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Finance for Media Companies Course

Introduction Course Importance


The ability of media managers to cope with rough financial circumstances and ensure a viable business environment is esential. Financial knowledge helps you to interpret financial statements, documents, and reports. You can determine the financial health of an organization by reading, interpreting and evaluating the financial statements of the organization.

Financial statements are like fine perfume; to be sniffed but not swallowed Abraham Brilloff

Introduction Course Goals


After this course, students will be able to:

Learn to read and interpret financial statements Learn about cash operating cycle Calculate financial ratios Understand what budgets are and how the budgeting process works Prepare different types of budgets Decide on the companys financing options Analyse the risk of an investment Evaluating a business

Course Structure

Finance

I. Companys financial statements IV. Investment risk analysis

II. Financial performances evaluation V. Calculating a business value

III. Budgeting for media companies

Chapter I FINANCIAL STATEMENTS

Cash Flow Production Cycle (I)


Example

Investment

Collection of credit sales

Cash

Production

Cash sales

Fixed assets

Accounts receivable

Depreciation

Inventory

Credit sales

Cash Flow Production Cycle (II)


Example debriefing: For simplicity, suppose the company is a new one that has raised money from owners and creditors The company uses cash to purchase raw material and hire workers; it makes the product and stores it in inventory When the company sales a product, inventory turns into cash; if the sale is for cash, otherwise, cash is not realized until accounts receivable is collected; the movement of cash to inventory, to cash receivable, ad back to cash is the firms working capital cycle. On the other hand, over a period of time, fixed assets are consumed; thr accountant recognize the process by continually reducing the value of asets and increasing the value of merchandise flowing into inventory by an ammount called depreciation

Cash Flow Production Cycle (III)


Example debriefing: To maintain productive capacity, the company must invest part of its newly received cash in new fixed assets. Profit do not equal cash flow. The profitability of a company is not an anssurence that its cash flow will be sufficient to maintain solvency. For example, if the company loses control of its accounts receivable by allowing clients more time to pay, or the company makes more merchandise than it sells, then, though the firm is selling at a profit, its sales may not be generating sufficient cash to replenish the cash for production and investment

Financial statements Balance Sheet


A Balance sheet is a financial snapshot, taken at a point in time, of all the assets the company owns and all the claims against those assets.

A balance sheet is based upon the basic accounting equation of: Assets = Liabilities + Shareholders equity

Financial statements Balance Sheet


Asset Something valuable which a business owns or has the use of Factories Office buildings Plant and equipments Computers Goods Raw material

Liability

Something which is owed to somebody else

A loan Amounts owed to suppliers for goods purchased

Capital and reserves

The money put into a business by its owners is capital. Capital is money owned to the shareholders by the business

Reserves include retained earning and revaluation reserve

Financial statements Balance Sheet


EXAMPLE (000 EUR)
ASSETS
Cash Beginning balance 1/1/10 Initial purchases Sales Wages Merchandise purchases Other expenses Depreciation Interest payment Ending Balance 31/12/10 (10) 215 25 110 45 20 100 250 (140) 875 (190) (360) (210) (15) 30 20 25 80 60 900 (190) (350) (210) (15) (10) 275 Accounts Receivable Inventory Fixed Assets

LIABILITIES
Accounts Payable Loans 100

+ EQUITY
Owners equity 150

Financial statements Balance Sheet


Example: BS of a newspaper (000 EUR)
ASSETS
Cash Beginning balance 1/1/10 Purchases Sales Wages Print & Paper 500 (140) 200 (500) (10) 30 370 800 80 60 1000 (500) (350) Accounts Receivable Inventory Fixed Assets

LIABILITIES
Accounts Payable Loans 100

+ EQUITY
Owners equity 400

Other expenses
Depreciation Interest payment Ending Balance 31/12/10

(10)
(15) (10) 30 800 110 45

200

(210)
(15) (10)

