cheaper in many countries, including India, than other forms of finance, including as loans, overdrafts, etc. Accounts Receivable Financing: Goods are supplied to the importer in an open account shipment or time draught without a bank's guarantee of payment. Banks frequently lend money to exporters depending on their creditworthiness, and the loans are typically backed by an assignment of their receivables.Even if the importer is unable to pay the exporter for any reason, the exporter is still obligated to reimburse the bank for the loan. Typically, such funding lasts between one to six months. Banks frequently require export credit insurance before funding international receivables due to added risks including government regulation and exchange restrictions. Factoring: Short-term transactions frequently employ factoring as a continuing arrangement. It entails the factor purchasing export receivables at a discounted price, or often 2% to 4% less than the full value. The type of product, the contract's conditions, etc. are a few more elements that affect the discount, too.In general, factors provide advances of up to 85% of the value of unpaid invoices. The exporter is still at danger of the importer not paying, even though the factor performs the factoring service with recourse to the seller. As the factor accepts the credit and non-payment risks, factoring may also be without recourse. Forfeiting: The word \"forfeiting\" comes from the French verb fait, which meaning to give up or abandon one's rights. Therefore, forfeiting is the act of an exporter giving up their claim to a receivable 60
that will be payable at a later time in exchange for an upfront payment of cash at a discounted rate, shifting all risks and the burden of collecting the debt to the forfeiter.Forfeiture is frequently used for medium-term credit sales (1 to 3 years) and entails the exporter issuing a bill of exchange or the buyer issuing promissory notes with a bank and the buyer's nation guaranteeing payment.Receivables are discounted through the process of forfeiting, usually through negotiations with bills drawn on L/Cs or co-accepted bills of exchange. In general, forfeiting is applied when products are exported on credit and the export receivables are backed by the bank of the importer.Thus, the risk can be purchased by the forfeiting bank \"without recourse\" to the exporter. The financing terms are mostly determined by the buyer's nation risk, the scope of the contract, and the viability of the bank that opens the L/C or the bank providing the guarantee.In exchange for quick cash payment, the exporter forfeits their right to pursue payment for the items they have already shipped. Therefore, an exporter has the option to convert a credit sale into a cash transaction with no recourse. Letters of Credit: International transactions continue to use one of the oldest types of international financing. Under a written guarantee, the issuing bank agrees to pay the exporter, who is the beneficiary, provided that certain requirements are met. Between the issuing bank and the beneficiary, there is a debt relationship as a result of the procedure.When an importer receives the goods but does not pay the exporter, terms credit is frequently utilised as a financing tool. Counter-Trade: Using counter-trade, one transaction can include price setting and trade financing. It includes several different types of reciprocal exchanges, including barter, clearing agreements, switch trading, counterpurchases, buy-backs, and offsets. In the form of reciprocal pledges from nations with payment issues, particularly in hard currencies, countertrade finances imports. 5.4 SUMMARY Financing is the process of providing funds for business activities, making purchases, or investing. 61
Financial intermediaries are the organisations that transfer money from savings to consumers. Corporate finance is a branch of applied economics that seeks to maximise the objectives of a corporation or other business entity by using the quantitative information provided by accounting, the instruments of statistics, and economic theory. Banker's acceptance (BA), which has been around for millennia, is frequently used to finance international trade. Exporters can \"discount\" the draught in order to turn their credit sales into cash, even if the bank does not accept it. Discounting could be done either \"with\" or \"without\" recourse. Short-term transactions frequently employ factoring as a continuing arrangement. The word \"forfeiting\" comes from the French verb fait, which meaning to give up or abandon one's rights. 5.5 Keywords Forfeiting - With the help of an intermediary, exporters can obtain quick cash by selling their medium- and long-term receivables—the money that the importer owes the exporter—for a discount. Letter of Credit - A letter of credit is a written promise from a bank or other financial institution that a seller will get paid promptly and in full by a buyer. Counter Trade - A reciprocal kind of international trade known as countertrade involves exchanging one good or service for another in place of hard currency. Account receivable - The balance of money owed to a business for goods or services delivered or utilised but not yet paid for by clients is known as accounts receivable (AR). Exporters - one who specifically exports: a wholesaler who sells to retailers or industrial customers abroad. 5.6Learning activity 1. What do you mean by Equity Financing? 62
2. What is Debt financing? 5.7 UNIT END QUESTIONS Descriptive questions A. Short questions 1. What is a financing? 2. Describe the term Bankers’ Acceptance 3. Discuss the term Letters of Credit. 4. What do you mean by business finance? 5. Explain the term Counter-Trade. Long questions 1. Explain the advantages and disadvantages of Debt Financing. 2. Discuss the advantages and disadvantages of Equity Financing. 3. Write short note on Financing. 4. Explain the difference between Equity and Debt financing. 5. Describe the financing alternatives including international financing 6. Explain the various types of financing. B. Multiple choice questions 1. Business finance is a form of applied economics that uses the quantitative data provided by: a. accounting b. costing c. financing 63
d. managing 2Which three major categories of finance have specific institutions, practises, norms, and objectives? a. business finance, organisation finance, and public finance b. business finance, Trade finance, and general finance c. business finance, personal finance, and public finance d. business finance, personal finance, and Holiday finance 3. Which credit used for business financing comes in the form of trade credit? a. Short term b. Long term c. Mode term d. Medium term 4. _____________is the time draft or bill of exchange drawn on and accepted by a bank. a. Bankers Rejected b. Bankers’ Acceptance c. Accounts Receivable Financing d. Discounting 5. Exporters can convert their credit sales into cash by way of ____________ a. Forfeiting b. Financing c. Factoring d. Discounting’ Answers: 64
