Sales growth 10%

Current assets/Sales 15%

Current Liabilities/Sales 8%
Net fixed assets/Sales 77%
Cost of Goods sold/Sales 50%
Depreciation rate 10%
Interest rate on debt 10.00%
Interest paid on cash and
marketable securities 8.00%
Tax rate 40%
Dividend Payout ratio 40%
Year 0
Income Statement
Sales 1,000 <--=this value is given to start the example
Costs of Goods sold (500) <--=functional relationship w/ sales
Interest paid on debt (32) <--=rate given(C15) times decision variable(C43)
Interest earned on cash 6 <--= rate given (C16) times "plug"
Depreciation (107) <--=(C14)* average fixed asset at cost of year
Profits before taxes 367 <--=Sales-COGS-int on D+int on Cash-Dep
Taxes (147) <--=C17 times C26
Profits after taxes 220 <--=C26-C27
Dividends (88) <--=C18timesC28
Retained earnings 132 <--=C28-C29
Balance sheet
Cash and marketable securities 80
Current assets 150 <--=15% of sales
Fixed assets
At cost 1,070 <--=C39-C38
Depreciation (300) <--=this value is given to start the example
Net fixed assets 770 <--=77% of sales
Total assets 1,000 <--=Sum of C34, C35, C39
Current liabilities 80 <--=8% of sales
Debt 320 <--=this value is given to start the example
Stock 450 <--=this value is given to start the example
Accumulated retained earnings 150 <--=this value is given to start the example
Total liabilities and equity 1000 <--=Sum of C42, C43,C44,C45
This is the "plug" value. The mechanical meaning
is Cash etc. is equal to TL-CA-NFA we guarantee
that A and L will always be equal. The financial
meaning makes a statement about how the firm
finances itself. If our firm sells no additional stock,
does not pay back any of its existing debt, and does
not raise any more debt then incremental financing
if needed comes from Cash and marketables. It also
means if the firm has additional cash, it will go to
this account. Can be viewed as "negative debt".
Almost all financial-statement models are driven by sales and sales estimates . This means that as many as possible
of the important statement variables are stated as functions of the level of sales
Basic Financial Statement Models
To solve a financial-planning model we need to distinguish
between those financial statement items that are functional
relationships of sales and those items that involve policy
decisions. The asset side of the balance sheet is usually
assumed to be dependent only on functional relationships.
The CL may also be taken to involve functional relationships
only, leaving the mix between long-term debt and equity as a
policy decision. The functional relationships for this example
are presented at right and the decision variables are entered in
the sheet. Note: Starting Accumulated Depreciation is also
given.
The Initial Pro Forma Example
Model parameters are in Boldface

Balance Sheet Equations:

Cash and Marketable securities = Total liabilities Current assets Net fixed
assets
This means that cash and marketable securities are the plug.

Current assets = Current assets/Sales * Sales

Net fixed assets = Net fixed assets/Sales * Sales

Accumulated depreciation = previous years accumulated depreciation +
Depreciation rate * Average fixed assets at cost over the year

Fixed assets at cost = Net fixed assets + Accumulated depreciation
Note: this model does not distinguish between plant and property and equipment
(PP&E) and other fixed assets such as land.

Current Liabilities = Current liabilities/Sales * Sales

Debt is assumed to be unchanged. An alternative model might assume that debt is
the balance sheet plug.

Stock doesnt change (the company is assumed to issue no new stock).

Accumulated retained earnings = Previous years accumulated retained earnings +
Current years additions to retained earnings
The Initial Pro Forma Example
Model parameters are in Boldface

Income statement equations:
Sales = Initial sales * (1+ sales growth)
year


Costs of goods sold = Sales * Cost of goods sold/Sales
The assumption is that the only expenses related to sales are costs of goods sold.
Most often you also see an expense item called selling, general, and
administrative expenses (SG&A). The changes to the model to accommodate this
item are fairly straight forward.

Interest payment on debt = Interest rate on debt * Average debt over the year
This formula allows us to accommodate changes in the model for repayment of
debt, as well as rollover of debt at different interest rates.

Interest earned on cash and marketable securities = Interest rate on cash *
Average cash and marketable securities over the year

Depreciation = Depreciation rate * Average fixed assets at cost over the year
This calculation assumes that all new fixed assets are purchased during the year.
We also assume there is no disposal of fixed assets.

Profit before taxes = Sales COGS interest payments on debt + Interest earned
on cash and marketable securities Depreciation

Taxes = Tax rate * Profit before taxes

Profits after taxes = Profits before taxes Taxes

Dividends = Dividend payout ratio * Profits after taxes
The firm is assumed to pay out a fixed percentage of its profits as dividends. An
alternative would be to assume that the firm has a target for its dividends per
share.