570

100

315

Financial statements Balance Sheet


EXAMPLE debriefing: A new founded newspaper, invested at the beginning of 2010 150 thou. EUR of his personal savings an borrowed additional 100 thou. EUR After buying furniture and computers for 60 thou. EUR and merchandise for 80 thous. EUR, his transactions can be summarised:
Sell 900 thou EUR (advertising+circulation), receiving 875 thou EUR in cash , with 25 thou EUR still to be paid Pay 190 thou EUR wages Purchaise 380 thou EUR merchandise, with 20 thous EUR still owning to suppliers and 30 thou EUR still in inventory Spend 210 thou EUR on other expenses, including distribution, rent, taxes Depreciate furniture and computers by 15 thou EUR Pay 10 thou EUR interest on loan

Specific of a Romanian newspaper


AR are high due tu late payments from distribution and advertising, therefore cash is low.

Financial statements Balance Sheet


Assets
Two main categories of assets: 1. Current Assets - are expected to be converted into cash or consumed within 1 year. Examples: Cash Accounts Receivables Inventory Prepaid expenses Short term investments ( bonds, stocks) 2. Non current Assets (> 1 year)

Financial statements Balance Sheet


Current Assets
Cash Usually includes cash in bank, cash in safe, short term investments (deposits).
Accounts Receivable the amount of money owed to the company by its customers (bad debts, Irrecoverable debts) Inventories Include raw materials, work in progress (goods in the process of being manufactured), finished goods already available for sale

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Financial statements Balance Sheet


Non-Current Assets
Assets intended to be held and used by a business for a number of years. Tangible Assets (Fixed Assets) have a physical form: property, plant, equipment Intangible Assets - not physical in nature: patents, trademarks, copyrights, goodwill (purchase price less fair value of an asset) , development costs Financial assets

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Financial statements Balance Sheet


Liabilities

Current Liabilities - Debts or obligation that will become due over the next 12 months. Examples:
Accounts Payable or creditors (e.g. suppliers, employees) Current tax Overdraft (short term credit from banks) Accrued expenses Current portion of long term debt ( the portion of loan or other debts that become due within one year) Provisions

Long Term Liabilities - Debt or obligations that become due in more than one year from the BS date. Examples: Bank loan (long term portion) Finance Lease (long term portion) Provisions

Financial statements Balance Sheet


Shareholders Equity
Equity = the amount of the funds contributed by the owners (share capital) plus the retained earnings (or losses) and reserves (revaluation, share premium). Equity = Share Capital + Reserves + Retained earnings (net of Dividends)

More simple: Equity = what the company owns what it owes

Financial statements Income Statement


Income statement - comprises the income and expenses during a period of time (accounting period). Income Statement = Profit and loss statement

Comprises: Revenues (Sales) Cost of sales Gross Profit Operating expenses Operating income Other expenses Other non operating Income Income before tax Tax Net Income (Profit)

Financial statements Income Statement


Revenues (Sales): Net Sales = Sales revenue for the period less returns, discounts. Cost of Sales: The purchase cost / production cost of goods sold Retail business: cost of sales = purchase cost from suppliers + other direct costs Manufacturing business: production cost = raw material +labor cost +production overheads Gross Profit Gross profit = Sales - cost of sales Other non operating Income: income form other sources: dividends, interest, sale of assets

Financial statements Income Statement


Operating expenses
Sale employees salaries and commissions Advertising and promotion expenses Delivery costs Bad Debt

Selling and distribution expenses = Costs directly attributable to the selling and delivering goods to customers.

General and administration expenses = Expenses of providing management and administration for the business.
Salaries of office staff (corporate function such as HR, Finance) Rent, utilities Printing, stationery

Depreciation:
Total cost of an long term assetmust be spread over the assets expected useful life Charging the full cost of a long-term asset to one yera distors reported income. Example: suppose in 2002 a company buys a facility expected to be in use for 12 years, for 10 mil EUR. If the entire cost is assign to 2002,income in 2002 will apear depressed, while income in the following years will look too high.