a,2-c ,3-a ,4-b ,5-d 5.8 SUGGESTED READING AND E- RESOURCES PunithavathyPandian, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, Vikas Publications Pvt. Ltd, New Delhi. 2001. Kevin.S, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, PHI, Delhi, 2011 YogeshMaheswari, INVESTMENT MANAGEMENT, PHI, Delhi, 2011 Bhalla V K, INVESTMENT MANAGEMENT: SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, S Chand, New Delhi, 2009 Prasanna Chandra, PORTFOLIO MANAGEMET, Tata McGraw Hill, New Delhi, 2008. 65
UNIT - 6 TRANSACTION ANALYSIS 6.0 Unit Objective 6.1 Introduction 6.2 Transaction analysis 6.3 Comparable Companies Analysis 6.4 Precedent Transactions analysis 6.5 Summary 6.6 Keywords 6.7 Learning activity 6.8 Unit end questions 6.9 Suggested Reading and E- Resources 6.0UNIT OBJECTIVES To discuss about Transaction analysis To anlayseComparable Companies Analysis To understand Precedent Transactions analysis 6.1 INTRODUCTION Comparable company analysis, sometimes known as \"comps,\" is a way of determining a business's value by examining the ratios of other, comparable public companies. Contrary to discounted cash flow (DCF) analysis, which is an intrinsic form of valuation, comparables are a relative form of valuation. Using data from previous merger and acquisition (M&A) deals, precedent transaction analysis is a technique for valuing businesses. This approach of valuation, often known as \"precedents,\" is frequently created by analysts working in investment banking, private equity, and corporate development when attempting to value a whole organisation as part of a merger or acquisition. 66
6.2 CONCEPT OF TRANSACTION ANALYSIS DEVLOPMENT OF TRANSAVTIONAL ANALYSIS Modern psychology's transactional analysis, created by psychiatrist Eric Berne, looks at a person's interactions and relationships. In order to create transactional analysis, Berne drew inspiration from Sigmund Freud's ideas of personality and combined them with his own observations of human interaction. To create and reinforce the idea that each person is valued and has the potential for positive transformation and personal growth, transactional analysis can be used in therapy to examine one's interactions and communications The term \"transaction\" refers to the basic unit of social contact, and Dr. Eric Berne created transactional analysis in the 1950s. Transactional analysis is the study of social interactions between people. René Spitz, Erik Erikson, Paul Federn, Edoardo Weiss, Freud, and Canadian neurosurgeon Wilder Penfield were among his contemporaries who influenced him.Berne created a method that he referred to as both neo- and extra-Freudian, which was influenced by Penfield's groundbreaking experiments involving the electrical stimulation of particular brain regions. Penfield's work involved stimulating specific brain regions to produce a variety of emotions, attitudes, and complex behaviour. Berne developed his own observable ego states of Parent, Adult, and Child after Freud proposed the existence of the Id (emotional and irrational component), Ego (rational component), and Superego (moral component) as distinct and unobservable factions of personality. Berne saw the need to expand upon the philosophical concepts Freud introduced with observable data. Berne paid particular attention to the difficulties of human communication. He emphasised the possibility that a recipient may view facial expressions, gestures, body language, and tone as being more significant than any spoken words. He remarked that humans occasionally express signals that are supported by ulterior objectives in his book Games People Play. Transactional analysis aims to strengthen the Adult state in the individual receiving therapy so they can obtain and keep their autonomy. Usually, a contract will be made between the patient and the therapist outlining the goals for the therapy session. This could encourage the therapist's patient to accept accountability for things that happen in therapy. After that, the person will typically be better able to rely on their Adult ego states to recognise and 67
analyse various thoughts, actions, and emotions that might impede their potential to flourish. Transactional analysis thrives in a setting of warmth, security, and deference. A healthy relationship that develops between the therapist and the patient seeking treatment frequently serves as a template for other relationships that are later built outside of the ther apy setting. Analysts who practise this type of therapy typically draw on a wide range of techniques from other fields, such as relational, cognitive behavioural, and psychodynamic treatments. 6.3 COMPARABLE COMPANIES ANALYSIS Comparably Company Analyses, often known as \"Comps,\" are a method of relative valuation that determines the worth of a company by contrasting its valuation multiples with those of its competitors. The multiples are typically a ratio of some valuation parameter, like equity market capitalization or enterprise value, to some financial performance statistic, like earnings per share (EPS), sales, or EBITDA. (An astute reader will recognise that Earnings/EPS is an equity- related statistic and should be used with Market Capitalization whereas Sales and EBITDA are enterprise-wide metrics and should be used with Enterprise Value.) The fundamental tenet is that, with all other factors being equal, businesses with comparable traits should trade at comparable multiples. WHY DO COMPS WORK? Comps are fairly simple to run, and the data they require is typically readily available (provided that the comparable companies are publicly traded). Comps should offer an acceptable valuation range, but other valuation methods like DCF depend on a wide range of assumptions, assuming that the market is efficient in pricing the securities of other companies Comps are among the valuation approaches that are most commonly utilised in practise because of these factors. Comps are used by investment bankers, sell-side analysts, private equity investors, and other market experts. They do, however, have some drawbacks. PROs and CONs of Using Comps PROs CONs 68
