FIRST FINANCIAL MODEL

Sales growth
Current assets/Sales
Current liabilities/Sales
Net fixed assets/Sales
Costs of goods sold/Sales
Depreciation rate
Interest rate on debt
Interest paid on cash and marketable securities
Tax rate
Dividend payout ratio
Year
Income statement
Sales
Costs of goods sold
Interest payments on debt
Interest earned on cash and marketable securities
Depreciation
Profit before tax
Taxes
Profit after tax
Dividends
Retained earnings

10%
15%
8%
77%
50%
10%
10.00%
8.00%
40%
40%
0

1,000
(500)
(32)
6
(100)
374
(150)
225
(90)
135

1,100
(550)
(32)
9
(117)
410
(164)
246
(98)
148

1,210
(605)
(32)
14
(137)
450
(180)
270
(108)
162

1,331
(666)
(32)
20
(161)
492
(197)
295
(118)
177

Balance sheet
Cash and marketable securities
Current assets
Fixed assets
At cost
Depreciation
Net fixed assets
Total assets

80
150

144
165

213
182

289
200

1,070
(300)
770
1,000

1,264
(417)
847
1,156

1,486
(554)
932
1,326

1,740
(715)
1,025
1,513

Current liabilities
Debt
Stock
Accumulated retained earnings
Total liabilities and equity

80
320
450
150
1,000

88
320
450
298
1,156

97
320
450
460
1,326

106
320
450
637
1,513

Year
0
Free cash flow calculation
Profit after tax
Add back depreciation
Subtract increase in current assets
Add back increase in current liabilities
Subtract increase in fixed assets at cost
Add back after-tax interest on debt
Subtract after-tax interest on cash and+A14 mkt. securities
Free cash flow

246
117
(15)
8
(194)
19
(5)
176

270
137
(17)
9
(222)
19
(9)
188

295
161
(18)
10
(254)
19
(12)
201

CONSOLIDATED STATEMENT OF CASH FLOWS: RECONCILING THE CASH BALANC

Cash flow from operating activities
Profit after tax

246

270

295

Add back depreciation

Adjust for changes in net working capital:
Subtract increase in current assets
Add back increase in current liabilities
Net cash from operating activities

117

137

161

(15)
8
356

(17)
9
400

(18)
10
448

(194)
0
0
(194)

(222)
0
0
(222)

(254)
0
0
(254)

Cash flow from financing activities

Net proceeds from borrowing activities
Net proceeds from stock issues, repurchases
Dividends paid
Net cash from financing activities

0
0
(98)
(98)

0
0
(108)
(108)

0
0
(118)
(118)

Net increase in cash and cash equivalents

Check: changes in cash and mkt. securities

64
64

70
70

76
76

Cash flow from investing activities

Aquisitions of fixed assets--capital expenditures
Purchases of investment securities
Proceeds from sales of investment securities
Net cash used in investing activities

1,464
(732)
(32)
26
(189)
538
(215)
323
(129)
194

1,611
(805)
(32)
33
(220)
587
(235)
352
(141)
211

371
220

459
242

<-<-<-<-<-<-<-<-<-<--

=F15*(1+$B$2)
=-G15*$B$6
=-$B$8*(F36+G36)/2
=$B$9*(F27+G27)/2
=-$B$7*(G30+F30)/2
=SUM(G15:G19)
=-G20*$B$10
=G21+G20
=-$B$11*G22
=G23+G22

<-- =G39-G28-G32
<-- =G15*$B$3

2,031
(904)
1,127
1,718

2,364
(1,124)
1,240
1,941

<-<-<-<--

=G32-G31
=F31+G19
=G15*$B$5
=G32+G28+G27

117
320
450
830
1,718

129
320
450
1,042
1,941

<-<-<-<-<--

=G15*$B$4
=F36
=F37
=F38+G24
=SUM(G35:G38)

5
<-<-<-<-<-<-<-<--

=G22
=-G19
=-(G28-F28)
=G35-F35
=-(G30-F30)
=-(1-$B$10)*G17
=-(1-$B$10)*G18
=SUM(G44:G50)

323
189
(20)
11
(291)
19
(16)
214

352
220
(22)
12
(333)
19
(20)
228

WS: RECONCILING THE CASH BALANCES

323

352

<-- =G22

189

220

<-- =-G19

(20)
11
502

(22) <-- =-(G28-F28)

12 <-- =G35-F35
562 <-- =SUM(G55:G59)

(291)
0
0
(291)

(333)
0
0
(333)

<-- =-(G30-F30)
<-- Not in our model
<-- Not in our model
<-- =SUM(G63:G65)

0
0
(129)
(129)

0
0
(141)
(141)

<-<-<-<--

82
82

88
88

=G36-F36
=G37-F37
=G23
=SUM(G69:G71)

<-- =G72+G66+G60
<-- =G27-F27

FIRST FINANCIAL MODEL

Here's a basic exercise that will help you understand what's going on in the modeling of financial statements.
Replicate the models in sections 3.2, 3.7, and 3.8 (First Financial Model). That is, enter the correct formulas
for the cells and see that you get the same results as the book. (This turns out to be more of an exercise in
accounting than in finance. If you're like many financial modelers, you'll see that there are some aspects of
accounting that you've forgotten!)