Financial statements Income Statement


Operating income (profit or loss) = profit from day-to-day operations excuding taxes, interest income and expense EBITDA = Earning before Interest, Taxation, Depreciation and Amortization. Great use in broadcasting for example, where depreciation overstate true economic depreciation EBIT = Earning before Interest and Taxation. Widely used to measure a business income before it is divided among creditors, owners and taxman

Net income (profit) Net profit earned by a company during accounting period Two choices: paid out as dividend or retained into the business in the form of retained earning for investments. Net profit less dividend paid is transferred to Balance Sheet, as

Retained earning

P/L STATEMENT RON


Subscribtions Newsstands Sales Advertisement Other Incomes Total Turnover Main Product extern
- Prod.Costs Paper - Prod. Costs Others

TOTAL

Example of a P&L statement of a newspaper

90.258.318 47.918.037 138.176.355 57.113.368


36.367.521 20.745.847

Other raw material / Prod. cost Total Production Contribution Editorial Advertisement Departement Distribution Departement Marketing Departement
- Personal Costs - Other Costs - Promotion extern - Promotion barter

114.226.736 23.949.620 82.365.000 1.913.019 12.963.036


11.299.109 984.848

Publishing Departement
- Other Costs - Depreciation

4.731.069
1.855.069 2.876.000

Total direct Costs Oparational Profit Administration (Finance, HR, IT) Total indirect Costs Profit / Loss

101.972.124 -78.022.504 7.475.202 -85.497.706

Financial statements Cash Flow


Cash Flow Is the movement of money into or out of a cash account over a period of time Shows companys ability to generate cash

Expands and rearranges the sources into 3 categories: Cash Flow from operating activities result of the principal activity of a company Cash Flow from investing activities - Acquisition or disposal of assets or investment in other companies Cash Flow from financing activities - Receipt/repayment to external providers of finance (loan, leases)

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Financial statements Cash Flow


EXEMPLE
Net profit before taxation Adjustments for: Depreciation Working capital Changes Increase in accounts receivables Decrease in inventory Decrease in accounts payables Cash generated from operation Income tax paid Interest paid Net cash from operating activities Purchase of property, plant, equipment Proceed from sale of cars Dividends received Net cash used in investing activities Proceed from issuance of share capital Dividend paid Net cash used in financing activities Net increase in cash and cash equivalents Cash and cash equivalents at beginning of period Cash and cash equivalents at end of period 250 (100) 150 1,460 1,000 2,460 (900) 10 100 (790) 3,200 500 (300) 300 (700) 3,000 (300) (600) 2,100

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Financial statements Cash Flow


Net profit or loss is adjusted for:
Changes in working capital (inventory, receivables, payables). Non-cash items like depreciation, provisions, losses on disposal of assets. Other items that need to be classified under investing or financing activities.

Adjustments (Add/subtract):
+ Depreciation (non cash item) + Loss on disposal (non cash item) - Increase in inventory (cash spent on buying inventory) - Increase in receivable (debtors have not paid) - Decrease in payables ( cash paid)

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Chapter II Financial performances evaluation

Financial performance ratios - Profitability


Net income

Return on Equity (ROE) = Shareholders Equity It measures the efficiency with wich a company employs owners capital Indicates the annual % return on each $ of owner's equity invested in the company

Rewrite:

Net income
ROE= Sales
1

Sales
x Assets
2

Assets
x Shareholders Equity
3

Debriefing: management has only 3 levers for controlling ROE 1. Earnings squeezed out of each dollar of sale = proffit margin 2. Sales generated from assets employed = asset turnover 3. Amount of equity used to finance the assets = financial leverage

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Financial performance ratios- Profitability


EBIT Return on capital employed (ROCE) =

Capital employed
Capital employed = Long term liabilities + Shareholder's equity. Annual return on each $ invested in the company by shareholders and debtors How well a company is using the capital to generate revenues.

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Financial performance ratios - Profitability


Return on Assets (ROA) is a basic measure of the efficiency with which a company allocates and manages its resources; it measures profit as a percentage oh money provided by owners and creditors Net income Return on Assets (ROA) = Total assets

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Financial performance ratios - Profitability


Profit margin measures the fractin of each $ of sales that trickles down through the income statement to profits ; it reflects companyspricing strategy and its ability to control operating costs
Sales - Cost of Sales

Gross Profit margin (%) =


Sales

The gross profit margin must cover all other costs


Profit After Tax (PAT)

Net Profit margin (%) = Sales The proportion of each $ of sale the firm retains as profit after all expenses including taxes

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Financial performance ratios - Profitability


Return on investment (ROI) is the annual percentage return from each $ of capital invested in the business by creditors and shareholders. Profit After Tax (PAT) Return on investment (ROI) = Total assets

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Financial performance ratios - Liquidity


Company debt capacity is the liquidity of its assets. An asset is liquid if it can be readily converted to cash. A liability is liquid if it must be repaid in the near future.

