MAF 2

Valuations


Question

I don't know if it would be possible but I'm finding quite a few contradictions with the
notes, the tutorials and what we've been told and I'm struggling to keep up with what's
right and wrong.

With interest income for example, do we include it in our valuation or exclude it?

The problem is that there are quite a few inconsistencies and they're all quite small. I
was wondering if it would be possible for you to maybe send a more comprehensive
and definitive list of all the rules we should be aware of. Or at least enough to cover
the basics and pass a valuations question.


Answer
It is important to be specific about the contradictions so I can address these as best I
can. If you are talking about the ITC (QE) questions and solutions, which represent
many of the tutorial questions, then I agree that there are inconsistencies but I have
tried to point these out in the tutorials. This is what you will need to face in a few
months time when you will write the ITC examination. The objective is to make you
ready for the ITC as well as the MAF2 examination. The approach in some of the
ITC (QE) questions is not ideal but you need to be prepared and you need to
understand how strategically to deal with questions and understand where the marks
are and which points often will attract marks and the importance of qualitative
analysis for this section. I cannot help you with a definitive list of rules because it
depends on the situation and a companys business model. For example, for most
companies, the investment in net working capital will represent cash outflows and yet
for the food retailers, the opposite applies, as increases in sales will result in the
growth in cash inflows from net working capital. So there are different rules, which
depend on a companys business model and the nature of the industry sector.

You did indicate the example of interest income. The general principle is that all
financing cash flows mainly interest income and interest expense is excluded from
operating cash flows and we normally assume that operating cash attracts a negligible
interest income. Surplus (excess) cash will earn a market related interest rate and
such cash is not needed to enhance the cash flows from operations.

However, there may be situations where a company will need to hold operating cash
in order to support its operations, and yet such cash may attract some interest income.
In this case it is correct to include the interest income in operating cash flows because
it is directly related to its operations. For example, lets assume that a company
wishes to hold cash in order to take advantage of lower than normal input prices that
come up regularly. The company may earn interest but the main objective of such
cash balances is to quickly take advantage of lower input prices when these arise and
these decisions show up in a lower cost of sales over the longer term. In our
valuation, we include the low interest income and discount this at the cost of capital
and so this will indirectly factor into our valuation the benefit and the cost of holding
such cash balances. We do not include such cash balances as a separate asset it is
part of our operations.

I have indicated that valuations are difficult because they involve decisions regarding
the future and there are also decisions regarding the methods we should use to value a
company. This will often be driven by the information in the question. Valuations
also involve judgement, wisdom and experience as well as evidence from comparable
investment decisions. I have given you a significant number of examples so that you
are ready to deal with a range of situations.


Question

V222
Carlos can you please explain to me how the financing cash flows for 2013 were
determined in question 2?

Answer
The financing flows generally arise from the Statement of Comprehensive Income
(CI) or changes in balances in the projected Statements of Financial Position.



The change in excess cash is R252688.94 (-1342305.07 + 1389616.13) [Do not worry
about rounding differences]



Question
I would just like to ask you how you got the revenue figure in 20x8 in working
example 1 of the valuations pack week 1, as I have attempted to grow I attempted to
grow it at 10% but my figure doesn't come to the same figure. I grew it 10% because
Financing Cash Flows 2011
Interest payable Projected Statement of CI -58,061.70
Tax shield on interest payable Tax rate x Interest 16,257.28
Dividends Statement of Changes in Equity -288,175.50
Change in short-term debt levels Change in Statement of FP -126,787.00
Change in non-controlling interest Change in Statement of FP 19,042.20
Change in long-term debt levels Change in Statement of FP -
Investment income (dividends) Projected IS (dividend income) 11,000.00
Interest and investment income Projected Statement of CI 111,169.29
Tax on interest & investment income Tax rate x Interest -31,127.40
Excess cash balance Change in surplus cash -252,688.94
Financing Cash Flows -599,371.78
Determination of surplus of cash
Cash per AFS 1,430,917.0 1,688,562.0
Operating cash 41,300.87 46,256.97
Surplus cash 1,389,616.13 1,642,305.07
1,430,917.00 1,688,562.05
-252,688.94
that was the growing rate for revenue in my calculations. Thank you for your
assistance.
Answer



I am not sure where you derived the 10% growth rate as the terminal growth
rate was indicated to be 6% per year after 20x7 (see bottom of the 3
rd

paragraph).