Retained earnings = Profits after taxes - Dividends
Sales growth 10%
Current assets/Sales 15%
Current Liabilities/Sales 8%
Net fixed assets/Sales 77%
Cost of Goods sold/Sales 50%
Depreciation rate 10%
Interest rate on debt 10.00%
Interest paid on cash and
marketable securities 8.00%
Tax rate 40%
Dividend Payout ratio 40%
Year 0 1
Income Statement
Sales 1,000 1100 <--=B20*(1+$B$8)
Costs of Goods sold (500) (550) <--=-C20*$B$12
Interest paid on debt (32) (32) <--=-$B$14*(B42+C42)/2
Interest earned on cash 6 9 <--=$B$15*(B33+C33)/2
Depreciation (107) (117) <--=$B$13*(B36+C36)/2
Profits before taxes 367 410 <--=SUM(C20:C24)
Taxes (147) (164) <--=-$B$16*C25
Profits after taxes 220 246 <--=SUM(C25:C26)
Dividends (88) (98) <--=$B$17*C27
Retained earnings 132 148 <--=C27+C28
Balance sheet
Cash and marketable securities 80 144 <--=C45-C34-C38
Current assets 150 165 <--=$B$9*C20
Fixed assets
At cost 1,070 1,264 <--=C38-C37
Depreciation (300) (417) <--=B37-$B$13*(B36+C36)/2
Net fixed assets 770 847 <--=$B$11*C20
Total assets 1,000 1,156 <--=C33+C34+C38
Current liabilities 80 88 <--=$B$10*C20
Debt 320 320 <--=B42
Stock 450 450 <--=B43
Accumulated retained earnings 150 298 <--=B44+C29
Total liabilities and equity 1000 1,156 <--=SUM(C41:C44)
We have taken the year zero financial statement and project the financial statement for year one.
Basic Financial Statement Models
These are all expected values--
Bullet estimates
A B C D E F G
1
2
3
4
5
6
7
8 Sales growth 0.1000
9 Current assets/Sales 0.1500
10 Current Liabilities/Sales 0.0800
11 Net fixed assets/Sales 0.7700
12 Cost of Goods sold/Sales 0.5000
13 Depreciation rate 0.1000
14 Interest rate on debt 0.1000
15
Interest paid on cash and
marketable securities 0.0800
16 Tax rate 0.4000
17 Dividend Payout ratio 0.4000
18 Year 0 1 2 3 4 5
19 Income Statement
20 Sales 1,000 1100 1210 1331 1464.1 1610.51
21 Costs of Goods sold (500) (550) (605) (666) (732) (805)
22 Interest paid on debt (32) (32) (32) (32) (32) (32)
23 Interest earned on cash 6 9 14 20 26 33
24 Depreciation (107) (117) (137) (161) (189) (220)
25 Profits before taxes 367 410 450 492 538 587
26 Taxes (147) (164) (180) (197) (215) (235)
27 Profits after taxes 220 246 270 295 323 352
28 Dividends (88) (98) (108) (118) (129) (141)
29 Retained earnings 132 148 162 177 194 211
30
31
32 Balance sheet
33 Cash and marketable securities 80 144 213 289 371 459
34 Current assets 150 165 182 200 220 242
35 Fixed assets
36 At cost 1,070 1,264 1,486 1,740 2,031 2,364
37 Depreciation (300) (417) (554) (715) (904) (1,124)
38 Net fixed assets 770 847 932 1,025 1,127 1,240
39 Total assets 1,000 1,156 1,326 1,513 1,718 1,941
40
41 Current liabilities 80 88 96.8 106.48 117.128 128.8408
42 Debt 320 320 320 320 320 320
43 Stock 450 450 450 450 450 450
44 Accumulated retained earnings 150 298 460 637 830 1,042
45 Total liabilities and equity 1000 1,156 1,326 1,513 1,718 1,941
This sheet displays an extention of the initial projections to five years. The way the model has been constructed allows
the extention simply by copying the columns across the sheet.
Basic Financial Statement Models
Free cash flow(FCF) is probably the most important calculation for valuation purposes.
FCF is the cash produced by a business without taking into account the way the business
is financed -- the best measure of the cash produced by a business.
Defining FCF
Profits after taxes Basic profitability measure of the business. However, it is an
accounting measure that includes financing flows (such as interest),
as well as non cash expenses such as depreciation. Profits after
taxes does not account for either changes in the firm's working
capital or purchases of new fixed assets, both of which can be
important cash drains on the firm.
+ Depreciation This non cash expense is added back to the profit after tax.
+After-tax interest
payments (net)
FCF is an attempt to measure the cash produced by the business
activity of the firm. To neutralize the effect of interest payments on
the firm's profits, you
Add back the after-tax cost of debt (after-tax since
interest payments are tax deductible).
Subtract out the after-tax interest payments on cash and
marketable securities.
- Increase in
current assets
When the firm's sales increase, more investment is needed in
inventories, accounts receivable, etc. This increase in current assets
is not an expense for tax purposes ( and is therefore ignored in the
profit after taxes), but it is a cash drain on the company.
+ Increase in
current liabilities
An increase in the sales often causes an increase in financing
related to sales (such as accounts payable or taxes payable). This
increase in current liabilities -- when related to sales -- provides
cash to the firm. Since it is directly related to sales, we include this
cash in the free cash flow calculations.
- Increase in fixed
assets at cost
An increase in fixed assets (the long-term productive assets of the
company) is a use of cash, which reduces the firm's free cash flow.
Sales growth 10%
Current assets/Sales 15%
Current Liabilities/Sales 8%
Net fixed assets/Sales 77%
Cost of Goods sold/Sales 50%
Depreciation rate 10%
Interest rate on debt 10.00%
Interest paid on cash and marketable
securities 8.00%
Tax rate 40%
Dividend Payout ratio 40%
Year 0 1 2 3 4 5
Income Statement
Sales 1,000 1100 1210 1331 1464.1 1610.51
Costs of Goods sold (500) (550) (605) (666) (732) (805)
Interest paid on debt (32) (32) (32) (32) (32) (32)
Interest earned on cash 6 9 14 20 26 33
Depreciation (107) (117) (137) (161) (189) (220)
Profits before taxes 367 410 450 492 538 587
Taxes (147) (164) (180) (197) (215) (235)
Profits after taxes 220 246 270 295 323 352
Dividends (88) (98) (108) (118) (129) (141)
Retained earnings 132 148 162 177 194 211
Balance sheet
Cash and marketable securities 80 144 213 289 371 459
Current assets 150 165 182 200 220 242
Fixed assets
At cost 1,070 1,264 1,486 1,740 2,031 2,364
Depreciation (300) (417) (554) (715) (904) (1,124)
Net fixed assets 770 847 932 1,025 1,127 1,240
Total assets 1,000 1,156 1,326 1,513 1,718 1,941
Current liabilities 80 88 96.8 106.48 117.128 128.8408
Debt 320 320 320 320 320 320
Stock 450 450 450 450 450 450
Accumulated retained earnings 150 298 460 637 830 1,042
Total liabilities and equity 1000 1,156 1,326 1,513 1,718 1,941
Year 0 1 2 3 4 5
Free Cash Flow Calculation
Profits after taxes 246 270 295 323 352
add back Depreciation 117 137 161 189 220
Subtract increase in CA (15) (17) (18) (20) (22)
Add back increase in CL 8 9 10 11 12
Subtract increase in fixed assets at cost (194) (222) (254) (291) (333)
Add back after-tax interest on debt 19 19 19 19 19
Subtract after-tax interest on cash &mktbles (5) (9) (12) (16) (20)
Free Cash Flow 176 188 201 214 228
This sheet demonstrates the calculation of the FCF for our firm.
Free Cash Flow Calculations
11% 7%
0 1 2 3 4 5
176 188 201 214 228
6107
176 188 201 214 6,336
$4,359
80
$4,439
-320
$4,119
subtract firm debt today
equity value
Terminal Value
Total
NPV
add initial Cash &Mkt
Enterprise value
Determining the enterprise value of the firm
In theory the enterprise value of the firm is the present value of the firm's future cash flows. We
will use the FCF projections to find the enterprise value of the firm. We will assume a cost of
capital of 11 percent.
Valuing the Firm
WACC =
Year
FCF
The terminal value is determined by employing the Gordon Growth model. We
assume that after the five year projection horizon the CF's will grow at a rate equal
to the growth of sales = 7%.


