Finance for Media Companies

7/29/2019 Finance for Media Companies

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Finance for Media CompaniesCourse
http://www.gate.com.ro/


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IntroductionCourse Importance

The ability of media managers to cope with rough financialcircumstances and ensure a viable business environment isesential.

Financial knowledge helps you to interpret financial statements,

documents, and reports. You can determine the financial healthof an organization by reading, interpreting and evaluating thefinancial statements of the organization.

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


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IntroductionCourse 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 processworks

Prepare different types of budgets

Decide on the companys financing options

Analyse the risk of an investment

Evaluating a business


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Course Structure

Finance

II. Financial performances

evaluation

III. Budgeting for media

companies

I. Companys financialstatements

V. Calculating a business

value

IV. Investment risk

analysis


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Chapter I

FINANCIAL STATEMENTS


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Cash FlowProduction Cycle (I)

Cash

Accounts

receivable

Fixed assets

Inventory

Collection of credit sales

Cash sales

Credit salesDepreciation

Production

Investment

Example


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Cash FlowProduction Cycle (II)

Example debriefing:

For simplicity, suppose the company is a new one that has raised money fromowners and creditors

The company uses cash to purchase raw material and hire workers; it makesthe product and stores it in inventory

When the company sales a product, inventory turns into cash; if the sale is forcash, otherwise, cash is not realized until accounts receivable is collected; themovement of cash to inventory, to cash receivable, ad back to cash is thefirms working capital cycle.

On the other hand, over a period of time, fixed assets are consumed; thraccountant recognize the process by continually reducing the value of asetsand increasing the value of merchandise flowing into inventory by anammount called depreciation


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Cash FlowProduction Cycle (III)

Example debriefing:

To maintain productive capacity, the company must invest part of its newlyreceived 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. Forexample, if the company loses control of its accounts receivable by allowingclients more time to pay, or the company makes more merchandise than itsells, then, though the firm is selling at a profit, its sales may not begenerating sufficient cash to replenish the cash for production and investment


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Financial statementsBalance 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


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Asset

Liability

Something valuable which abusiness owns or has the

use of

Factories

Office buildingsPlant and equipments

ComputersGoods

Raw material

Something which is owed to

somebody else

A loan Amounts owed to

suppliers for goodspurchased

Capital and

reserves

The money put into abusiness by its ownersis capital. Capital ismoney owned to theshareholders by thebusiness

Reserves includeretained earning andrevaluation reserve


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EXAMPLE (000 EUR)

ASSETS = LIABILITIES + EQUITY

Cash Accounts

Receivable

Inventory Fixed

Assets

Accounts

Payable

Loans Owners

equity

Beginning balance

1/1/10

250 100 150

Initial purchases (140) 80 60

Sales 875 25 900

Wages (190) (190)

Merchandise

purchases

(360) 30 20 (350)

Other expenses (210) (210)

Depreciation (15) (15)

Interest payment (10) (10)

Ending Balance

31/12/10

215 25 110 45 20 100 275


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Example: BS of a newspaper (000 EUR)

ASSETS = LIABILITIES + EQUITY

Cash Accounts

Receivable

Inventory Fixed

Assets

Accounts

Payable

Loans Owners

equity

Beginning balance

1/1/10

500 100 400

Purchases (140) 80 60

Sales 200 800 1000

Wages (500) (500)

Print & Paper (10) 30 370 (350)

Other expenses (10) 200 (210)

Depreciation (15) (15)

Interest payment (10) (10)

Ending Balance

31/12/10

30 800 110 45 570 100 315


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EXAMPLE debriefing:

A new founded newspaper, invested at the beginning of 2010 150 thou. EUR of his personalsavings an borrowed additional 100 thou. EUR

After buying furniture and computers for 60 thou. EUR and merchandise for 80 thous. EUR, histransactions 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.


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Assets

Two main categories of assets:

1. Current Assets - are expected to be converted into cash orconsumed within 1 year. Examples:

Cash

Accounts Receivables

Inventory

Prepaid expenses

Short term investments ( bonds, stocks)

2. Non current Assets (> 1 year)



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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 (baddebts,Irrecoverable debts)

Inventories

Include raw materials, work in progress (goods in the process of beingmanufactured), finished goods already available for sale

Current Assets



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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

Non-Current Assets



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Liabilities

Current Liabilities - Debts or obligation that will become due over thenext 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



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Shareholders Equity

Equity = the amount of the funds contributed by the owners (sharecapital) plus the retained earnings (or losses) and reserves (revaluation,share premium).