With readily available data, it is simple to Transitory market conditions or non- determine. fundamental factors having an impact Simple to communicate with a wide range of When there are few or no comparable market players. companies, it is useless. Establish a reference price for the valuation Finding suitable comparable companies may multiples. be challenging for a variety of reasons. Describe a practical method for evaluating When comparable firms are lightly traded, it market assumptions about fundamental becomes less reliable. elements incorporated into valuations. Table No 6.1 Pros And Cons Of Using Comps Essential terms. Comparable company analysis compares businesses using comparable criteria in order to ascertain their enterprise value. Whether a company is overvalued or undervalued is determined by its valuation ratio. The ratio indicates overvaluation if it is high. If it's low, the business isn't worth enough. Enterprise value to sales (EV/S), price to earnings (P/E), price to book (P/B), and price to sales (P/S) are the most often utilised valuation metrics in comparable business comparison. Establishing a peer group of comparable businesses in the same sector or locale that are similar in size is the first step in doing a comparable company analysis. Investors can then do a relative comparison of a specific company to its rivals. This data can be used to compute a company's enterprise value (EV) and other ratios that are used to evaluate a company in relation to others in its peer group. Comparable comps are simply establishing how to perform relative valuations in the manner of a professional to determine the firm's fair value. Finding comparable companies, choosing the best techniques for valuation, and creating a table that can make it simple to draw conclusions about the fair value of the company and the industry are the first steps in the comparable comp process. 69
How to Identify Comparable Companies Finding the appropriate selection of comparable is the most crucial component of comparative analysis. It makes no sense to compare the worth of apples and oranges in this situation. A preliminary analysis of comparable businesses is crucial, and it often consists of the following three steps: a) Identifying the industry Make an effort to narrow down the industries that the companies fall under. The fact that different sources might include different sectors for the same company and that different sources would use different industry names can be irritating. In general, the existing classifications are rather wide and cannot be relied upon entirely. Try to find some keywords related to the business descriptions of the companies if there is uncertainty regarding the industry classification (which is typically the case). For instance, the appropriate keywords for a building materials company might be roofing, plumbing, framing, insulation, tiling, construction service, etc. Although this example is straightforward, in order to apply it to real-world situations, one must first identify the value and the value driver and then make a number of modifications. Understand the Company description In order to choose comparable organisations, it is crucial to comprehend the business. Make an effort to learn the company's thorough business description. The following sources, in order of preference, could be used for this:The company website Business filings (Latest 10K, Annual Report, etc.) c) Google Finance Research reports and corporate filings provide actual segment data to give a true business mix of the company, but company websites are particularly helpful in helping to visualise all the products and services. 70
c) Identify key competitors In order of preference, the following sources might be used to locate comparable businesses Study Reports Yahoo Finance's Competitors and Industry sections; Company Filings' Competition Section The Competitors and Industry parts of Hoovers TYPES OF MULTIPLES Multiples of several kinds can be employed in a Comps analysis. Operating multiples and equity multiples are the two main categories into which multiples can be divided. While equity multiples refer to the value gained from the company that is accessible to equity/shareholders, operating multiples refer to the operating performance of the business as a whole. Common multipliers for Comps are as follows: EV/Sales: The Enterprise value of the company divided by Sales/Revenue (Operating multiple) EV/EBITDA: The Enterprise value of the company divided by EBITDA (Operating multiple) P/E: Price/Earnings ratio for a company (Equity multiple). This is either calculated as Share Price ÷ EPS, or Market Capitalization ÷ Earnings (they are mathematically equivalent). P/B: 71
Price/Book ratio for a company (Equity multiple). This is either calculated as Share Price ÷ Book Value per Share, or Market Capitalization ÷ Shareholders’ Equity (they are mathematically equivalent). P/(Levered) Cash Flow: Price/Cash Flow ratio for a company (Equity multiple). This is either calculated as Share Price ÷ Levered Cash Flow per Share, or Market Capitalization ÷ Levered Cash Flow (they are mathematically equivalent). The numerator for the computation of operating multiples is enterprise value, whereas the numerator for the calculation of equity multiples is market capitalization. Generally speaking, neither EV nor market capitalization should be used for performance indicators that pertain to equity or the firm. STEPS TO REMEMBER FOR EXECUTING A COMPS VALUATION 1. Select a Peer Universe: Pick a group of competitor/similar companies with comparable industries and fundamental characteristics. 2. Calculate Market Capitalization: It is equal to Share price × Number of Shares Outstanding. 3. Calculate Enterprise Value: Market Capitalization + Debt + Preferred Stock + Minority Interest (less common) – Cash. 4. Historical & Projected Financials: Use historical financials from filings and projections from management, sell-side equity analysts, etc. 72
5. Spread Multiples: Using Market Capitalization, Enterprise Value and historical/projected financials, spread (i.e., calculate) EV/EBITDA and P/E multiples. 6. Value Target Company: Pick the appropriate benchmark valuation multiple for the peer group, and value the target company based on that multiple. Typically, an average or median is used. Comparable Company Analysis Method The next step is learning how to do a comparable company study after you have an understanding of what it entails. Here, we'll go over how to build the table. This will be crucial since it will give you the information to compare your business and determine its value. Analysts, investment bankers, business developers, equity researchers, and even private equity investors frequently carry out this approach. These are the steps in a comparable company analysis: Company EV/Rev EV/EBITD A 2016 2017 2018 2019 2020 2016 2017 2018 2019 2020 ADOBE INC. 8.10 11.78 13.93 13.62 17.85 30.17 38.32 42.92 44.18 52.22 AVID 0.64 0.89 0.88 1.30 2.33 3.74 27.21 17.94 15.97 22.94 TECHNOLOGY INC. CORELOGIC INC. 2.44 2.99 3.08 3.53 4.83 11.17 13.29 12.77 15.34 15.61 73
Company EV/Rev EV/EBITD A INTERNATIONAL 2.41 2.25 1.70 2.25 2.18 14.23 13.55 10.26 16.48 23.67 BUSINESS MACHINE CORP Average 3.40 4.48 4.90 5.17 6.80 14.82 23.09 20.97 22.99 28.61 Median 2.43 2.62 2.39 2.89 3.58 12.70 20.38 15.35 16.22 23.31 25th Percentile 1.97 1.91 1.50 2.01 2.29 9.31 13.49 12.14 15.81 21.11 75th Percentile 3.86 5.19 5.79 6.05 8.08 18.21 29.99 24.18 23.40 30.81 Table No 6.2 Comparable Company Analysis Method 1. ANALYZE THE TARGET COMPANY The analysis of the target company is the first phase in this procedure. Given that it is largely subjective, this is one of the most difficult aspects in the process. An analyst will compile all the data on the relevant company from certain websites, which will enable you to obtain an industry classification and an in-depth summary of the business. In order to identify comparable companies that have the same attributes as your company in the future, you must now acquire the correct information about the company. The following step is to look for companies in your sector that have traits that are similar to yours. For your valuation, the more comparable the company, the better. A screening and a criterion will be done by the analyst who is performing this process. The selection procedure will involve: 74