Other ways to calculate the terminal value. These are all common variations that
can be implemented in this model.

Terminal value = Year-5 book value of debt + Equity
This calculation assumes that the book value correct predicts the market value.

Terminal value = (Enterprise market/book multiple)*(Year-5 book value of debt
+Equity)

Terminal value = P/E ratio * Year-5 profits + Year-5 book value of debt

Terminal value = EBITDA ratio * Year -5 anticipated EBITDA

EBITDA ratio = (year -0 equity + debt)/(Net income + Income tax + Interest
expense + Depreciation + Amortization )

$4,359
(240)
$4,119 equity value
Cash and marketable Securities as Negative Debt
NPV
subtract firm debt today
The terminal value is determined by employing the Gordon Growth model. We
assume that after the five year projection horizon the CF's will grow at a rate equal
to the growth of sales = 7%.


Other ways to calculate the terminal value. These are all common variations that
can be implemented in this model.

Terminal value = Year-5 book value of debt + Equity
This calculation assumes that the book value correct predicts the market value.

Terminal value = (Enterprise market/book multiple)*(Year-5 book value of debt
+Equity)

Terminal value = P/E ratio * Year-5 profits + Year-5 book value of debt

Terminal value = EBITDA ratio * Year -5 anticipated EBITDA

EBITDA ratio = (year -0 equity + debt)/(Net income + Income tax + Interest
expense + Depreciation + Amortization )

Treatment of Cash and Marketable Securities:
Note we added the initial cash balances back to the PV of the projected FCF to get
the enterprise value. This assumes the following:
Year-0 balances of cash and marketable securities are not needed to produce the
FCF's in subsequent years.
Year-0 balances of cash and marketable securities are "surpluses" that could be
drawn down or paid out to shareholders without affecting the future economic
performance of the firm.
An equivalent assumption sometimes made by investment bankers and equity
analysts is to assume that initial cash balances are negative debt.