Equity = Share Capital + Reserves + Retained earnings (net ofDividends)

More simple: Equity = what the company ownswhat it owes



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Income statement - comprises the income and expenses during a period oftime (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 statementsIncome Statement


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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 directcosts

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, saleof assets



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Operating expenses

Selling and distribution expenses= Costs directly attributable to the selling and delivering goods to customers. Sale employees salaries and commissions

Advertising and promotion expenses

Delivery costs

Bad Debt

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 in2002 a company buys a facility expected to be in use for 12 years, for 10 mil EUR. If the entire cost isassign to 2002,income in 2002 will apear depressed, while income in the following years will look toohigh.



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Operating income (profit or loss) = profit from day-to-day operations excuding

taxes, interest income and expense

EBITDA = Earning before Interest, Taxation, Depreciation andAmortization. Great use in broadcasting for example, where depreciationoverstate 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 dividendor retainedinto the business in the form

of retained earning for investments. Net profit less dividendpaid is transferred to Balance Sheet, as

Retained earning



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P/L STATEMENT TOTAL

RON

Subscribtions -

Newsstands Sales 90.258.318

Advertisement 47.918.037

Other Incomes -

Total Turnover 138.176.355

Main Product extern 57.113.368

- Prod.Costs Paper 36.367.521

- Prod. Costs Others 20.745.847

Other raw material / Prod. cost -

Total Production 114.226.736

Contribution 23.949.620

Editorial 82.365.000

Advertisement Departement -

Distribution Departement 1.913.019

Marketing Departement 12.963.036

- Personal Costs -

- Other Costs -

- Promotion extern 11.299.109

- Promotion barter 984.848

Publishing Departement 4.731.069

- Other Costs 1.855.069

- Depreciation 2.876.000

Total direct Costs 101.972.124

Oparational Profit -78.022.504

Administration (Finance, HR, IT) -

Total indirect Costs 7.475.202

Profit / Loss -85.497.706

Example of aP&L statement

of a newspaper
http://www.gate.com.ro/http://www.gate.com.ro/http://www.gate.com.ro/http://www.gate.com.ro/


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Cash Flow

Is the movement of money into or out of a cash account over a periodof time

Shows companys ability to generate cash

Expands and rearranges the sources into 3 categories:

Cash Flow from operating activitiesresult of the principalactivity of a company

Cash Flow from investing activities - Acquisition or disposal ofassets or investment in other companies

Cash Flow from financing activities - Receipt/repayment toexternal providers of finance (loan, leases)

Financial statementsCash Flow


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EXEMPLENet profit before taxation 3,200

Adjustments for:Depreciation 500Working capital Changes

Increase in accounts receivables (300)Decrease in inventory 300Decrease in accounts payables (700)

Cash generated from operation 3,000Income tax paid (300)Interest paid (600)

Net cash from operating activities 2,100

Purchase of property, plant, equipment (900)Proceed from sale of cars 10Dividends received 100

Net cash used in investing activities (790)

Proceed from issuance of share capital 250

Dividend paid (100)

Net cash used in financing activities 150

Net increase in cash and cash equivalents 1,460

Cash and cash equivalents at beginning of period 1,000Cash and cash equivalents at end of period 2,460



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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


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Net income

Return on Equity (ROE) =

Shareholders Equity

It measures the efficiencywith wich a company employs owners capital Indicates the annual % return on each $ of owner's equity invested in the company

Rewrite:

Net income Sales Assets

ROE= x x

Sales Assets Shareholders Equity

Debriefing:management has only 3 levers for controlling ROE1. Earnings squeezed out of each dollar of sale =proffit margin2. Sales generated from assets employed = asset turnover3. Amount of equity used to finance the assets = financial leverage

Financial performance ratios - Profitability

1 2 3


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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.

Financial performance ratios- Profitability


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Return on Assets (ROA) is a basic measure of the efficiency with which acompany allocates and manages its resources; it measures profit as a percentageoh money provided by owners and creditors

Net income

Return on Assets (ROA) = Total assets



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Profit margin measures the fractin of each $ of sales that trickles down through theincome 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 includingtaxes



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Return on investment (ROI) is the annual percentage return from each $ ofcapital invested in the business by creditors and shareholders.

Profit After Tax (PAT)

Return on investment (ROI) =

Total assets



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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 itscurrent assets for cash to meet its obligation. It must rely instead onoperating income and outside financing.

Financial performance ratios - Liquidity


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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 thebook value)

Financial performance ratios - Liquidity


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Accounts receivable

Collection period = x 365

Sales

Long collection period may indicate problems with credit quality or credit grantingprocedures.