Geography Growth rate Size Profitability Industry classifications Margins Fig no 6.1 Comparable Company Analysis 2. SET COMPARABLE CRITERIA You must then compile all of the information on their financials once you have identified the businesses that are comparable to and important to your target firm. These companies' information can be found online on a variety of websites. Depending on the stage of the business' lifecycle and the sector, different data will be needed. The information you need will be the EPS and the EBITDA if the companies you are comparing are mature. When evaluating immature businesses, you must consider their income or gross profit. 3. FIND AND SELECT THE RIGHT COMPARABLE COMPANIES – CREATE A PEER GROUP You must choose the appropriate candidates from the list of businesses that are most similar to your target firm after gathering the pertinent information about them. After choosing similar businesses, compile all of their information into a peer group. 75
4. COLLECT NECESSARY FINANCIAL DATA You must make a table and enter all the data you have acquired once you have identified all the appropriate comparable businesses. You can analyse them better if you do this. The following data must be included in the table for comparison: Company name EPS EBITDA Revenue Net Debt Analyst estimates Share price Value of the Enterprise Market Data Financial Data Valuation Comp Price/ Mar TEV Sales EBIT EBI Earni EV/Sa EV/EBI EV/E P/ BIT E any sh ket DA T ngs les TDA - - Name Cap - - - - Chivit 76.28 336,0 370,2 93,70 26,208 22,2 14,762 - - a 11,236 - - Pepsi 162.7 82 44 8 54 4 247,7 287,6 132,8 24,688 19,7 66 48 30 56 Coco- 104.6 20,65 25,52 11,99 2,638 2,20 1,240 - - Cola 2 2 8 4 6 Red 1399. 23,23 22,00 4,492 1,212 1,16 714 - - -- Bull 24 6 4 8 76
Power 41.62 1,928 1,936 1,290 156 132 82 - - - Horse Table no 6.3 data 5. CALCULATE MULTIPLES OF COMPARABLE COMPANY The analyst must now begin calculating the pertinent ratios using all the necessary data in one location. The value of the intended company will be calculated using these ratios. The analyst must compute the following ratios: P/E (price-earnings ratio) P/B (price-book ratio) P/NAV (price-net asset value ratio) EV/ Gross Profit (enterprise value-gross profit ratio) EV/Revenue (enterprise value-revenue ratio) EV/EBITDA (enterprise value-earnings before interest, tax, depreciation, amortization) 6. APPLYING MULTIPLES TO THE TARGET COMPANY In order to determine the value, the analyst will need to apply the multiples to the pertinent financial information of the target company. The following are suggestions for using the range of multiples: The CFO, equity from the most recent fiscal year, EBITDA, and sales figures for the target company in the past. The targeted company's anticipated data will typically be used to get the business ready for the analyst. 7. DETERMINE THE VALUATION Typically, an analyst will use the median or average of the multiples for the comparable company and apply it to the measures in the table, such as EBITDA, gross profit, net 77
income, and revenue. The analyst will eliminate the outliers and manipulate the figures till they appear realistic or pertinent in order to calculate a reasonable average. Let's use an example: If the average P/E ratio for the group of comparable companies is 13, the analyst would multiply the target company's earnings by 13 to determine the equity value. 6.4 PRECEDENT TRANSACTIONS ANALYSIS Precedent Transactions Analysis, also known as \"M&A Comps\" or \"Comparable Transactions,\" determines the value of the present transaction by comparing it to the prices paid for comparable companies in the past. Additionally, it provides a projected implied stock price in the event of an acquisition. Keep in mind, though, that it produces the acquisition price of the company at the moment the transaction closes, not today. PTA employs the price paid by the buyer for a business as the basis for valuation as opposed to comparable companies analysis (comps), which uses the traded market prices of the company's securities. PTA produces a higher valuation than other approaches because it frequently considers the control premium (the value connected with controlling the business rather than holding a share of ownership). Why do we even try to use previous transactions analysis when it has so many problems and restrictions? PTA is occasionally favoured above other approaches for a number of reasons. To determine the value of a private company without public trading comparables To determine the level of market interest in a particular industry To find prospective buyers for purchased firms If a corporation is looking to acquire another company, to find possible sellers. Steps to Perform Precedent Transaction Analysis: 1. Search for relevant transaction The first step in the procedure is to serach for similar transactions that have taken place in recent (preferably) past and are in the same sector. 78
Setting criteria like these is necessary for the screening process. Industry classification Type of business (public, private, etc.) Financial indicators (revenue, EBITDA, net income) Geographical (headquarters, revenue mix, customer mix, employees) Business size (revenue, employees, locations) Product mixture (the more similar to the company in question, the better) The type of buyer (public/private, strategic/competitor, private equity) Deal volume (value) Value (many paid; for example, EV/Revenue, EV/EBITDA, etc.) A financial database like Bloomberg or CapIQ can be used to define the aforementioned criteria, which can then be exported to Excel for more research. 2. Examine and improve the transactions that are provided. It's time to begin filtering out the transactions that don't fit the current circumstance after the initial screen has been completed and the data has been entered into Excel. An analyst must \"clean\" the transactions by carefully examining the business descriptions of the listed organisations and deleting any that don't satisfy the criteria for sorting and filtering. If the deal conditions weren't made public, many transactions would have missing or incomplete information. A press release, equity research study, or other source that includes deal metrics will be sought after diligently by the analyst. If nothing is discovered, those businesses will be crossed off the list. 3. A range of valuation multiples should be determined. The average, or chosen range, of value multiples can be determined once a shortlist has been created (by doing processes 1 and 2). EV/EBITDA and EV/Revenue are the most often used multiples for antecedent transaction analysis. 79