Sales growth
10%
Current assets/Sales
15%
Current liabilities/Sales
8%
Net fixed assets/Sales
77%
Costs of goods sold/Sales
50%
Depreciation rate
10%
Interest rate on debt
10.00%
Interest paid on cash and marketable securities8.00%
Tax rate
40%
Dividend payout ratio
40%
Year
0
Income statement
Sales
1,000
Costs of goods sold
(770)
Interest payments on debt
49
Interest earned on cash and marketable securities 8
Depreciation
(100)
Profit before tax
187
Taxes
(15)
Profit after tax
172
Dividends
(69)
Retained earnings
103

1,000
(770)
49
9
(253)
35
(3)
32
(13)
19

1,000
(770)
49
6
(422)
(137)
11
(126)
50
(76)

1,000
(770)
49
(10)
(704)
(434)
35
(400)
160
(240)

1,000
(770)
49
(48)
(1,173)
(941)
75
(866)
346
(520)

1,000
(770)
49
(123)
(1,955)
(1,799)
144
(1,655)
662
(993)

(216)
100

(736)
100

(1,729)
100

Balance sheet
Cash and marketable securities
Current assets
Fixed assets
At cost
Depreciation
Net fixed assets
Total assets

80
100

99
100

23
100

380
(300)
80
260

633
(553)
80
279

1,056
(976)
80
203

1,759
(1,679)
80
(36)

2,932
(2,852)
80
(556)

4,887
(4,807)
80
(1,549)

Current liabilities
Debt
Stock
Accumulated retained earnings
Total liabilities and equity

150
(490)
450
150
260

150
(490)
450
169
279

150
(490)
450
93
203

150
(490)
450
(146)
(36)

150
(490)
450
(666)
(556)

150
(490)
450
(1,659)
(1,549)

Year
Free cash flow calculation
Profit after tax

2
32

(126)

3
(400)

4
(866)

5
(1655)

Add back depreciation

253
Subtract increase in current assets
0
Add back increase in current liabilities
0
Subtract increase in fixed assets at cost
(253)
Add back after-tax interest on debt
(45)
Subtract after-tax interest on cash and+A14 mkt. securities (8)
Free cash flow
(21)

422
0
0
(422)
(45)
(6)
(177)

704
0
0
(704)
(45)
9
(436)

1173
0
0
(1173)
(45)
44
(867)

1955
0
0
(1955)
(45)
113
(1587)

CONSOLIDATED STATEMENT OF CASH FLOWS: RECONCILING THE CASH BALANCES

Cash flow from operating activities
Profit after tax
Add back depreciation
Adjust for changes in net working capital:
Subtract increase in current assets
Add back increase in current liabilities
Net cash from operating activities

32
253

(126)
422

(400)
704

(866)
1,173

285

296

304

307

(253)
0
0
(253)

(422)
0
0
(422)

(704)
0
0
(704)

(1,173)
0
0
(1,173)

(1,955)
0
0
(1,955)

Cash flow from financing activities

Net proceeds from borrowing activities
Net proceeds from stock issues, repurchases
Dividends paid
Net cash from financing activities

0
0
(13)
(13)

0
0
50
50

0
0
160
160

0
0
346
346

0
0
662
662

Net increase in cash and cash equivalents

Check: changes in cash and mkt. securities

19
19

(76)
(76)

(240)
(240)

(520)
(520)

(993)
(993)

Cash flow from investing activities

Aquisitions of fixed assets--capital expenditures
Purchases of investment securities
Proceeds from sales of investment securities
Net cash used in investing activities

(1,655)
1,955
300

<-<-<-<-<-<-<-<-<-<--

=F16*(1+$B$2)
=-G16*$B$6
=-$B$8*(F37+G37)/2
=$B$9*(F28+G28)/2
=-$B$7*(G31+F31)/2
=SUM(G16:G20)
=-G21*$B$10
=G22+G21
=-$B$11*G23
=G24+G23

<-- =G40-G29-G33
<-- =G16*$B$3
<-<-<-<--

=G33-G32
=F32+G20
=G16*$B$5
=G33+G29+G28

<-<-<-<-<--

=G16*$B$4
=F37
=F38
=F39+G25
=SUM(G36:G39)

<-- =G23

<-<-<-<-<-<-<--

=-G20
=-(G29-F29)
=G36-F36
=-(G31-F31)
=-(1-$B$10)*G18
=-(1-$B$10)*G19
=SUM(G45:G51)

ASH BALANCES
<-- =G23
<-- =-G20
<-- =-(G29-F29)
<-- =G36-F36
<-- =SUM(G56:G60)

<-- =-(G31-F31)
<-- Not in our model
<-- Not in our model
<-- =SUM(G64:G66)

<-<-<-<--

=G37-F37
=G38-F38
=G24
=SUM(G70:G72)

<-- =G73+G67+G61
<-- =G28-F28

EXERCISE 2

Sales growth
Current assets/Sales
Current liabilities/Sales
Net fixed assets/Sales
Costs of goods sold/Sales
Sales, general and administrative expenses
Depreciation rate
Interest rate on debt
Interest paid on cash & marketable securities
Tax rate
Dividend payout ratio
Year
Income statement
Sales
Costs of goods sold
SG&A
Interest payments on debt
Interest earned on cash & marketable securities
Depreciation
Profit before tax
Taxes
Profit after tax
Dividends
Retained earnings

The model of section 3.2 includes cost of goods sold but not selling, general,
and administrative (SG&A) expenses. Suppose that the firm has $200 of
these expenses each year, irrespective of the level of sales. a. Change the
model to accommodate this new assumption. Show the resulting profit and
loss statements, balance sheets, free cash flows, and valuation. b. Create a
data table in which you show the sensitivity of the equity value to the level
of SG&A. Let SG&A vary from 0 to $500 per year.
10%
15%
8%
77%
50%
200 <-- Added
10%
10.00%
8.00%
40%
40%
0

1,000
(500)
(32)
6
(100)
374
(150)
225
(90)
135

1,100
(550)
(200)
(32)
6
(117)
207
(83)
124
(50)
75

1,210
(605)
(200)
(32)
5
(137)
241
(96)
145
(58)
87

1,331
(666)
(200)
(32)
5
(161)
277
(111)
166
(67)
100

Balance sheet
Cash and marketable securities
Current assets
Fixed assets
At cost
Depreciation
Net fixed assets
Total assets

80
150

71
165

65
182

63
200

1,070
(300)
770
1,000

1,264
(417)
847
1,083

1,486
(554)
932
1,178

1,740
(715)
1,025
1,288

Current liabilities
Debt
Stock
Accumulated retained earnings
Total liabilities and equity