Inventory

Inventory days = x 365Cost of sales

Shows how long the company hold inventory in stock before selling

Trade payables

Accounts payable period = x 365

Purchases

Generally, the higher the better, butan increase may be a sign of lack of long term finance orpoor management of current assets

Financial performance ratios - Assets


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SalesFixed 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 capitalintensity

Indicates the number of $ of sales generated per $ of fixed assets

High ratio is usually preferred to a low ratio, but may indicate obsoletefixed assets

Ratio should be compared with the industry average

Financial performance ratios - Assets


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Total Debt (Liabilities)

Debtto-equity =Total Equity

A high ratio indicates that more of the company is financed by creditors (higherrisk and lower profit available for shareholders)

Total liabilities

Debt-to-assets =

Total assets

Indicates the percentage of assets that are paid by creditors

Financial performance ratiosBalance sheet


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EBITInterest cover =

Interest paid

Indicates whether a company is earning enough profits to pay its interest

More specific, Interest covershows how many times over the companyearned its interest obligations

Financial performance ratiosCoverage


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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 lowrisk

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

Financial performance ratiosInvestor


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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.

Financial performance ratiosInvestor


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Chapter III - BUDGETING


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BUDGETING

What is a budget?

A budget is the financial action plan for an organization. It translates strategicplans into measurable expenditures and anticipated returns over a certainperiod of time.

Budgeting includes:

Forecasting future business results, such as sales volume, revenues, capitalinvestments, and expenses

Reconciling those forecasts to organizational goals and financialconstraints

Obtaining organizational support for the proposed budget Managing subsequent business activities to achieve budgeted results


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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 thentranslate these directives into financial goals that are relevant for their particularactivities.

STRP 2: Evaluating and choosing options. A variety of tactics may be used to meeta 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 areused to develop assumptions about future costs and revenues (See example bellow)

Goal Options Budget ImpactsBecome the most reliable

newspaper on the market

Hire the best journalists on the market Higher labor and training costs

Conduct social snd media campaigns Increased spending in marketing

Increase revenues by 10% Raise prices Lower sales volume, higher gross margin

Expand marketing Increased sales, higher marketing costs,

increased production costs


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BUDGETING PROCESS

STEP 4: Coordinating departmental budgets. Individual unit and division budgets

are combined into a single master budgetthat expresses the organizations overallfinancial objectives and strategic goals.

To achieve this end, communication is essential. Senior managers need to communicatethe 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 revenuesby 10% over the next fiscal year. One of the ways in which the company plans toachieve this goal is to enter new markets. Entering new markets will impact manyunitsspecifically marketing, sales, product development, research and development,and so forth.

T T


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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, andproduct development. Capital budgets may cover periods of three, five, or ten years.

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

A G B DG T G


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PREPARING FOR BUDGETING

Fixed costs include:

RentBasic utilities including electric andtelephone service

Equipment leasesDepreciationInsuranceInterest paymentsAdministrative costsMarketing and advertising

Indirect labor, such as salariedsupervisory employees

Variable costs include:

Raw materialsDirect laborPackaging

Depreciation due to usagePower and gas used in manufacturingShippingSales commissionsIncome taxes

Allocated costscosts associated with operatingthe overall company that are not tied toindividual products or departments: officerent for corporate headquarters, and salariesand expenses associated with corporatemanagement.

Categorizing EXPENSES

A A AT T


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PREPARING AN OPERATING BUDGET

1. Defining goals

Some goals may be set by senior management, while others are determined by theindividual 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 thecompany for the future?

PR PAR G A OP RAT G B DG T


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2. Setting assumptions

All budgeting requires making assumptions about the future. In many companies seniormanagement will communicate key assumptions that are to be used throughout theorganizationsuch as a 5% increase in salaries, or a 10% increase in sales volumes. Inother 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 alsocommunicate with each other about their expectations for customer response, supplierperformance, financial market fluctuation, and so on. Be sure to document all of yourassumptions and keep notes of sources of information you use.



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3. Forecasting sales and revenues

Sales projections for a given period are developed by product or product group. If youare forecasting product sales, consider whether it is appropriate to base your forecastson current sales trends. Some factors to consider, in addition to overall demand trendsfor 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



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4. Forecasting expected cost of goods sold

Production costs including materials, labor, other direct product costs, andmanufacturing overhead, are estimated based on units of product or, for a servicecompany, hours of service.

5. Estimating SG&A

Selling, general, and administrative costs can include costs generated by research anddevelopment, 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 orderto 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

A A


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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. Askquestions 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 yourbudget. Then be sure to address those concerns.

4. Get buy-in from the decision makers. Spend time educating the finance person ordecision maker about your area of the business. That will lay the groundwork forimplementing 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 moreyou plan, the more you will be able to respond to unplanned contingencies.

7. Avoid unpleasant surprises! As they become available, compare actual figures to thebudgeted amounts. If there is a significant or unexpected variance, find out why. Andbe sure to notify the finance person who needs to know.