Any extreme outliers, such as deals with EV/EBITDA multiples that were significantly lower or higher than usual, may be excluded by an analyst (assuming there is a good justification for doing so). 4. Calculate the valuation multiples for the questioned company. These ratios can be applied to the financial indicators of the company in issue after a range of valuation multiples from prior transactions has been established. If the valuation range was, for instance, as follows: • 4.5x EV/EBITDA (low) • 6.0x EV/EBITDA (high) Additionally, the company in question has an EBITDA of $150 million. The company is valued between: $675 million (low) to $900 million (high) 5. Graph the results (with other methods) in a football field It's crucial to graph the results once a valuation range has been established for the company being assessed so they can be clearly understood and contrasted with other approaches. The most effective technique to clearly illustrate the numerous approaches on one page is with the football field graphic. The chart's primary valuation techniques are: Analysis of comparable businesses Analyzing prior transactions 80
DCF evaluation Analysis of ability to pay 52-week high-low (if a public company) How to Precedent Transaction Analysis Works In order to provide a credible approximation of the multiples or premiums that others have paid for a publicly traded company, precedent transaction analysis uses information that is readily accessible to the general public. The research looks at the types of investors who have bought comparable businesses under comparable conditions in the past and assesses the likelihood that the corporations making the acquisitions will shortly make another acquisition.Finding the most relevant transactions is one of the most crucial aspects of prior transaction analysis. The first criteria for choosing companies is that they should belong to the same industry and have comparable financial features. Second, the magnitude of the transactions should be comparable to the transaction that the target firm is considering. Third, the sort of transaction and the buyer's qualities ought to be comparable. In terms of analytical value, more recent transactions are regarded as more valuable. Identify the precedent transaction analysis The choice of the most pertinent transactions will determine how well a previous transaction analysis turns out. Several factors need to be taken into account while selecting relevant transactions: Industry and financial traits – The business and financial traits of the target organisation should be comparable. Deal size: Transactions that are roughly equivalent in size to the one under consideration are more important than those that are significantly smaller or larger Characteristics specific to the transaction – 81
In order to derive relevant insights, it is required to comprehend the context and circumstances of the transaction (e.g. strategic vs. financial buyer, domestic vs. cross-border, full auction vs. negotiated deal, underlying market conditions) Timing – The benchmark is more meaningful the more recent the data is. Advantages of Precedent transactions analysis Based on public information Realistic in the sense that prior deals at particular valuation levels were successfully concluded. As a result, the research shows a range of plausibility for multiples or premiums offered to public stock prices. Could reveal patterns like consolidated acquisitions, international buying, financial buyers, etc. It Could also reveal which industry participants are consolidators or aggressive buyers. Assists in determining the market demand for various sorts of assets (i.e. frequency of transactions and multiples paid) Disadvantage of Precedent transactions analysis Limited and inaccurate public data about previous transactions may be available. Valuation can be significantly impacted by market conditions at the time of a transaction (e.g. business cycle, competitive environment, scarcity of the asset) Not all characteristics of a transaction (such as the existence of commercial agreements or governance difficulties; the Section 338(h)(10) election) can be accounted for in valuation multiples. Values obtained can be of limited use because they frequently cover a wide range. Transactions are rarely directly comparable to those in the past because each one involves a different set of special conditions. 82
6.5 SUMMARY Comparable company analysis, sometimes known as \"comps,\" is a way of determining a business's value by examining the ratios of other, comparable public companies. The term \"transaction\" refers to the basic unit of social contact, and Dr. Eric Berne created transactional analysis in the 1950s. Transactional analysis thrives in a setting of warmth, security, and deference. Comparably Company Analyses, often known as \"Comps,\" are a method of relative valuation that determines the worth of a company by contrasting its valuation multiples with those of its competitors. Precedent Transactions Analysis, also known as \"M&A Comps\" or \"Comparable Transactions,\" determines the value of the present transaction by comparing it to the prices paid for comparable companies in the past. 6.6 KEYWORDS Enterprise value-to-revenue multiple - The enterprise value-to-revenue multiple (EV/R) compares a company's enterprise value to its revenue in order to determine the stock's value. P/E ratio - Investors can use the P/E ratio to determine whether a company's stock is overvalued or undervalued in relation to its earnings. Market capitalization - The total value of the outstanding common shares owned by stockholders of a publicly traded firm is its market capitalisation, often known as market cap. Target Value - A process' preferred numerical goal for the desired quality attribute is known as its target value. Net debt - If all debts were paid off, a company's net debt would indicate how much cash would be left over and if it would have adequate liquidity to pay its debt commitments. 83
6.7LEARNIG ACTITIVITY 1. On what does Transactional analysis thrives? 2. What is the another name for Precedent Transactions Analysis? 6.8 UNIT END QUESTIONS A. Descriptive questions Short questions 1. Describe the Precedent Transactions analysis. 2. Explain the important keywords of transactional analysis. 3. What is a goal of transactional analysis? 4. Discuss the transactional analysis Long questions 1. Discuss the development of transactional analysis 2. How to Identify Comparable Companies? 3. Explain the steps to Perform Precedent Transaction Analysis 4. How to Precedent Transaction Analysis Works? 5. Explain the Advantages and disadvantages of Precedent transactions analysis Multiple choice questions 1. Dr. Eric Berne developed transactional analysis in the last ______________ 84