80
320
450
150
1,000

88
320
450
225
1,083

97
320
450
311
1,178

106
320
450
411
1,288

Year
Free cash flow calculation

Profit after tax

Add back depreciation
Subtract increase in current assets
Add back increase in current liabilities
Subtract increase in fixed assets at cost
Add back after-tax interest on debt
Subtract after-tax interest on cash & mkt. securities
Free cash flow

124
117
(15)
8
(194)
19
(4)
56

145
137
(17)
9
(222)
19
(3)
68

166
161
(18)
10
(254)
19
(3)
81

Valuing the firm

Weighted average cost of capital
Year
FCF
Terminal value
Total

20%
0

NPV of row 61
Add in initial (year 0) cash and mkt. securities
Enterprise value
Subtract out value of firm's debt today
Equity value

56

68

81

56

68

81

709 <-- =NPV(B56,C61:G61)

80
789
-320
469

Cash and marketable securities as negative debt

NPV of row 61 = enterprise value
Net year 0 debt
Equity value

709
-240 <-- =-B37+B28
469

Valuing the firm--using mid-year discounting

Weighted average cost of capital
Year
FCF
Terminal value
Total

20%
0

NPV of row 81
Add in initial (year 0) cash and mkt. securities
Enterprise value
Subtract out value of firm's debt today
Equity value

Data table: Value as function

of SG&A

56

68

81

56

68

81

850 <-- =NPV(B76,C81:G81)*(1+B76)

80
930
-320
610

0
50
100
150
200
250

610 <-- =B88, data table header

1,677
1,411
Effect of SG&A on
1,144
877
2,000
610
1,500
343
1,000

Equit

Data table: Value as function

of SG&A and sales growth

77
-190
-457
-724
-991
-1,257
-1,524

610
0
50
100
150
200
250
300
350
400
450
500
550
600

0%
1,028
848
668
488
308
128
nmf
nmf
nmf
nmf
nmf
nmf
nmf

Value

300
350
400
450
500
550
600

1,500
1,000
500
0
-500 0
-1,000
-1,500
-2,000

3%
1,143
947
752
557
362
166
nmf
nmf
nmf
nmf
nmf
nmf
nmf

6%
1,306
1,089
872
655
438
220
3
nmf
nmf
nmf
nmf
nmf
nmf

t of goods sold but not selling, general,

. Suppose that the firm has $200 of
of the level of sales. a. Change the
mption. Show the resulting profit and
ash flows, and valuation. b. Create a
itivity of the equity value to the level
$500 per year.

1,464
(732)
(200)
(32)
5
(189)
317
(127)
190
(76)
114

1,611
(805)
(200)
(32)
5
(220)
359
(144)
215
(86)
129

65
220

72
242

2,031
(904)
1,127
1,412

2,364
(1,124)
1,240
1,553

117
320
450
525
1,412

129
320
450
654
1,553

190
189
(20)
11
(291)
19
(3)
94

215
220
(22)
12
(333)
19
(3)
108

5
94
94

108
1,191 <-- =G59*(1+B3)/(B56-B3)
1,300

5
94
94

108
1,191 <-- =G72*(1+B3)/(B69-B3)
1,300

data table header

Effect of SG&A on Equity Value

100

200

300

400

500

SG&A

9%
1,559
1,308
1,057
806
555
304
53
nmf
nmf
nmf
nmf
nmf
nmf

12%
2,002
1,692
1,382
1,071
761
451
141
nmf
nmf
nmf
nmf
nmf
nmf

15%
2,976
2,536
2,095
1,655
1,214
774
333
nmf
nmf
nmf
nmf
nmf
nmf

600

EXERCISE 3

The model of section 3.2 includes cost of goods sold but not selling, general, a
(SG&A) expenses. Suppose that the firm has $200 of these expenses each yea
level of sales. a. Change the model to accommodate this new assumption. Sho
and loss statements, balance sheets, free cash flows, and valuation. b. Create a
show the sensitivity of the equity value to the level of SG&A. Let SG&A vary
year.

Sales growth
Current assets/Sales
Current liabilities/Sales
Fixed assets at cost/Sales
Costs of goods sold/Sales
Depreciation rate
Interest rate on debt
Interest paid on cash & marketable securities
Tax rate
Dividend payout ratio

10%
15%
8%
100%
50%
10%
10.00%
8.00%
40%
40%

Year
Income statement
Sales
Costs of goods sold
Interest payments on debt
Interest earned on cash & marketable securities
Depreciation
Profit before tax
Taxes
Profit after tax
Dividends
Retained earnings

1,000
(500)
(32)
6
(100)
374
(150)
225
(90)
135

1,100
(550)
(32)
(18)
(109)
392
(157)
235
(94)
141

1,210
(605)
(32)
(45)
(116)
412
(165)
247
(99)
148

Balance sheet
Cash and marketable securities
Current assets
Fixed assets
At cost
Depreciation
Net fixed assets
Total assets

80
150

(524)
165

(609)
182

1,070
(300)
770
1,000

1,100
(409)
1,509
1,149

1,210
(524)
1,734
1,306

Current liabilities
Debt
Stock
Accumulated retained earnings
Total liabilities and equity

80
320
450
150
1,000

88
320
450
291
1,149

97
320
450
439
1,306

Year
Free cash flow calculation
Profit after tax
Add back depreciation

2
235
109

247
116

Subtract increase in current assets

Add back increase in current liabilities
Subtract increase in fixed assets at cost
Add back after-tax interest on debt
Subtract after-tax interest on cash & mkt. securities
Free cash flow

(15)
8
(30)
19
11
336

(17)
9
(110)
19
27
292

Valuing the firm

Weighted average cost of capital
Year
FCF
Terminal value
Total

20%
0

NPV of row 61
Add in initial (year 0) cash and mkt. securities
Enterprise value
Subtract out value of firm's debt today
Equity value

2
336

292

336

292

2,710 <-- =NPV(B55,C60:G60)