Current Assets Current ratio = Current Liabilities A company with a low current ratio lacks liquidity and canot reduce its current assets for cash to meet its obligation. It must rely instead on operating income and outside financing.

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Financial performance ratios - Liquidity


Current assets - Inventory Quick (acid) ratio = Current Liabilities Inventory is not very liquid, because the cash cycle may be long Under distress conditions, a company or its creditors may realize little cash from the sale of inventory (sellers tipicaly receive 40% or less of the book value)

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Financial performance ratios - Assets


Accounts receivable Collection period = Sales x 365

Long collection period may indicate problems with credit quality or credit granting procedures.
Inventory x 365 Cost of sales

Inventory days =

Shows how long the company hold inventory in stock before selling Trade payables = Purchases x 365

Accounts payable period

Generally, the higher the better, but an increase may be a sign of lack of long term finance or poor management of current assets

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Financial performance ratios - Assets


Sales
Fixed assets Turnover = Net fixed assets

Companies requiring large investments in long term assets are said to be capital intensive. Fixed assets turnover is a measurement of capital intensity Indicates the number of $ of sales generated per $ of fixed assets High ratio is usually preferred to a low ratio, but may indicate obsolete fixed assets Ratio should be compared with the industry average

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Financial performance ratios Balance sheet


Total Debt (Liabilities) Debt to-equity = Total Equity A high ratio indicates that more of the company is financed by creditors (higher risk and lower profit available for shareholders) Total liabilities Debt-to-assets = Total assets Indicates the percentage of assets that are paid by creditors

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Financial performance ratios Coverage


EBIT Interest cover =

Interest paid

Indicates whether a company is earning enough profits to pay its interest More specific, Interest cover shows how many times over the company earned its interest obligations

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Financial performance ratios Investor


Net income Earning per Share (EPS) = Average Number of ordinary shares Market price per share

P/E (price to earning) =


EPS Indicates how much the market is wiling to pay for each $1 of company earning A high number suggest the company has excellent growth prospects or is very low risk In general, P/E ratio indicates what investors belive about the future prospects; sometimes the earnings are weak, but investors belive the weakness is temporary

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Financial performance ratios Investor


EPS Dividend cover = Dividend per share Proportion of profit for the year that is available for distribution to shareholders

Dividend per share


Dividend yield = Market Price per Share It is the return a shareholder is currently expecting on the share of a company
Dividend per share Dividend payout = EPS Indicates the percentage of each $1 of net income that is paid out to its shareholders in the form of a dividend High growth companies have a low dividend payout ratios.
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Chapter III - BUDGETING

BUDGETING
What is a budget?
A budget is the financial action plan for an organization. It translates strategic plans into measurable expenditures and anticipated returns over a certain period of time. Budgeting includes: Forecasting future business results, such as sales volume, revenues, capital investments, and expenses Reconciling those forecasts to organizational goals and financial constraints Obtaining organizational support for the proposed budget Managing subsequent business activities to achieve budgeted results

BUDGETING PROCESS
STEP 1: Setting goals. Some organizations mandate company wide goals such as "increase net profits by 10% during the next year." Individual departments then translate these directives into financial goals that are relevant for their particular activities. STRP 2: Evaluating and choosing options. A variety of tactics may be used to meet a specific goal. To boost sales, for example, a company might change its pricing, increase advertising, add sales people, or utilize new distribution channels. STEP 3: Identifying budget impacts. Decisions about strategic goals and tactics are used to develop assumptions about future costs and revenues (See example bellow)
Goal Become the most reliable newspaper on the market Increase revenues by 10% Options Hire the best journalists on the market Conduct social snd media campaigns Raise prices Expand marketing Budget Impacts Higher labor and training costs Increased spending in marketing Lower sales volume, higher gross margin Increased sales, higher marketing costs, increased production costs