a. 1951 b. 1950 c. 1949 d. d.1952 2. ______________is a valuation method in which the price paid for similar companies in the past is considered an indicator of a company’s value. a.Investment transaction analysis b.Precedent transaction analysis c.Precedent transaction analysis d.Traditional transaction analysis 3. EV/S stands as _________________ a. enterprise value to sales b. enterprise value to system c. enterprise value to save b. d enterprise value to specific 4. _______________is the process of comparing companies based on similar metrics to determine their enterprise value. a. Traditional company analysis b. Comparable company analysis c. Precedent company analysis d. Compatible company analysis 5. Transactional analysis, developed by psychiatrist _________ a. Paul Federn, 85
b. Edoardo Weiss c. Paul Federn d. Eric Berne Answers: b,2-c ,3-a ,4- b,5-d 6.9 SUGGESTED READING AND E- RESOURCES PunithavathyPandian, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, Vikas Publications Pvt. Ltd, New Delhi. 2001. Kevin.S, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, PHI, Delhi, 2011 YogeshMaheswari, INVESTMENT MANAGEMENT, PHI, Delhi, 2011 Bhalla V K, INVESTMENT MANAGEMENT: SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, S Chand, New Delhi, 2009 Prasanna Chandra, PORTFOLIO MANAGEMET, Tata McGraw Hill, New Delhi, 2008. 86
UNIT – 7 DISCOUNTED CASH FLOW ANALYSIS 7.0 Unit Objective 7.1 Introduction 7.2 Discounted Cash flow analysis 7.3 Identify Key Characteristics of the Target 7.4 Summary 7.5 Keywords 7.6 Learning objective 7.7 Unit end questions 7.8 Suggested Reading and E- Resources 7.0UNIT OBJECTIVES To understand Discounted Cash flow analysis To identify Key Characteristics of the Target 7.1 INTRODUCTION A financial model known as the \"Discounted Cash Flow Model,\" or \"DCF Model,\" estimates future cash flows of an organisation then discounts those projections to determine the company's present value. A DCF has the distinction of being widely utilised in both practise and academia. For investment bankers, private equity, equity research, and \"buy side\" investors, valuing businesses using the DCF is seen as a fundamental skill. The DCF model calculates an organization's intrinsic value (value based on an organization's capacity to produce cash flows) and is frequently used to compare an organization's intrinsic worth to its market value. 7.2 CONCEPT OF DISCOUNTED CASH FLOW ANALYSIS 87
The discounted cash flow (DCF) analysis approach lowers the projected future cash flows to determine the investment value. DCF analysis is frequently employed in both the investing business and corporate finance management since it can be used to value a stock, company, project, among many other assets or activities.After accounting for the time value of money, DCF analysis calculates the value of return that an investment produces. It can be used for any investments or initiatives that are anticipated to provide future cash flows. The DCF and the initial investment are frequently contrasted. The investment is profitable if the DCF exceeds the current cost. The investment yields a bigger return the higher the DCF. Whenever the DCF is less than the current investors should rather hold the cash.Estimating future cash flows over a certain time period and the investment's terminal value are the first steps in a DCF analysis. Your investment horizon could be the estimation term. If extra investment is needed during that time, a future cash flow could be negative.The next step is to choose the right rate to discount the future cash flows to the present. The discount rate is often the cost of capital, which varies greatly depending on the project or investment. The weighted-average cost of capital (WACC) method can be used if a project is funded by both loan and equity. (a) Calculation of Discounted Cash Flow (DCF) In a compounding environment, DCF analysis takes time value of money into account. The formula below can be used to compute DCF after predicting future cash flows and calculating the discount rate: The CFn value should comprise both the expected cash flow of that period and the terminal value. The calculation of net present value (NPV), which adds the present values of all future cash flows, is remarkably similar to the formula. The original investment is not subtracted in DCF, which is the only distinction. 88
Here is an illustration to help you understand. A $150,000 initial investment is needed by a business for a project that will produce cash flow over the following five years. In the first two years, it will produce $10,000; in the third year, $15,000; in the fourth year, $25,000; and in the fifth year, $20,000 with a terminal value of $100,000. The DCF of the project can be computed as follows if the cost of capital is 5% and no additional investments are needed during the duration: This project will generate a total cash return of $180,000 after five years, which is more than the initial investment and appears to be lucrative even without taking time value of money into account. The present value of the return, however, is only $146,142 after discounting the cash flow of each year; this is less than the initial investment of $150,000. It implies that the business shouldn't finance the initiative. How to used DCF? To make wise investment selections, investors must forecast and discount the predicted cash flows when they are considering an investment in a stock, business, etc. An investment is cheap and may be a potentially profitable investment if its price is less than the total of its discounted cash flows. The asset is most likely overvalued if the price exceeds the total of discounted cashflows.The DCF calculation examines a company's current worth by estimating its future cash flows or earnings, making it suited for particular businesses or industries. This calls for estimation and assumption regarding, among other things, future business development and profitability.Simply put, this valuation approach is best for bigger businesses with a somewhat steady development trajectory. For predicting the growth of smaller organisations or those that endure volatility, it might not be effective. As a result, sectors like utilities, oil and gas, etc., use 89
DCF more frequently because their income, spending, and growth are generally consistent over time. 6 Steps to Building a DCF The DCF model is based on the idea that a company's value is solely determined by its projected future cash flows. Consequently, defining and computing the cash flows that a business generates represents the first barrier in developing a DCF model. There are two typical methods for figuring out the cash flows that a company produces. Unlevered DCF approach The operating cash flows are projected and discounted. You may simply add any non-operating assets, like cash, and deduct any financing-related liabilities, like debt, once you have a current value. Levered DCF approach After cash flows to all debt (i.e., non-equity claims) have been subtracted, forecast and discount the cash flows that are still available to equity stockholders. Although it can be challenging to achieve exact equality in practise, both should ultimately result in the same value. Since it is the most used, the unlevered DCF technique is the main topic of this guide. There are 6 phases in this method: 1. Forecasting unlevered free cash flows After taking into account all operating costs and investments, step one is to anticipate the cash flows a business generates from its main operations. \"Unlevered free cash flows\" are the name given to these cash flows. 2. Calculating the terminal value Cash flow forecasting is a temporary endeavour. At some point, you must estimate a lump-sum valuation of the company past its explicit forecast term in order to make some high level assumptions regarding cash flows beyond the final explicit forecast year. The phrase \"final value\" refers to that total amount. 90