80
2,790
-320
2,470

Cash and marketable securities as negative debt

NPV of row 61 = enterprise value
Net year 0 debt
Equity value

2,710
-240 <-- =-B36+B27
2,470

Valuing the firm--using half-year discounting

Weighted average cost of capital
Year
FCF
Terminal value
Total
NPV of row 81
Add in initial (year 0) cash and mkt. securities
Enterprise value
Subtract out value of firm's debt today
Equity value

20%
0

2
336

292

336

292

3,251 <-- =NPV(B75,C80:G80)*(1+B75)

80
3,331
-320
3,011

Growth
0%
2%
4%
6%
8%
10%

3,011 <-- =B86

1,871
1,998
2,156
2,360
2,631
3,011

12%
14%
16%

3,581
4,531
6,431

<-- =IF(B75<=B2,"nmf",B86)
WACC

growth rate of sales

3,011.40
0%
2%
4%
6%
8%
10%
12%
14%
16%

10%
3,571.40
4,300.15
5,514.73
7,943.90
15,231.40
nmf
nmf
nmf
nmf

12%
3,004.73
3,471.40
4,171.40
5,338.07
7,671.40
14,671.40
nmf
nmf
nmf

of goods sold but not selling, general, and administrative

m has $200 of these expenses each year, irrespective of the
ccommodate this new assumption. Show the resulting profit
cash flows, and valuation. b. Create a data table in which you
to the level of SG&A. Let SG&A vary from 0 to $500 per

1,331
(666)
(32)
(52)
(127)
454
(182)
272
(109)
163

1,464
(732)
(32)
(60)
(140)
500
(200)
300
(120)
180

1,611
(805)
(32)
(69)
(154)
551
(220)
330
(132)
198

(702)
200

(805)
220

(917)
242

1,331
(651)
1,982
1,479

1,464
(791)
2,255
1,670

1,611
(945)
2,555
1,880

106
320
450
603
1,479

117
320
450
783
1,670

129
320
450
981
1,880

4
272
127

5
300
140

330
154

(18)
10
(121)
19
31
321

(20)
11
(133)
19
36
353

321

353

321

353

(22)
12
(146)
19
41
388

388
4,268 <-- =G58*(1+B2)/(B55-B2)
4,656

321

353

321

353

388
4,268 <-- =G78*(1+B2)/(B75-B2)
4,656

G80)*(1+B75)

Sales Growth and Equity Value

8,000
6,000
4,000
2,000

2,000
0
0%

5%

14%
16%
2,599.97
2,296.40
2,918.90
2,524.26
3,365.40
2,828.07
4,035.15
3,253.40
5,151.40
3,891.40
7,383.90
4,954.73
14,081.40
7,081.40
nmf
13,461.40
nmf
nmf

10%

18%
2,060.29
2,228.28
2,444.26
2,732.23
3,135.40
3,740.15
4,748.07
6,763.90
12,811.40

15%

20%
1,871.40
1,998.07
2,156.40
2,359.97
2,631.40
3,011.40
3,581.40
4,531.40
6,431.40

22%
1,716.85
1,813.90
1,932.51
2,080.78
2,271.40
2,525.57
2,881.40
3,415.15
4,304.73

20%

24%
1,588.07
1,663.22
1,753.40
1,863.62
2,001.40
2,178.54
2,414.73
2,745.40
3,241.40

26%
1,479.09
1,537.65
1,606.85
1,689.90
1,791.40
1,918.28
2,081.40
2,298.90
2,603.40

EXERCISE 4--ASSETS AT COST

GIVEN BY A STEP FUNCTION

Sales growth
Current assets/Sales
Current liabilities/Sales
Costs of goods sold/Sales
Depreciation rate
Interest rate on debt
Interest paid on cash & marketable securities
Tax rate
Dividend payout ratio
Year
Income statement
Sales
Costs of goods sold
Interest payments on debt
Interest earned on cash & marketable securities
Depreciation
Profit before tax
Taxes
Profit after tax
Dividends
Retained earnings

Referring again to the model of section 3.2, suppose that the fixed
the following step
function:
Incorporate this function into the model.

10%
15%
8%
50%
10%
10.00%
8.00%
40%
40%
0

1,000
(500)
(32)
6
(100)
374
(150)
224
(90)
135

1,100
(550)
(32)
15
(109)
425
(170)
255
(102)
153

1,210
(605)
(32)
31
(115)
489
(196)
293
(117)
176

1,331
(666)
(32)
47
(126)
554
(222)
332
(133)
199

Balance sheet
Cash and marketable securities
Current assets
Fixed assets
At cost
Depreciation
Net fixed assets
Total assets

80
150

304
165

479
182

688
200

1,070
(300)
770
1,000

1,100
(409)
692
1,161

1,209
(524)
685
1,346

1,318
(650)
668
1,555

Current liabilities
Debt
Stock
Accumulated retained earnings
Total liabilities and equity

80
320
450
150
1,000

88
320
450
303
1,161

97
320
450
479
1,346

106
320
450
678
1,555

Year
Free cash flow calculation
Profit after tax
Add back depreciation
Subtract increase in current assets

255
109
(15)

293
115
(17)

332
126
(18)

Add back increase in current liabilities

Subtract increase in fixed assets at cost
Add back after-tax interest on debt
Subtract after-tax interest on cash & mkt. securities
Free cash flow

8
(30)
19
(9)
336

9
(109)
19
(19)
292

10
(109)
19
(28)
332

Valuing the firm

Weighted average cost of capital
Year
FCF
Terminal value
Total
NPV of row 61
Add in initial (year 0) cash and mkt. securities
Enterprise value
Subtract out value of firm's debt today
Equity value

20%
0

336

292

332

336

292

332

2,858 <-- =NPV(B56,C61:G61)

80
2,938
-320
2,618

Cash and marketable securities as negative debt

NPV of row 61 = enterprise value
Net year 0 debt
Equity value

2,858
-240 <-- =-B37+B28
2,618

Valuing the firm--using half-year discounting

Weighted average cost of capital
Year
FCF
Terminal value
Total
NPV of row 81
Add in initial (year 0) cash and mkt. securities
Enterprise value
Subtract out value of firm's debt today
Equity value

20%
0

336

292

332

336

292

332

3,430 <-- =NPV(B76,C81:G81)*(1+B76)

80
3,510
-320
3,190

section 3.2, suppose that the fixed assets at cost follow

the following step
function:
rate this function into the model.