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Chapter IV

INVESTMENT RISK ANALYSIS

Ti V l f M


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Time Value of Money

PRINCIPLE: A dollar today is worth more than a dollar in the future,

vecause:

1. Inflation reduces the purchasing power of future money relative to currentones

2. The uncertainty of actually receiving the money as the date of receipt recedes

into the future

3. The money today can be productively invested and will grow into the future

Ti V l f M


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Time Value of Money

Future value of an investment

FV = C x (1+r)t

Where Cis cash flow, ris interest rate and tis time

Example: if you deposit 100 eUR into a saving account that gives 10% interestand you keep it there for 2 years, you will get 121 EUR

Present value of a projectC

PV =

(1+r)t

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

N t P t V l f I t t


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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 PRESENTVALUE

NPV is the projects net contribution to wealth

NPV is the measure of how much value is created or added by undertakingthe investment

NPV = PVInitial cost of investment

If NPV > 0 then the project is worth undertaking and should beaccepted

IF NPV


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NPV = -C0 + Ctt=1 (1+rt)

t

C0is negative because is usualy a cost (initial cash outlay)

Ct are the PV of all cash flows(1+rt)

t

EXERCICE

What is the NPV of following cash flow stream if the discount rate is 6% andthe cash outlay is 5600 EUR?

Y1: 2000 EUR

Y2: 4000 EUR

Y3: 6000 EUR

Net Present Value of an Investment

A RISK A ?


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Are you RISK Averse?

TEST: Which of the following investment opportunities do you prefer?

1. You pay 10.000 EUR today and flip a coin in one year to determine whetheryou will receive 50.000 EUR or pau another 20.000 EUR

2. 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 thatmost people prefer certainty of option 2. The presence of risk reduces thevalue of 1 relative to 2

RISK d di ifi ti


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RISK and diversificationExample

Investing in the ice cream stand isrisky, since the investor stands to make 60% returnif it is sunny, but lose 20% if it rains

Investing in the umbrella shop is also risky, investor loosing 30% if tomorrow is sunnybut make 50% if it rains

Despite that these 2 investments are risky viewed isolated, they are not risky as part ofa portfolio. Regardless of the weather tomorrow, the outcome is a certain 15%

Investment Weather probability Return on investment Outcome

Ice cream stand Sun 0.5 60% 30%Rain 0.5 -20% -10%

20%

Umbrela shop Sun 0.5 -30% -15%

Rain 0.5 50% 20%

10%

Portfolio: Sun 0.5 15% 7.5%

Stand and umbrela shop Rain 0.5 15% 7.5%

15%

RISK nd di r ifi ti n


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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 beeliminated by diversification

Estimating In estment RISK


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Estimating Investment RISK

3 techniques:

1. Sensitivity analysisinvolves 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 anoptimistic, a pessimistic and a most likely forecast for the uncertain variables.

2. Scenario analysisis a modest extension that changes several of the uncertainvariables in a mutually consistent way to describe a particular event

3. Simulationis an extension of 1 and 2, in which the analyst assigns aprobabilitydistribution to each uncertain factor. For each set of values the computer calculates

particula outcome

Estimating Investment RISK


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Estimating Investment RISKExamplesensitivity analysis:

Relative impact of key variables on NPV (Investment NPV=21.259 EUR)

Out of the 5 variables tested, the NPV is most sensitive to changes in the projectedprofit 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 thesequantities closely.

A 1% increase in: Increase NPV by: % increase

Sales growth rate 2240 10.5%

Operating profit margin 2462 11.6%

Capital investment -1249 -5.9%

Working capital investment -1143 -5.4%

Discount rate -1996 -9.4%


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Chapter V

VALUING A BUSINESS

Valuating a Business


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

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

Valuating a Business Assets or Equity?


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Valuating a BusinessAssets 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 sellersliabilities.

Example: if you purchase a house for 100 thou EUR cash and assumption of thesellers 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 equitypurchase. 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?


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Valuating a BusinessDead 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 itsassets individually

Going-Concern value is the present worth of expected future cash flows generatedby a business

Valuating a Business Market value vs book value


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Valuating a BusinessMarket 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)

2. 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, bettermanagement)

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


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Valuating a BusinessDiscounted Cash flow

Absent market prices, the most direct way to estimate going-concern value is bycalculating the present value of expected future cash flows going to owners andcreditors.

When this number exceeds the acquisition price, the purchase has a possitive netpresent value and is therefore attractive. Converselly, when the net present value ofthe 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 cashflows to capital suppliers discounted at an risk adjusted discount rate; discounted rate

should be target companys weighted average cost per capital



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Value of equity = Value of firmValue 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 thebalance sheet



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Terminal value

Because a firm can have an infinitely long life expectancy, we can not estimate cashflow for hundreds of years

We think of the companys future as composed of 2 periods: first (5-15 years) wepresume company has a unique cash flow patern and growth trajectorywe estimateannual free cash flows; secondafter the firs period company becomes stable, slowgrowth businesswe 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)+ DepreciationCapital expendituresWorking Capital



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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.

Documents

Finance for Media Companies