1. What is a Financial Model
A financial model is a (quantitative,
accounting or hybrid of the two) logic
chain that is designed to forecast possible
future outcomes based on data inputs
2. Basis of Modeling in Engineering
and Science.
•Newton invented calculus to model his physics
theories
•The Wright Brothers used models to develop and
select airfoil designs
•Cad-Cam software is an aggregation of many
models used to design products, tools, furniture….
3. Several Types of Financial
Models
•Econometric Models and Quantitative Models
•Leading Economic Indicators
•Black Scholes
•Industry Models
•Regression Models
•Earnings Models (Often hybrid b/t accounting and Quant)
•Revenue Models
•Valuation models
•Cost and Breakeven Analysis
4. Example of a Model
Regression Model(hypothetical):
•A reit analyst observes a statistical correlation b/t housing starts and the
Population of the US
•The model looks like this: #New Homes = 780,000+.004(POP)
•If the US population estimate is 280mm then the analyst may forecast #New
Homes of approx. 1.9mm
780,000
Problems Benefits H
o
Assumptions Better than guessing m
Other variables Forecasting 1,900,000
e
Change Objectivity s
Integrity
280,000,000 Population
6. Valuation Analysis and Models
Two Schools of Thought
(not an oxymoron)
Top Down
Bottom Up
7. Top Down
The CFA institute recommends that most
analysts focus on Top Down Analysis because;
the correlation between corporate earnings and
the economy is strong, earnings and investment
performance is strong and the correlation
between stock returns and industry returns is
also strong.
8. Case Study of a Top Down
Earnings Model Model
Step 1 Step 2 Step 3
The Analyst Collects The Analyst Develops Analyst plugs revenue, cost
Income Statement and share estimates into
Economic Data Model accounting model and
Financial Data forecasts EPS
Industry Data Based on observations,
Customer Data experience and Estimates generated and
Product Data assumptions compared with real world
Other Data outcomes
New Earnings Data
9. BNHN Model
Assumptions:
Recent Share Price: $14.00 As of November 18, 2005
Equity Purchase Price per Share: 17.00 21.4% Premium to recent share price
Shares Outstanding: 9,795.9 Based on most recent 10-Q, includes effect of outstanding options
Market Value (Recent) $137,142.2 Price times shares
Market Value (Offer) 166,529.8 Price times shares
Transaction Value (Offer) 180,463.3 Market Value + Debt + Trans. Costs - Cash
Trans. Value / LTM EBITDA 7.9x
Tax Rate: 33.5% Approximate tax rate in 4Q 2004
Interest Rate: 7.0% Assumption
$ %
Sources:
Total Debt: $125,000 68.0% Assumes all traditional and institutional bank debt
New Equity: 50,422 27.4% Assumes additional equity to keep Debt/EBITDA at closing at approx. 5x
Rolled Equity: 8,326 4.5% Assumes insiders with 5% of common stock roll into LBO
Total Sources: $183,748
Uses: Summary of LBO Returns: IRR
Refinance Debt: $11,706 Holding Period $17/Sh $18/Sh $19/Sh
Purchase Equity: 166,530 3 Year 24.9% 18.4% 13.2%