1,464
(732)
(32)
65
(137)
627
(251)
376
(151)
226

1,611
(805)
(32)
85
(149)
710
(284)
426
(170)
255

928
220

1,205
242

1,431
(788)
644
1,791

1,548 <-- =IF(G14<=1200,G14,IF(G14<=1400,1200+0.9*(G14-1200),1380+0.8*(G14-1400)))

(937)
612
2,058

117
320
450
904
1,791

129
320
450
1,160
2,058

5
376
137
(20)

426
149
(22)

11
(113)
19
(39)
372

12
(117)
19
(51)
415

5
372
372

415
4,569 <-- =G59*(1+B3)/(B56-B3)
4,984

5
372
372

415
4,569 <-- =G72*(1+B3)/(B69-B3)
4,984

+0.8*(G14-1400)))

EXERCISE 5--MODELING DIVIDENDS ON A PER-SHARE BASIS

Sales growth
Current assets/Sales
Current liabilities/Sales
Net fixed assets/Sales
Costs of goods sold/Sales
Depreciation rate
Interest rate on debt
Interest paid on cash and marketable securities
Tax rate
Year 1 dividend per share
Number of shares
Dividend annual growth rate
Year
Income statement
Sales
Costs of goods sold
Interest payments on debt
Interest earned on cash and marketable securities
Depreciation
Profit before tax
Taxes
Profit after tax
Dividends
Retained earnings

20%
20%
8%
80%
50%
10%
10.00%
8.00%
40%
0.25
1,200
16%
0

1,000

1,200
(600)
(47)
3
(124)
432
(173)
259
(300)
(41)

1,440
(720)
(68)
(156)
496
(198)
298
(348)
(50)

1,728
(864)
(98)
(194)
572
(229)
343
(404)
(61)

Balance sheet
Cash and marketable securities
Current assets
Fixed assets
At cost
Depreciation
Net fixed assets
Total assets

80
200

240

288

346

1,100
(300)
800
1,080

1,384
(424)
960
1,200

1,732
(580)
1,152
1,440

2,157
(774)
1,382
1,728

Current liabilities
Debt
Stock
Accumulated retained earnings
Total liabilities and equity

80
400
450
150
1,080

96
545
450
109
1,200

115
816
450
59
1,440

138
1,142
450
(2)
1,728

Year
Free cash flow calculation
Profit after tax
Add back depreciation
Subtract increase in current assets
Add back increase in current liabilities
Subtract increase in fixed assets at cost
Add back after-tax interest on debt

259
124
(40)
16
(284)
28

298
156
(48)
19
(348)
41

343
194
(58)
23
(425)
59

Subtract after-tax interest on cash and mkt. securities

Free cash flow

(2)
101

Part b:

Dividend growth rate

0%
2%
4%
6%
8%
10%
12%
14%
16%
18%

0
118

0
137

Table: Debt/Equity (book values) ratio as a function of

Year 1
Year 2
Year 3
0.975
1.604
2.548
0.975
1.373
1.617
0.975
1.400
1.702
0.975
1.427
1.793
0.975
1.455
1.893
0.975
1.483
2.001
0.975
1.512
2.119
0.975
1.542
2.248
0.975
1.573
2.391
0.975
1.604
2.548
0.975
1.636
2.723

5. Consider the model in section 3.7 (where debt is the plug).

a. Suppose that the firm has 1200 shares and that it decides
to pay, in year 1, a dividend per share of 25 cents. In
addition, suppose that it wants this dividend per share to
grow in subsequent years by 16 percent per year.
Incorporate these changes into the pro forma model. b. Do a
sensitivity analysis in which you show the effect on the
debt/equity ratio of the nnual growth rate of dividends. Vary
this rate from 0 percent to 18 percent, in steps of 2 percent.
For this exercise, define debt as net debt (i.e., debt minus
cash and marketable securities).

SHARE BASIS

2,074
(1,037)
(134)
(242)
662
(265)
397
(468)
(71)

2,488
(1,244)
(176)
(299)
769
(308)
461
(543) <-- =-$B$12*$B$11*(1+$B$13)^(G15-1)
(82)

415

498

2,675
(1,016)
1,659
2,074

3,306
(1,315)
1,991
2,488

166
1,531
450
(73)
2,074

199
1,994
450
(155)
2,488

397
242
(69)
28
(518)
80

461
299
(83)
33
(631)
106

0
159

0
186

book values) ratio as a function of dividend growth rate

Year 4
Year 5
4.064
6.764 <-- =(G38-G29)/(G39+G40), data table header
1.651
1.517
1.804
1.717
1.980
1.963
2.185
2.269
2.427
2.662
2.717
3.185
3.069
3.912
3.506
4.993
4.064
6.764
4.799
10.194

EXERCISE 7--TERMINAL VALUE = DEBT + EQUITY AT BOOK VALUE

Sales growth
Current assets/Sales
Current liabilities/Sales
Net fixed assets/Sales
Costs of goods sold/Sales
Depreciation rate
Interest rate on debt
Interest paid on cash & marketable securities
Tax rate
Dividend payout ratio
Year
Income statement
Sales
Costs of goods sold
Interest payments on debt
Interest earned on cash & marketable securities
Depreciation
Profit before tax
Taxes
Profit after tax
Dividends
Retained earnings

