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Financial Modeling and Valuation Study Guide of Midterm

by: Kwan

Financial Modeling and Valuation Study Guide of Midterm BU.230.620.W4.SP16

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Financial Modeling and Valuation
Dr. Ken Yook
Study Guide
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This 4 page Study Guide was uploaded by Kwan on Thursday March 31, 2016. The Study Guide belongs to BU.230.620.W4.SP16 at Johns Hopkins University taught by Dr. Ken Yook in Spring 2016. Since its upload, it has received 190 views. For similar materials see Financial Modeling and Valuation in Finance at Johns Hopkins University.


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Date Created: 03/31/16
MIDTERM 1. CHAPTER 1 This chapter aims to give you some finance basics and their Excel implementa­ tion. If you have had a good introductory course in finance, this chapter is  1  likely to be at best a refresher. This chapter covers:  • Net present value (NPV)• Internal rate of return (IRR)• Payment schedules  and loan tables• Future value• Pension and accumulation problems•  Continuously compounded interest• Time­dated cash flows (Excel functions  XNPV and XIRR)  Almost all financial problems are centered on finding the value today of a  series of cash receipts over time. The cash receipts (or cash flows, as we will  call them) may be certain or uncertain. The present value of a cash flow CF t  anticipated to be received at time t is  t. The numerator of this1r t  expression is usually understood to be the expected time t cash flow, and the  discount rate r in the denominator is adjusted for the riskiness of this expected  cash flow—the higher the risk, the higher the discount rate.  The basic concept in present value calculations is the concept of opportunity  cost. Opportunity cost is the return which would be required of an investment  to make it a viable alternative to other, similar investments. In the financial  literature there are many synonyms for opportunity cost, among them: discount rate, cost of capital, and interest rate. When applied to risky cash flows, we will sometimes call the opportunity cost the risk­adjusted discount rate (RADR) or  the weighted average cost of capital (WACC). It goes without saying that this  discount rate should be risk­adjusted, and much of the standard finance  literature discusses how to do this. As illustrated below, when we calculate the  net present value, we use the investment’s opportunity cost as a discount rate.  When we calculate the internal rate of return, we compare the calculated return to the investment’s opportunity cost to judge its value.  2. CHAPTER 31 Data table commands are powerful commands that make it possible to do  complex sensitivity analyses. Excel offers the opportunity to build a table in  which only one variable is changed, or one in which two variables are changed. Excel data tables are array functions, and thus change dynamically when  related spreadsheet cells are changed.  In this chapter you will learn how to build both one­dimensional and two­  dimensional Excel data tables.  3. CHAPTER 33 Excel contains several hundred functions. This chapter surveys only those  functions used in this book. The functions discussed are the following:  • Financial functions: NPV, IRR, PV, PMT, XIRR, and XNPV• Date  functions: Now, Today, Date, Weekday, Month, Datedif• Statistical  functions: Average, Var, Varp, Stdev, Stdevp, Correl, Covar • Regression  functions: Slope, Intercept, Rsq, Linest• Conditional functions: If, VLookup, HLookup• Large, Rank, Percentile, Percentrank• Count, CountA, CountIf • Offset  A separate chapter, Chapter 34, is devoted to the important topic of array  functions.  4. CHAPTER 35 This chapter covers a grab bag of Excel hints dealing with problems and needs  that we sometimes run into. The chapter makes no pretence at uniformity or  extensiveness of coverage. Topics covered include:  • Fast fills and copy• Graph titles that change when data changes  • Creating multi­line cells (useful for putting line breaks in cells and linked  graph titles)  • Typing Greek symbols• Typing sub­ and superscripts (but not both)• Naming  cells• Hiding cells• Formula auditing• Writing on multiple spreadsheets• Using Excel’s personal notebook to copy and paste and format quickly  5. CHAPTER 5 The usefulness of financial statement projections for corporate financial man­  agement is undisputed. Such projections, termed pro forma financial state­  2 ments, are the bread and butter for much corporate financial analysis. In this  and the next chapter we will focus on the use of pro formas for valuing the firm and its component securities, but pro formas also form the basis for many  credit analyses; by examining pro forma financial statements we can predict  how much financing a firm will need in future years. We can play the usual  “what if” games of simulation models, and we can use pro formas to ask what  strains on the firm may be caused by changes in financial and sales parameters. In this chapter we present a variety of financial models. All the models are  sales driven, in that they assume that many of the balance sheet and income  statement items are directly or indirectly related to sales. The mathematical  structure of solving the models involves finding the solution to a set of simul­  taneous linear equations predicting both the balance sheets and the income  statements for the coming years. However, the user of a spreadsheet need never worry about the solution of the model; the fact that spreadsheets can solve—by iteration—the financial relations of the model means that we only have to  worry about correctly stating the relevant accounting relations in our Excel  model.  6. CHAPTER 2 What Is Corporate Valuation About?  When we discuss the valuation of a company, we may be referring to any of  the following:  • Enterprise value: Valuing the company’s productive activities.  • Equity: Valuing the shares of a company, whether for the purpose of buying  or selling a single share or valuing all of the equity for purposes of a corporate  acquisition.  • Debt: Valuing the company’s debt. When debt is risky, its value depends on  the value of the company that has issued the debt.  • Other: We may want to value other securities related to the company—for  example, the firm’s warrants or options, employee stock options, etc.  7. CHAPTER 4 Although both Chapter 4 (this chapter) and Chapter 5 differ in their method for deriving the free cash flows to be discounted, both chapters boil down to the  following template:  3 The difference between the two DCF approaches is in the derivation of the  future FCFs. In this chapter we examine the firm’s consolidated statement of  cash flows (CSCFs) and use it as a basis for estimating the future FCFs. We  then discuss issues related to estimating the short­term growth rate (8% above), the long­term growth rate (5%), assuming that you have learned from Chapter  3 how to compute the weighted average cost of capital (WACC) (11% above).  We focus on a number of important technical issues:  • Adjustments that need to be made in the passage from the consolidated  statement of cash flows (CSCFs) to the free cash flow (FCF). These adjust­  ments involve:    ▯ Financing adjustments  ▯ Corrections for the vagaries of accounting rules  ▯ Eliminating non­forward­looking items • Dates that don’t  match. Quite often the dates are not evenly spaced. We may be, for  example, projecting from annual statements that end on 31 December,  but the current valuation date may be September. How do we make our  valu­ ation appropriate to this? The answer is to use XNPV, as we shall  see. • Estimating the return on assets versus the return on equity. XIRR  can provide us with the answer. Finally, we discuss the methodology for making reality fit our template (or is it vice versa? Sometimes it’s hard  to tell!).  4


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