3. Discounting the cash flows to the present at the weighted average cost of capital The weighted average cost of capital (WACC) is the discount rate that incorporates the riskiness of the unlevered free cash flows. All operating cash flows are represented by unlevered free cash flows, which \"belong\" to the company's lenders and owners. Because of this, it is necessary to account for the risks of both capital suppliers using suitable capital structure weights (thus, \"weighted average\" cost of capital). The enterprise value is the discounted present value of all unlevered free cash flows. 4. Add the value of non-operating assets to the present value of unlevered free cash flows The present value of the unlevered free cash flows must be increased to account for any non-operating assets that a company may have, such as cash or investments that are merely held on the balance sheet. For instance, if we determine that Apple has unlevered free cash flows with a present value of $700 billion but also find out that it has $200 billion in cash lying about, we should add this cash. 5. Subtract debt and other non-equity claims The DCF's main objective is to seize the equity owners' property (equity value). Therefore, we must deduct any lenders from the present value if a corporation has any (as well as any other non-equity claims against the company). The equity owners are entitled to any remaining funds. In our example, if Apple had debt obligations of $50 billion at the time of valuation, the equity value would be determined as follows: $700 billion (enterprise value) + $200 billion (non- operating assets) - $50 billion (debt) = $850 billion. Non-operating assets and debt claims are frequently put together to form a single term known as net debt (debt and other non-equity claims – non-operating assets). The following formula is frequently seen: enterprise value - net debt = equity value. Now that the DCF has produced its equity value, it can be contrasted with the market capitalization, which represents how the market values the equity. 91
6. Divide the equity value by the shares outstanding We can determine the overall value to owners from the equity value. But how much is each share worth? We compute this by dividing the equity value by the outstanding diluted shares of the corporation. Advantages of DCF A DCF model makes extensive use of information to calculate the intrinsic value of a stock or business. Here are a few of its main benefits: Simple to use, quite thorough, and takes crucial business assumptions into account It aids in determining the \"intrinsic\" worth of a company or asset. There is no requirement for similar assets or businesses in the calculation. Additionally, it can be used to examine mergers and acquisitions. used to determine an investment's internal rate of return (IRR) for important investment choices. The model enables taking into account various possibilities for sensitivity analysis. Disadvantages of DCF Some of this model's primary flaws include: Projecting the variables involved takes a lot of time. Although some factors, such as operating cost and income, are simpler to predict in advance, other factors, such as capital expenditure, funding mix, and other investments, may be more difficult to gauge. As a result, even a small change in some of the variables might cause a significant change in the stock's or company's valuation. Usually, DCF is used to project for a longer time. However, given the potential volatility and cyclicality in any business or asset, long-term estimates might not always be true. 7.3 IDENTIFY KEY CHARACTERISTICS OF THE TARGET This key income-based valuation method in Value Adder requires the following inputs: Net cash flow projections Discount rate Terminal value or future business sale gain value 92
The net cash flow is the amount that the owners can take out of the company without affecting how well it runs for the purposes of discounted cash flow business valuation. Assuming that both loan and stock are emplo yed as acquisition capital, the following formula is used to determine net cash flow: Net after-tax income. Plus depreciation and amortization expenses. Plus the after-tax portion of the interest expense. Minus capital expenditures. Historic requirements can be found on the company’s Statements of Cash Flows. Minus increases in working capital. Step 1: Forecast your business cash flows Create your company's net cash flow estimates for the desired time frame, such as the next five years. If a business sale is anticipated at the conclusion of this time frame, calculate the gain from the sale. Calculate the so-called terminal value by capitalising the anticipated cash flow if you want to continue running the business after this point. Step 2: Calculate your discount rate Consult the WACC definition and the guide on how to build up the equity discount rate when estimating the rate. Step 3: Calculate the worth of your business terminal The following formula can be used to calculate the terminal value: Where CFn denotes the anticipated cash flow for year n, d denotes the discount rate, and g denotes the anticipated average annual growth rate of the cash flow. The capitalization rate is the 93
difference between the discount rate and the anticipated average cash flow growth rate in the aforementioned denominator. Assume that the business net cash flow will be $150,000 in year 5. Assume further that the cash flow can be expected to grow annually at the rate of 5% going forward. If your discount rate is 25%, then the terminal value is: The capitalization rate in this case is 20%, which is the difference between t he discount rate of 25% and the expected average growth rate of 5%. Please note that your choice of the capitalization rate is significant when determining the terminal value. The above example indicates that the business value is 787,500/150,000 or 5.25 times its net cash flow in year 5. 7.4 SUMMARY The DCF model calculates an organization's intrinsic value (value based on an organization's capacity to produce cash flows) and is frequently used to compare an organization's intrinsic worth to its market value. The discounted cash flow (DCF) analysis approach lowers the projected future cash flows to determine the investment value. The DCF and the initial investment are frequently contrasted. The DCF model is based on the idea that a company's value is solely determined by its projected future cash flows. The DCF's main objective is to seize the equity owners' property (equity value). A DCF model makes extensive use of information to calculate the intrinsic value of a stock or business. The net cash flow is the amount that the owners can take out of the company without affecting how well it runs for the purposes of discounted cash flow business valuation. 94