10%
15%
8%
77%
50%
10%
10.00%
8.00%
40%
40%
0

1,000
(500)
(32)
6
(100)
374
(150)
225
(90)
135

1,100
(550)
(32)
9
(117)
410
(164)
246
(98)
148

1,210
(605)
(32)
14
(137)
450
(180)
270
(108)
162

1,331
(666)
(32)
20
(161)
492
(197)
295
(118)
177

Balance sheet
Cash and marketable securities
Current assets
Fixed assets
At cost
Depreciation
Net fixed assets
Total assets

80
150

144
165

213
182

289
200

1,070
(300)
770
1,000

1,264
(417)
847
1,156

1,486
(554)
932
1,326

1,740
(715)
1,025
1,513

Current liabilities
Debt
Stock
Accumulated retained earnings
Total liabilities and equity

80
320
450
150
1,000

88
320
450
298
1,156

97
320
450
460
1,326

106
320
450
637
1,513

Year
Free cash flow calculation
Profit after tax
Add back depreciation
Subtract increase in current assets
Add back increase in current liabilities
Subtract increase in fixed assets at cost
Add back after-tax interest on debt
Subtract after-tax interest on cash & mkt. securities
Free cash flow

246
117
(15)
8
(194)
19
(5)
176

270
137
(17)
9
(222)
19
(9)
188

295
161
(18)
10
(254)
19
(12)
201

Valuing the firm

Weighted average cost of capital
Year
FCF
Terminal value
Total
NPV of row 61
Add in initial (year 0) cash and mkt. securities
Enterprise value
Subtract out value of firm's debt today
Equity value

20%
0

176

188

201

176

188

201

1,317 <-- =NPV(B55,C60:G60)

80
1,397
-320
1,077

Cash and marketable securities as negative debt

NPV of row 61 = enterprise value
Net year 0 debt
Equity value

1,317
-240 <-- =-B36+B27
1,077

Valuing the firm--using mid-year discounting

Weighted average cost of capital
Year
FCF
Terminal value
Total
NPV of row 81
Add in initial (year 0) cash and mkt. securities
Enterprise value
Subtract out value of firm's debt today
Equity value

20%
0

176

188

201

176

188

201

1,580 <-- =NPV(B76,C81:G81)*(1+B76)

80
1,660
-320
1,340

Growth
0%
2%
4%
6%
8%
10%
12%
14%
16%

1,340 <-- =B86

1,028
1,100
1,191
1,306
1,461
1,677
2,002
2,543
3,625

4,000
3,500
3,000
2,500
2,000
1,500
1,000

Cell B106 contains formula <-- =IF(B75<=B2,"nmf",B86)

growth rate of sales

1,340.03
0%
2%
4%
6%
8%
10%
12%
14%
16%

WACC
10%
2,030.04
2,458.87
3,173.58
4,603.01
8,891.30
nmf
nmf
nmf
nmf

12%
1,696.78
1,970.59
2,381.29
3,065.80
4,434.82
8,541.87
nmf
nmf
nmf

14%
1,458.43
1,644.72
1,905.52
2,296.72
2,948.73
4,252.74
8,164.77
nmf
nmf

In the valuation exercise of section

3.4, the terminal value is calculated
using a Gordon dividend model on the
cash flows. Replace this terminal value
by the year-5 book value of debt plus
equity. In making this change, you are
essentially assuming that the book
value correctly predicts the market
value.7. In the valuation exercise of
section 3.4, the terminal value is
calculated using a Gordon dividend
model on the cash flows. Replace this
terminal value by the year-5 book

AT BOOK VALUE

1,464
(732)
(32)
26
(189)
538
(215)
323
(129)
194

1,611
(805)
(32)
33
(220)
587
(235)
352
(141)
211

371
220

459
242

2,031
(904)
1,127
1,718

2,364
(1,124)
1,240
1,941

117
320
450
830
1,718

129
320
450
1,042
1,941

323
189
(20)
11
(291)
19
(16)
214

352
220
(22)
12
(333)
19
(20)
228

5
214

228
1,812 <-- =SUM(G36:G38)
2,040

214

5
214

228
1,812 <-- =SUM(G36:G38)
2,040

214

4,000 Sales

Growth and Equity Value

3,500
3,000
2,500
2,000
1,500
1,000
500
0
0%

2%

4%

6%

8%

10% 12% 14% 16%

0%

16%
1,279.41
1,411.68
1,588.03
1,834.92
2,205.27
2,822.51
4,056.99
7,760.42
nmf

2%

4%

6%

18%
1,139.96
1,236.67
1,361.01
1,526.79
1,758.89
2,107.03
2,687.27
3,847.75
7,329.19

8%

10% 12% 14% 16%

20%
1,028.23
1,100.37
1,190.54
1,306.48
1,461.06
1,677.48
2,002.10
2,543.14
3,625.21

22%
936.67
991.18
1,057.80
1,141.07
1,248.14
1,390.90
1,590.76
1,890.55
2,390.21

24%
860.24
901.71
951.47
1,012.28
1,088.30
1,186.04
1,316.36
1,498.80
1,772.47

26%
795.47
827.04
864.35
909.13
963.85
1,032.26
1,120.21
1,237.48
1,401.65

EXERCISE 8--THE EBITDA CALCULATIONS START IN ROW 53

Sales growth
Current assets/Sales
Current liabilities/Sales
Net fixed assets/Sales
Costs of goods sold/Sales
Depreciation rate
Interest rate on debt
Interest paid on cash & marketable securities
Tax rate
Dividend payout ratio
Year
Income statement
Sales
Costs of goods sold
Interest payments on debt
Interest earned on cash & marketable securities
Depreciation
Profit before tax
Taxes
Profit after tax
Dividends
Retained earnings

10%
15%
8%
77%
50%
10%
10.00%
8.00%
40%
40%
0

1,000
(500)
(32)
6
(100)
374
(150)
225
(90)
135

1,100
(550)
(32)
9
(117)
410
(164)
246
(98)
148

1,210
(605)
(32)
14
(137)
450
(180)
270
(108)
162

1,331
(666)
(32)
20
(161)
492
(197)
295
(118)
177

Balance sheet
Cash and marketable securities
Current assets
Fixed assets
At cost
Depreciation
Net fixed assets
Total assets