BUDGETING PROCESS
STEP 4: Coordinating departmental budgets. Individual unit and division budgets are combined into a single master budget that expresses the organizations overall financial objectives and strategic goals. To achieve this end, communication is essential. Senior managers need to communicate the companys strategic objectives to all levels of the organization, and the different groups within the company need to communicate with each other. For example, consider an organization that has a strategic goal of increasing revenues by 10% over the next fiscal year. One of the ways in which the company plans to achieve this goal is to enter new markets. Entering new markets will impact many unitsspecifically marketing, sales, product development, research and development, and so forth.

TYPES OF BUDGETS
1. Operating budgets reflect day-to-day expenses and depreciation. They typically cover a one-year period.

2. Capital budgets outline planned outlays for investments in plant, equipment, and product development. Capital budgets may cover periods of three, five, or ten years.

3. Cash budgets plot the expected cash balances the organization will experience during the forecast period, based on information provided in operating and capital budgets. Cash budgets are prepared by the finance department and are critical to ensuring that the company has sufficient liquidity (cash and credit) available to meet expected cash disbursements.

PREPARING FOR BUDGETING


Categorizing EXPENSES
Fixed costs include: Rent Basic utilities including electric and telephone service Equipment leases Depreciation Insurance Interest payments Administrative costs Marketing and advertising Indirect labor, such as salaried supervisory employees Variable costs include: Raw materials Direct labor Packaging Depreciation due to usage Power and gas used in manufacturing Shipping Sales commissions Income taxes Allocated costscosts associated with operating the overall company that are not tied to individual products or departments: office rent for corporate headquarters, and salaries and expenses associated with corporate management.

PREPARING AN OPERATING BUDGET


1. Defining goals Some goals may be set by senior management, while others are determined by the individual department or unit. These goals will reflect both the organizations larger strategic priorities and the department or business units tactical goals. Examples: What technological changes are affecting the industry? How can current processes be improved?

What longer-term initiatives need to be considered in order to position the company for the future?

PREPARING AN OPERATING BUDGET


2. Setting assumptions All budgeting requires making assumptions about the future. In many companies senior management will communicate key assumptions that are to be used throughout the organizationsuch as a 5% increase in salaries, or a 10% increase in sales volumes. In other cases the assumptions are specific to an individual departments activities. Managers use a wide variety of data and approaches in developing assumptions, including historical trends, purchasing surveys, and industry projections. They also communicate with each other about their expectations for customer response, supplier performance, financial market fluctuation, and so on. Be sure to document all of your assumptions and keep notes of sources of information you use.

PREPARING AN OPERATING BUDGET


3. Forecasting sales and revenues Sales projections for a given period are developed by product or product group. If you are forecasting product sales, consider whether it is appropriate to base your forecasts on current sales trends. Some factors to consider, in addition to overall demand trends for these types of products, are:
The history of sales growth for your company's products Competitive products that have or may be introduced in the market Availability of substitute products Price sensitivity of purchasers Percentage of purchasers who demonstrate repeat purchases Planned changes in sales and promotion activities

PREPARING AN OPERATING BUDGET


4. Forecasting expected cost of goods sold Production costs including materials, labor, other direct product costs, and manufacturing overhead, are estimated based on units of product or, for a service company, hours of service. 5. Estimating SG&A Selling, general, and administrative costs can include costs generated by research and development, product design, marketing, distribution, customer service, commissions, administration, and overhead. 6. Calculating expected operating income = Total revenue-Total costs

Obs: Typically, it will be necessary to rework the first draft of an operating budget in order to bring the budgeted results into line with goals and constraints. Practical, a budget is an extension of a P&L, with a forecast on 3-5 years

TIPS FOR NEGOTIATING YOUR TEAMS BUDGET


1. Make sure you understand your organizations budgeting process. 2. Communicate often with the controller or finance person in your department. Ask questions about points you dont understand. Get that persons advice about the assumptions your team is making. 3. Know what real concerns are driving the people making the decisions about your budget. Then be sure to address those concerns. 4. Get buy-in from the decision makers. Spend time educating the finance person or decision maker about your area of the business. That will lay the groundwork for implementing changes later. 5. Understand each line item in the budget youre working on. 6. Have an ongoing discussion with your team throughout the budget period. The more you plan, the more you will be able to respond to unplanned contingencies. 7. Avoid unpleasant surprises! As they become available, compare actual figures to the budgeted amounts. If there is a significant or unexpected variance, find out why. And be sure to notify the finance person who needs to know.