7.5 KEYWORDS Initial investment- Initial investment is the amount of money required to start a business or project. Also known as initial capital cost or simply initial cost. Discounted cash flow (DCF) - Discounted cash flow (DCF) refers to a valuation technique that estimates the value of an investment based on expected future cash flows. Unlevered DCF - Unlevered free cash flow is the money the business has before paying those financial obligations. Forecasting - Forecasting is the technique of using historical data as input to make informed estimates that predict the direction of future trends. Weighted average cost of capital - Weighted average cost of capital (WACC) represents a company's average after-tax cost of capital from all sources including common stock, preferred stock, bonds, and other forms of debt. WACC is the average rate at which a firm expects to fund its assets. 7.6LEARNIG ACTVITY 1. On what does is DCF model based? 2. What is the meaning of net cash flow? 7.7 UNIT AND QUESTIONS Descriptive questions 95
A. Short questions 1. 1.What do you mean by DCF? 2. Write a full form of WAAC and explain its concept. 3. How to Calculation of Discounted Cash Flow? 4. What do you mean by Terminal value? 5. Explain the levered DCF approach. Long questions 1. How to used DCF? 2. Describe the steps to Building a DCF. 3. What are the advantages of DCF? 4. Explain the disadvantages of DCF 5. Which are the following inputs in valuation methods of income based? B. Multiple choice questions 1. WACC stands for ______________ a. weighted average cost of capital b. weighted adding cost of capital c. weighted Automatic cost of capital d. weighted Anti cost of capital 2. The DCF model calculates an organization's _____________value. a. high b. general c. extrinsic d. intrinsic 3. CFn denotes the anticipated ________________ 96
a. cash flow for year b. cash flow for week c. cash flow for month d. cash flow for month 4. The ______________model is based on the idea that a company's value is solely determined by its projected future cash flows. a. Financial b. Investment c. NPV d. DCF 5. A financial model known as the________________ a. Fiscal policy b. DCF Model c. NPV Model d. WAAC Model Answers: 1- a,2-d ,3-a ,4-d ,5-b 7.8 SUGGESTED READING AND E- RESOURCES PunithavathyPandian, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, Vikas Publications Pvt. Ltd, New Delhi. 2001. Kevin.S, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, PHI, Delhi, 2011 YogeshMaheswari, INVESTMENT MANAGEMENT, PHI, Delhi, 2011 Bhalla V K, INVESTMENT MANAGEMENT: SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, S Chand, New Delhi, 2009 97
Prasanna Chandra, PORTFOLIO MANAGEMET, Tata McGraw Hill, New Delhi, 2008. 98
UNIT – 8 FINANCIAL FIGURES 8.0 Unit Objective 8.1 Introduction 8.2 Financial figures 8.3 Screen for Comparable Companies 8.4 Calculation of Key Financial Statistics and Ratios 8.5 Summary 8.6 Keywords 8.7 Learning objective 8.8 Unit end questions 8.9 Suggested Reading and E- Resources 8.0UNIT OBJECTIVES To explain financial figures To anlayse the Screen for Comparable Companies To understand the calculation of Key Financial Statistics and Ratios 8.1 INTRODUCTION A company's financial health may be seen at a single glance thanks to the financial statements that reveal information about its operations, performance, and cash flow.Since they reveal details about a company's earnings, costs, profitability, and debt, financial statements are crucial. Financial statement line item evaluation is done through financial ratio analysis in order to compare performance to prior periods and competitors.The ability of a corporation to pay off its debts and commitments is indicated by its liquidity and solvency ratios.A company's shares' fair value or price objective can be calculated using valuation ratios. 8.2 CONCEPT OF FINANCIAL FIGURES Financial information, often known as \"financial statements\" or \"financial reports,\" is a record of the financial operations and condition of a person, business, or other institution. They are used to assess a company's financial standing and assess whether it would be a wise investment. 99
Financial data must be reported and presented in a systematic manner in order to be understandable by anyone with even a basic understanding of financial processes. A financial statement, as well as management assessments and conversations, are typically included in key financial figures. The financial statement should consist of at least the following four elements: Statement of Cash Flow, Statement of Income, Statement of Equity, and Balance SheetUsing Key Financial Figures Key financial figures can be used by a variety of people for a range of purposes. Employees– When debating promotions, pay, or labour conflicts, employees can refer to the data in the important financial figures. Owners and managers: These data can be used by owners and managers to help them with crucial business and operational choices. They also give them a chance to gain a deeper understanding of the finances of the organisation. Financial institutions – Financial institutions, such as banks and lending organisations, can evaluate the risks of providing more working capital using the important financial numbers. They can also be used to decide whether to extend current loans. Prospective investors – Financial investors can utilise the key financial figures to assess the viability of investing in the company. These could form the basis of financial analyst reports that provide investors with a basis for choosing which investments to make. You need to understand crucial financial parameters if you want to succeed as a day trader. 100
Search
Read the Text Version
- 1
- 2
- 3
- 4
- 5
- 6
- 7
- 8
- 9
- 10
- 11
- 12
- 13
- 14
- 15
- 16
- 17
- 18
- 19
- 20
- 21
- 22
- 23
- 24
- 25
- 26
- 27
- 28
- 29
- 30
- 31
- 32
- 33
- 34
- 35
- 36
- 37
- 38
- 39
- 40
- 41
- 42
- 43
- 44
- 45
- 46
- 47
- 48
- 49
- 50
- 51
- 52
- 53
- 54
- 55
- 56
- 57
- 58
- 59
- 60
- 61
- 62
- 63
- 64
- 65
- 66
- 67
- 68
- 69
- 70
- 71
- 72
- 73
- 74
- 75
- 76
- 77
- 78
- 79
- 80
- 81
- 82
- 83
- 84
- 85
- 86
- 87
- 88
- 89
- 90
- 91
- 92
- 93
- 94
- 95
- 96
- 97
- 98
- 99
- 100
- 101
- 102
- 103
- 104
- 105
- 106
- 107
- 108
- 109
- 110
- 111
- 112
- 113
- 114
- 115
- 116
- 117
- 118
- 119
- 120
- 121
- 122
- 123
- 124
- 125
- 126
- 127
- 128
- 129
- 130
- 131
- 132
- 133
- 134
- 135
- 136
- 137
- 138
- 139
- 140
- 141
- 142
- 143
- 144
- 145
- 146
- 147
- 148
- 149
- 150
- 151
- 152
- 153
- 154
- 155
- 156
- 157
- 158
- 159
- 160
- 161
- 162
- 163
- 164
- 165
- 166
- 167
- 168
- 169
- 170
- 171
- 172
- 173
- 174
- 175
- 176
- 177
- 178
- 179