80
150

144
165

213
182

289
200

1,070
(300)
770
1,000

1,264
(417)
847
1,156

1,486
(554)
932
1,326

1,740
(715)
1,025
1,513

Current liabilities
Debt
Stock
Accumulated retained earnings
Total liabilities and equity

80
320
450
150
1,000

88
320
450
298
1,156

97
320
450
460
1,326

106
320
450
637
1,513

Year
Free cash flow calculation
Profit after tax
Add back depreciation
Subtract increase in current assets
Add back increase in current liabilities
Subtract increase in fixed assets at cost
Add back after-tax interest on debt
Subtract after-tax interest on cash & mkt. securities
Free cash flow

246
117
(15)
8
(194)
19
(5)
176

270
137
(17)
9
(222)
19
(9)
188

295
161
(18)
10
(254)
19
(12)
201

EBITDA Calculation
Profit before taxes
Add back depreciation
Add back net interest
EBITDA

410
117
23
550

450
137
18
605

492
161
12
666

Valuing the firm

Weighted average cost of capital
EBITDA multiple for terminal value
Year
FCF
Terminal value
Total
NPV of row 68
Add in initial (year 0) cash and mkt. securities
Enterprise value
Subtract out value of firm's debt today
Equity value

20%
6
0

176

188

201

176

188

201

2,530 <-- =NPV(B61,C67:G67)

80
2,610
-320
2,290

Cash and marketable securities as negative debt

NPV of row 61 = enterprise value
Net year 0 debt
Equity value

2,530
-240 <-- =-B36+B27
2,290

Valuing the firm--using half-year discounting

Weighted average cost of capital (WACC)
EBITDA multiple for terminal value
Year
FCF
Terminal value
Total
NPV of row 89
Add in initial (year 0) cash and mkt. securities
Enterprise value
Subtract out value of firm's debt today
Equity value

20%
6
0

176

188

201

176

188

201

3,036 <-- =NPV(B82,C88:G88)*(1+B82)

80
3,116
-320
2,796

growth
6
7
8
9

2,796 <-- =B94

2,796
3,185
3,573
3,961

EBITDA Multiple and

8,000

10
11
12
13
14

8,000

4,350
4,738
5,126
5,515
5,903

6,000
4,000
2,000
0
6

Cell B114 contains formula <-- =B94

Data table of equity value as function of

EBITDA Multiple

2,796
6
7
8
9
10
11
12
13
14

WACC
10%
3,890
4,440
4,990
5,540
6,090
6,640
7,190
7,740
8,290

12%
3,632
4,144
4,656
5,167
5,679
6,191
6,703
7,214
7,726

14%
3,396
3,873
4,350
4,826
5,303
5,780
6,257
6,733
7,210

8. Repeat exercise 7, but this time replace

the terminal value by an EBITDA ratio times
year-5 anticipated
EBITDA. Show a graph of the equity value of
the firm as a function of the assumed year-5
EBITDA ratio,
varying this ratio from 6 to 14.

RT IN ROW 53

1,464
(732)
(32)
26
(189)
538
(215)
323
(129)
194

1,611
(805)
(32)
33
(220)
587
(235)
352
(141)
211

371
220

459
242

2,031
(904)
1,127
1,718

2,364
(1,124)
1,240
1,941

117
320
450
830
1,718

129
320
450
1,042
1,941

323
189
(20)
11
(291)
19
(16)
214

352
220
(22)
12
(333)
19
(20)
228

538
189
6
732

587
220
(1)
805

5
214
214

228
4,832 <-- =G57*B62
5,060

5
214
214

228
4,832 <-- =B83*G57
5,060

EBITDA Multiple and Equity Value

16%
3,179
3,624
4,069
4,513
4,958
5,403
5,848
6,292
6,737

18%
2,980
3,395
3,811
4,226
4,641
5,057
5,472
5,887
6,303

10

11

20%
2,796
3,185
3,573
3,961
4,350
4,738
5,126
5,515
5,903

12

13

22%
2,627
2,991
3,354
3,718
4,081
4,445
4,808
5,172
5,535

14

24%
2,471
2,811
3,152
3,493
3,833
4,174
4,515
4,855
5,196

26%
2,326
2,646
2,965
3,285
3,604
3,924
4,243
4,563
4,882

EXERCISE 9

PROJECT FINANCE

Sales growth
Current assets/Sales
Current liabilities/Sales
Costs of goods sold/Sales
Depreciation rate
Interest rate on debt
Interest paid on cash & marketable securities
Tax rate
Dividend payout ratio

15%
15%
8%
55%
10%
10.00%
8.00%
40%
0% <-- No dividends until all the debt is paid off

Debt repayment table (essentially a loan table from Chapter 1): The principal amounts are
entered into the balance sheet and the interest is put into the profit and loss statement.
Principal
Debt
Of which:
at begin. payment
Year
of year
at end yr. Interest
1
200
52.76
20.00
2
167.24
52.76
16.72
3
131.21
52.76
13.12
4
91.57
52.76
9.16
5
47.96
52.76
4.80

Year
Income statement
Sales
Costs of goods sold
Interest payments on debt
Interest earned on cash & marketable securities
Depreciation
Profit before tax
Taxes
Profit after tax
Dividends
Retained earnings

1,150
(633)
(20)
(26)
(211)
261
(104)
156
156

1,323
(727)
(17)
(47)
(233)
298
(119)
179
179

1,521
(836)
(13)
(35)
(257)
379
(152)
227
227

Balance sheet
Cash and marketable securities the plug:
=C39-C28-C32
Current assets
Fixed assets
At cost
Depreciation
=B31-$B$7*(C30+B30)/2
Net fixed assets
Total assets

200

(657)
173

(526)
198

(352)
228

2,000
2,000
2,200

2,211
(211)
2,000
1,516

2,443
(443)
2,000
1,672

2,700
(700)
2,000
1,876

Current liabilities
Debt
Stock
Accumulated retained earnings
Total liabilities and equity

