Financial Modeling Training Series: Consistent Cash Flow Valuation.
Transcript of Financial Modeling Training Series: Consistent Cash Flow Valuation.
Financial Modeling Series: A Consistent Cash Flow Valuation using MS Excel©
A Theoretical Approach to Using a Consistent Discount Rate
in Valuing a Company
Why This Training is Important to Know?
Participants that want to study Financial Modeling for Valuation purposes always go to the Financial Modeling class in which they will be taught with the MS Excel techniques and formulas that they could use in applying the Corporate Valuation Model. The most shown approach in building the Corporate Valuation Model is Discounted Cash Flow, or known as DCF method.
There is no point to understand as to how to build an excellent Financial Modeling, yet the VALUE RESULT is questionable.
Why we said this?
First, the forecasted Financial Statements, in many cases, are constructed using Plug Method, and later discount the forecasted Free Cash Flow using one single Weighted Average Cost of Capital (WACC).
Second, the WACC used as a discount rate is shown to be independent from the Free Cash Flow. So it is common to see the practitioners calculate a WACC separately and then use it independently from the firm value.
Third, WACC as a discount rate that is used to obtain the present value of the forecasted Free Cash Flow is in many cases, a single same rate during the forecast period.
THE USE OF ABOVE THREE IS INCORRECT!
VALUE RESULT WILL NOT BE CORRECT SINCE THEY ARE NOT CONSISTENT TO EACH OTHER
Yet Before We Go Further, You Need to
Understand Why as Internal Analysts,
You Have to Study Valuation
As a manager or internal analyst, you learn in your capital budgeting that the company needs to take all (and only) positive- Net Present Value project, thus, it will maximize the firm value.
This will mean that a company which acts in the its shareholders’ interest should accept those investments which increase the value of the shareholders’ equity in the company.
In order to do this, IT IS NECESSARY FOR YOU TO UNDERSTAND WHAT DETERMINES THE COMPANY SHARE’S VALUE.
Learning Financial Modeling is about Learning the Business Model and Strategy of the Company.
As the manager or internal analyst, you know that the business strategy is the outcome of the VALUATION ANALYSIS. A strategy is chosen after determining whether that strategy WILL ADD VALUE to the company. The internal analyst will help design strategies to maintain competitive advantage.
Which strategies adding value that should be chosen?
So it is about the value…
A valuation model not only tells you how to think about the value generation in the future, but it also tells you how to ACCOUNT for the value generation.
A valuation model is really a model of pro forma accounting for the future.
Valuation is a matter of ACCOUNTING FOR VALUE.
This is WHY YOU NEED TO STUDY AND UNDERSTAND HOW VALUATION MODEL WORKS AND MORE IMPORTANT THAN THAT, YOU SHOULD KNOW HOW TO BUILD A GOOD AND CORRECT VALUATION MODEL THAT WILL GIVE YOU CORRECT AND CONSISTENT RESULTS AMONG ALL THOSE APPROACHES THAT ARE IN THE MARKET.
Be Careful to Introduce Perpetuity into Your
Valuation Model
Why we said this?
Introducing perpetuity in cash flows and formula, though beautiful in mathematics, well, this is where the analysts would like to say implicitly: “Cash Flows I Just Don't Know" or “Cash Flows: Anything Could Happen".
Using the examples of forecasting the free cash flows into the perpetuity, explicitly, it captures value in the long run.., well, as Keynes, the British economist said, in the long run, are all dead…..
One thing we need to remember that in reality, there is no such thing called “perpetuity”. We could see this from the company life, which business is the subject of the valuation. On average, the lifetime of the companies in US has reduced to around 15 years!
We teach the Finance Techniques in Valuation
that you will not get in any university class, even
from your MBA class
Training Syllabus
We are going to show using Excel
examples:
Building a Financial Model
without Plugs and without
Circularity for Valuation
Purposes
Cost of Capital depends on
Free Cash Flow, so it means
the Weighted Average Cost of
Capital cannot be the same
during the forecast period
Three methods mostly used in
Discounted Cash Flow Approach :
Capital Cash Flow
Adjusted Present Value
Free Cash Flow to the Firm
Here we are going to show using
Excel examples how to use
consistent discount rate formulas
to make sure all those methods
above will give the same results
of value.
We are going to show that the
use of the same WACC during
the forecast period IS WRONG
Train Your Employees! By now, we’ve probably all heard
the classic HR executives’ exchange
—
Colleague #1: “What if we pay to
train our people and they leave?”
Colleague #2: “Right, but what if we
DON’T train them and they NEVER
leave?!?”
We can all agree that the latter
scenario is worse.