Chapter IV INVESTMENT RISK ANALYSIS

Time Value of Money


PRINCIPLE: A dollar today is worth more than a dollar in the future, vecause: 1. 2. Inflation reduces the purchasing power of future money relative to current ones The uncertainty of actually receiving the money as the date of receipt recedes into the future The money today can be productively invested and will grow into the future

3.

Time Value of Money


Future value of an investment FV = C x (1+r)t Where C is cash flow, r is interest rate and t is time Example: if you deposit 100 eUR into a saving account that gives 10% interest and you keep it there for 2 years, you will get 121 EUR Present value of a project
C

PV =
(1+r)t

Exercice: you are recommended to invest in a magazine 85.000 EUR. You are certain thet the next year the magazine will worth 91.000 EUR. Given the discount rate of 10%, should you undertake this investment?

Net Present Value of an Investment


How to decide if a particular project/investment is worth to be accepted? While PV presents the value of a project in todays term, it is not the gain you make. The amount that you can actualy pocket is called the NET PRESENT VALUE NPV is the projects net contribution to wealth NPV is the measure of how much value is created or added by undertaking the investment NPV = PV Initial cost of investment If NPV > 0 then the project is worth undertaking and should be accepted IF NPV<0 then the project should be rejected

Net Present Value of an Investment


NPV = -C0 +

t=1

Ct

(1+rt)t C0 is negative because is usualy a cost (initial cash outlay)

Ct
(1+rt)t

are the PV of all cash flows

EXERCICE What is the NPV of following cash flow stream if the discount rate is 6% and the cash outlay is 5600 EUR?
Y1: Y2: Y3: 2000 EUR 4000 EUR 6000 EUR

Are you RISK Averse?


TEST: Which of the following investment opportunities do you prefer? 1. 2. You pay 10.000 EUR today and flip a coin in one year to determine whether you will receive 50.000 EUR or pau another 20.000 EUR You pau 10.000 EUR today and receive 15.000 EUR in one year If your chice is 2, join the crowd; you are risk averse; studies indicate that most people prefer certainty of option 2. The presence of risk reduces the value of 1 relative to 2

RISK and diversification


Example
Investment Ice cream stand Weather Sun Rain probability 0.5 0.5 Return on investment 60% -20% Outcome 30% -10% 20% Umbrela shop Sun Rain 0.5 0.5 -30% 50% -15% 20% 10%

Portfolio:
Stand and umbrela shop

Sun
Rain

0.5
0.5

15%
15%

7.5%
7.5% 15%

Investing in the ice cream stand isrisky, since the investor stands to make 60% return if it is sunny, but lose 20% if it rains Investing in the umbrella shop is also risky, investor loosing 30% if tomorrow is sunny but make 50% if it rains Despite that these 2 investments are risky viewed isolated, they are not risky as part of a portfolio. Regardless of the weather tomorrow, the outcome is a certain 15%

RISK and diversification


An assets rosk in isolation is greather than its risk as part of a portfolio, even if the asset and the portfolio are not perfectly correlated Total risk = Systematic risk + Unsystematic risk Systematic risk reflects exposure to economywide events: interest rate changes, business cycles, and cannot be reduced by diversification Unsystematic risk reflects investment specific events: fires, lawsuits, which can be eliminated by diversification

Estimating Investment RISK


3 techniques:
1. Sensitivity analysis involves an estimation of how the investments figure of merit (NPV) varies with changes in one of the uncertain economic factors that it depens on, such as: price, sales, etc. one approach is to calculate three returns coresponding to an optimistic, a pessimistic and a most likely forecast for the uncertain variables. Scenario analysis is a modest extension that changes several of the uncertain variables in a mutually consistent way to describe a particular event Simulation is an extension of 1 and 2, in which the analyst assigns aprobability distribution to each uncertain factor. For each set of values the computer calculates particula outcome

2.