100
200
1,100
1,400

92
167
1,100
156
1,516

106
131
1,100
335
1,672

122
92
1,100
563
1,876

RETURN ON EQUITY (ROE)

Year
Equity cash flow
RETURN ON EQUITY (ROE)

Data table: ROE as a function of initial

equity investment

1
156
211
28
(8)
(211)
20
26
222

2
179
233
(26)
14
(233)
17
47
231

3
227
257
(30)
16
(257)
13
35
262

0
1
2
-1,100
15.90% <-- =IRR(B70:G70)

2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200

3
-

15.90% <-- =B71

11.31%
11.98%
45%
12.79%
40%
13.81%
35%
15.10%
16.82%
30%
19.23%
25%
22.86%
29.04%
42.69%

ROE

FREE CASH FLOW CALCULATION

Year
Profit after tax
Add back depreciation
Subtract increase in current assets
Add back increase in current liabilities
Subtract increase in fixed assets at cost
Add back after-tax interest on debt
Subtract after-tax interest on cash & mkt. securities
Free cash flow
Note that the cash flow generated by
depreciation equals the increase in fixed
assets at cost.

ROE as a Function

20%
15%
10%
5%
0%
0

In the project finance pro forma of section 3.9 it is

assumed that the firm pays off its initial debt of
1,000 in equal installments of principal over five
years. Change this assumption and assume
instead that the firm pays off its debt in equal
payments of interest and principal over five years.

all the debt is paid off

Repaid
principal
32.76
36.04
39.64
43.60
47.96

4
1,749
(962)
(9)
(19)
(284)
474
(190)
285
285

(127)
262
2,985
(985)
2,000
2,135
140
48
1,100
848
2,135

5
2,011
(1,106)
(5) <-- {=-TRANSPOSE(E17:E21)}
2
(314)
588
(235)
353
353

167
302
3,299
(1,299)
2,000
2,469
161
8 <-- =F47-$B$47/5
1,100
1,200
2,469

4
285
284
(34)
18
(284)
9
19
297

4
-

5
353
314
(39)
21
(314)
5
(2)
337

5
2,300 <-- =G34+G48+G49

ROE as a Function of Initial

Equity Investment

Equity investment

500

1,000

1,500

2,000

EXERCISE 10 PROJECT FINANCE

Uses functions IPMT and PPMT
Sales growth
Current assets/Sales
Current liabilities/Sales
Costs of goods sold/Sales
Depreciation rate
Interest rate on debt
Interest paid on cash & marketable securities
Tax rate
Dividend payout ratio

Year
Income statement
Sales
Costs of goods sold
Interest payments on debt
Interest earned on cash & marketable securities
Depreciation
Profit before tax
Taxes
Profit after tax
Dividends
Retained earnings

15%
15%
8%
55%
10%
10.00%
8.00%
40%
0% <-- No dividends until all the debt is paid off

1,150
(633)
(100)
(1)
(211)
206
(82)
124
124

1,323
(727)
(84)
(3)
(233)
276
(110)
166
166

1,521
(836)
(66)
(4)
(257)
358
(143)
215
215

Balance sheet
Cash and marketable securities the plug:
=C39-C28-C32
Current assets
Fixed assets
At cost
Depreciation
=B31-$B$7*(C30+B30)/2
Net fixed assets
Total assets

200

(21)
173

(47)
198

(45)
228

2,000
2,000
2,200

2,211
(211)
2,000
2,152

2,443
(443)
2,000
2,151

2,700
(700)
2,000
2,184

Current liabilities
Debt
Stock
Accumulated retained earnings
Total liabilities and equity

100
1,000
1,100
2,200

92
836
1,100
124
2,152

106
656
1,100
289
2,151

122
458
1,100
504
2,184

FREE CASH FLOW CALCULATION

Year
Profit after tax
Add back depreciation
Subtract increase in current assets
Add back increase in current liabilities
Subtract increase in fixed assets at cost
Add back after-tax interest on debt

1
124
211
28
(8)
(211)
100

2
166
233
(26)
14
(233)
84

3
215
257
(30)
16
(257)
66

Subtract after-tax interest on cash & mkt. securities

Free cash flow
Note that the cash flow generated by
depreciation equals the increase in fixed
assets at cost.

Data table: ROE as a function of initial

equity investment

3
240

4
270

0
1
2
-1,100
15.07% <-- =IRR(B59:G59)

2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200

15.07% <-- =B60

10.78%
11.40%
12.16%
13.11%
14.32%
15.94%
18.21%
21.65%
27.54%
40.67%

ROE

RETURN ON EQUITY (ROE)

Year
Equity cash flow
RETURN ON EQUITY (ROE)

1
244

3
-

50%
40%
30%

20%
10%
0%
0

In the project finance pro forma of section

3.9 it is assumed that the firm pays off its
initial debt of 1,000 in equal installments
of principal over five years. Change this
assumption and assume instead that the
firm pays off its debt in equal payments of
interest and principal over five years. Hint:
You have to use the PMT function to find
the annual payments; then set up a loan
table (as in Chapter 1) to split the annual
payments into an interest and repayment
of principal.

all the debt is paid off

1,749
(962)
(46)
(2)
(284)
455
(182)
273
273

(5)
262

2,011
(1,106)
(24) <-- =IPMT($B$7,G13,5,1000)
3
(314)
570
(228)
342
342

78
302

2,985
(985)
2,000
2,257

3,299
(1,299)
2,000
2,380

140
240
1,100
777
2,257

161
1,100
1,119
2,380

4
273
284
(34)
18
(284)
46

5
342
314
(39)
21
(314)
24

<-- =F36-PPMT($B$7,G13,5,-1000,0)

2
305

4
-

(3)
345

5
2,219 <-- =G23+G37+G38

ROE as a Function of Initial

Equity Investment

Equity investment

500

1,000

1,500

2,000