Transaction Expenses 5,512 4 Year 22.9% 18.1% 14.1%
Total Uses: $183,748 5 Year 20.7% 16.9% 13.7%
Income Statement 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014
Revenues $207,252.0 $217,614.6 $228,495.3 $239,920.1 $247,117.7 $254,531.2 $262,167.2 $270,032.2 $278,133.1 $286,477.1
Revenue Growth --- 5.0% 5.0% 5.0% 3.0% 3.0% 3.0% 3.0% 3.0% 3.0%
EBITDA $24,642.2 $25,874.3 $27,168.1 $28,526.5 $29,382.3 $30,263.7 $31,171.6 $32,106.8 $33,070.0 $34,062.1
EBITDA Margin 11.9% 11.9% 11.9% 11.9% 11.9% 11.9% 11.9% 11.9% 11.9% 11.9%
Depreciation 9,041.0 8,992.7 8,948.7 8,908.6 8,872.2 8,838.9 8,808.7 8,781.1 8,756.0 8,733.1
EBIT $15,601.2 $16,881.6 $18,219.3 $19,617.8 $20,510.1 $21,424.8 $22,363.0 $23,325.7 $24,314.0 $25,328.9
Pro Forma Interest Expense 8,574.0 8,177.3 7,696.1 7,131.9 6,497.8 5,801.4 5,032.0 4,184.9 3,254.9 2,237.0
Pro Forma Interest Income 98.6 98.6 98.6 98.6 98.6 98.6 98.6 98.6 98.6 98.6
Pre-Tax Income 7,125.8 8,802.9 10,621.8 12,584.4 14,110.9 15,721.9 17,429.5 19,239.4 21,157.6 23,190.5
Income Taxes 2,388.3 2,950.4 3,560.0 4,217.8 4,729.4 5,269.3 5,841.6 6,448.2 7,091.1 7,772.5
Net Income $4,737.5 $5,852.5 $7,061.8 $8,366.7 $9,381.5 $10,452.6 $11,587.9 $12,791.1 $14,066.5 $15,418.0
Calculation of Free Cash Flow
Net Income $4,737.5 $5,852.5 $7,061.8 $8,366.7 $9,381.5 $10,452.6 $11,587.9 $12,791.1 $14,066.5 $15,418.0
Working Capital Requirements (250.0) (39.5) (67.7) (98.7) (311.2) (338.4) (367.0) (397.0) (428.5) (461.5)
Depreciation 9,041.0 8,992.7 8,948.7 8,908.6 8,872.2 8,838.9 8,808.7 8,781.1 8,756.0 8,733.1
Maintenance Capex (8,500.0) (8,500.0) (8,500.0) (8,500.0) (8,500.0) (8,500.0) (8,500.0) (8,500.0) (8,500.0) (8,500.0)
Free Cash Flow $5,028.5 $6,305.8 $7,442.8 $8,676.6 $9,442.5 $10,453.1 $11,529.5 $12,675.2 $13,894.0 $15,189.7
Summary Balance Sheet Items
Cash 3,285.0 3,285.0 3,285.0 3,285.0 3,285.0 3,285.0 3,285.0 3,285.0 3,285.0 3,285.0
Current Assets 12,597.0 13,226.9 13,888.2 14,582.6 15,020.1 15,470.7 15,934.8 16,412.8 16,905.2 17,412.4
Days of Sales 22.2 22.2 22.2 22.2 22.2 22.2 22.2 22.2 22.2 22.2
Current Liabilities 22,314.0 22,904.4 23,498.0 24,093.8 24,220.0 24,332.2 24,429.3 24,510.3 24,574.2 24,619.9
Days of CoGS 44.6 43.6 42.6 41.6 40.6 39.6 38.6 37.6 36.6 35.6
Debt 125,000.0 119,971.5 113,665.7 106,222.9 97,546.3 88,103.8 77,650.7 66,121.2 53,446.0 39,552.0
Equity 58,748.3 64,600.8 71,662.6 80,029.3 89,410.8 99,863.4 111,451.3 124,242.4 138,308.8 153,726.8
PP&E Schedule
Beginning Assets $101,258.0 $100,717.0 $100,224.3 $99,775.6 $99,367.0 $98,994.8 $98,655.9 $98,347.2 $98,066.1 $97,810.1
Depreciation (9,041.0) (8,992.7) (8,948.7) (8,908.6) (8,872.2) (8,838.9) (8,808.7) (8,781.1) (8,756.0) (8,733.1)
Additions 8,500.0 8,500.0 8,500.0 8,500.0 8,500.0 8,500.0 8,500.0 8,500.0 8,500.0 8,500.0
Ending Assets 100,717.0 100,224.3 99,775.6 99,367.0 98,994.8 98,655.9 98,347.2 98,066.1 97,810.1 97,577.0
Beg. Assets / Depr. -11.2x -11.2x -11.2x -11.2x -11.2x -11.2x -11.2x -11.2x -11.2x -11.2x