3.

Estimating Investment RISK


Example sensitivity analysis:
Relative impact of key variables on NPV (Investment NPV=21.259 EUR)
A 1% increase in: Sales growth rate Operating profit margin Capital investment Working capital investment Discount rate Increase NPV by: 2240 2462 -1249 -1143 -1996 % increase 10.5% 11.6% -5.9% -5.4% -9.4%

Out of the 5 variables tested, the NPV is most sensitive to changes in the projected profit margin and sales growth rate. This suggests that management would be smart to pay special attention to their estimates of these 2 variables, and once the investment is undertaken, to manage these quantities closely.

Chapter V VALUING A BUSINESS

Valuating a Business
First setp in valuating a business is to decide what is to be valuated: 1. Do we want to valuate the companys assets or its equity?

2.
3.

Shall we valuate the business as a going concern or in liquidation?


Are we to value a minority interest in the business or controlling interest?

Valuating a Business Assets or Equity?


When a company acquires another, it can do so by purchasing either the sellers assets or its equity. When the buyer purcases the sellers equity, it must assume the sellers liabilities. Example: if you purchase a house for 100 thou EUR cash and assumption of the sellers 400 thou EUR mortgage, you say you buy the house for 500 thou EUR, with 100 thou EUR down.

Most acquisition involving companies of any size are structured as an equity purchase. However, never lose sight of the fact that the true cost is the cost of equity + value of liabilities

Valuating a Business Dead or Alive?


Companies can generate value for owners in 2 states: in liquidation or as growing concerns

Liquidation value is the cash generated by terminating the business and selling its assets individually
Going-Concern value is the present worth of expected future cash flows generated by a business

Valuating a Business Market value vs. book value


Market value Book value
Why?
1. Financial statements (that give a value of the shareholders equity) are transaction based. For example, an asset for 1 mil EUR in 1950 and used by the accountant in the balance sheet, may have no relevance today (inflation, the asset is obsolete) Companies tipicaly have many assets and liabilities that do not appear on the balance sheet, but affect future income (patents and trademarks, loyal customers, technology, better management)

2.

When a company is publicly listed, it is a simple matter to calculate its market value

#of shares x market price per share

Valuating a Business Discounted Cash flow


Absent market prices, the most direct way to estimate going-concern value is by calculating the present value of expected future cash flows going to owners and creditors. When this number exceeds the acquisition price, the purchase has a possitive net present value and is therefore attractive. Converselly, when the net present value of the future cash flows is less than the acquisition price, th epurchase is unattractive

Fair market value FMV of firm = PV{expected cash flows to owners and creditors} Maximum price one should pay for a business = present value of expected future cash flows to capital suppliers discounted at an risk adjusted discount rate; discounted rate should be target companys weighted average cost per capital

Valuating a Business Discounted Cash flow


Value of equity = Value of firm Value of debt

Therefore, in order to value a companys equity, we need to estimate firm value and subtract debt.
Market value and book value of debt are usually the same an can be taken from the balance sheet

Valuating a Business Discounted Cash flow


Terminal value Because a firm can have an infinitely long life expectancy, we can not estimate cash flow for hundreds of years We think of the companys future as composed of 2 periods: first (5-15 years) we presume company has a unique cash flow patern and growth trajectory we estimate annual free cash flows; second after the firs period company becomes stable, slow growth business we estimate a single terminal value reprsenting the worth of all subsequent free cash flows FMV of firm = PV(FCF years 1-10 + Terminal Value at year 10) Where FCF = EBIT (1- Tax)+ Depreciation Capital expenditures Working Capital

Valuating a Business Discounted Cash flow


In boom times, the newspaper companies would sell at:

10 x multiple of EBITDA
Today, multiple of EBITDA decreased. The highest multiple is at internet companies. Please check on Yahoo finance for Yahoo, Google.