Intern Guide

The Intern Guide
Intern Guide
Intern Guide Contents

How to prepare a benchmarking of an industry..................................................................................... 3
Benchmarking grid example .................................................................................................................. 4
Key numbers ............................................................................................................................................ 4
How to do a trading comparable valuation basics .............................................................................. 8
Step 1: Calculate diluted market capitalization ................................................................................... 8
Step 2: Calculate Enterprise Value ...................................................................................................... 10
Step 3: Take key earnings numbers and calendarize where appropriate ..................................... 12
Step 4: Calculate the range of multiples and ratios .......................................................................... 13
Step 5: Prepare footnotes and formatting for output ...................................................................... 14
How to do a transaction comparable valuation - basics...................................................................... 15
Choosing the comparable transactions ............................................................................................. 15
Nature of the acquisition and consideration ..................................................................................... 16
An acquirer can either pay with cash or in shares: ........................................................................... 16
Where you get the information from (US versus Europe) ............................................................... 17
Calculating the control premium ........................................................................................................ 17
Historical Premia analysis .................................................................................................................... 18
Calculation of premium for a cash offer ............................................................................................ 19
Premia analysis for cash and share offer ........................................................................................... 19
Calculating the historic transaction multiples ................................................................................... 20
Step 1: Calculating the Enterprise Value ........................................................................................... 20
Step 2: Calculating LTM earnings and why you use LTM earnings ................................................. 20
Step 3: Calculating the Transaction Multiples ................................................................................... 21
How to do a discounted cash flow valuation - basics........................................................................... 22
Overview of a discounted cash flow valuation .................................................................................. 22
Step 1: Forecasting Free Cashflow to steady state .......................................................................... 23
Constructing the Free Cashflows......................................................................................................... 24
Calculating Weighted Average Weighted Capital (include Capital Asset Pricing Model).............. 25
Step 1: Calculate the cost of debt ....................................................................................................... 25
Step 2: Calculate the cost of equity .................................................................................................... 26
WACC calculation Example for Tumi ................................................................................................ 28
Calculating Terminal value ................................................................................................................... 28
Discounting to a deal date ................................................................................................................... 30
Enterprise Value to implied share price ............................................................................................. 31
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Intern Guide
Sensitivity tables .................................................................................................................................... 31

How to prepare index graphs .................................................................................................................. 32
How to prepare benchmarking graphs .................................................................................................. 34
How to build a three statement model .................................................................................................. 35
Key standards ........................................................................................................................................ 35
Modelling steps ...................................................................................................................................... 35
Step 1: Input historical data for income statement and balance sheet ......................................... 36
Step 2: Calculate Ratios and key metrics ............................................................................................ 37
Step 2: Decide on the forecast assumptions ..................................................................................... 38
Building the income statement and calculations .............................................................................. 38
Calculating the balance sheet items ................................................................................................... 40
Building Net debt and Interest Calculations ...................................................................................... 43
Calculating the cash flow statement ................................................................................................... 44
You can complete your cash flow ....................................................................................................... 45
Balancing the balance sheet ................................................................................................................ 45
Circularity................................................................................................................................................ 46
Prepare for hand-off ............................................................................................................................. 46

Intern Guide
How to prepare a benchmarking of an industry

Benchmarking is a way to establish a company's relative position and performance in an
industry. The task centres around preparing comparable key numbers and ratios around key
performance areas. It helps answer who is biggest, who is best, and who has the highest
leverage.
Key performance areas include:
Size
- Revenues
- EBIT or EBITDA
- Enterprise Value
- Market capitalization
Growth rates
- Calculate growth over several years or the average of three years. Beware of
years where there is M&A activity which will manipulate the sales number
Profitability
- EBIT / revenues
- EBITDA / revenues
- Net income / revenues
Returns
- First calculate the invested capital = net debt + shareholders equity (book value)
- Then calculate unlevered net income = EBIT x (1-corporate tax rate)
- The unlevered net income / invested capital
Asset efficiency
- Operating working capital / revenues
- Net PP&E / revenues
Financial leverage
- Gross credit ratios:
Total debt / EBITDA
Total debt / gross interest
- Net credit ratios
Net debt / EBITDA
Net debt / net interest
Generally, debt / EBITDA ratios in excess of 3x is high for an ordinary industrial company,
and will probably mean they are below an investment grade credit rating (below BBB-)

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Benchmarking grid example

Always put your case company separately on its own
Enterprise Market 5year LTM Grossdebt/

Company Value Capitalization EPSgrowth EBITmargin LTMROIC EBITDA
KelloggCompany 34,166.4 27,104.4 6.9% 11.0% 10.5% 3.8x
TheKraftHeinzCompany 132,350.4 95,086.4 19.1% 22.4% 3.1% 6.9x

ConAgraFoods,Inc. 24,347.4 19,401.2 7.5% 11.1% 12.5% 3.0x
GeneralMills,Inc. 46,990.5 36,348.3 6.5% 17.4% 13.0% 3.1x
CampbellSoupCompany 23,431.0 19,063.8 7.1% 16.5% 14.6% 2.9x
MondelezInternational,Inc. 81,649.9 67,540.7 12.0% 13.1% 5.8% 4.7x
TheHersheyCompany 22,559.3 19,846.2 6.7% 19.4% 25.6% 1.8x
TheJ.M.SmuckerCompany 21,145.7 15,292.1 8.9% 15.3% 5.6% 3.9x
TheWhiteWaveFoodsCompany 9,559.8 7,219.0 18.0% 8.7% 6.0% 5.4x
HormelFoodsCorporation 20,195.7 20,467.2 14.0% 12.6% 18.3% 0.5x
DeanFoodsCompany 3,419.4 1,579.6 9.0% 2.7% 6.1% 4.8x
Mean 10.9% 13.9% 11.0% 3.7x

Median 8.9% 14.2% 9.3% 3.5x
High 19.1% 22.4% 25.6% 6.9x
Low 6.5% 2.7% 3.1% 0.5x
Notes: Ensure you have a place for your footnotes to reference

Averages should be
any adjustments you have made to the numbers
medians and not
include the case
company
Key numbers
First you have to calculate the key numbers. Sales is easy, but profit is more complex. When we
are measuring performance we look at the ability of companies to generate revenues and profits
in the future.
Revenues
For a size comparison, take net revenues from the income statement. Watch for acquisition
activity as the sales will only be consolidated from the date the deal is completed. Ideally find the
pro-forma number in the accounts, or calculate it yourself by grossing up the target company
sales to the full year.

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EBIT
Start at operating profit and look above the line for non-recurring items:
The press release related to the issuance of the financial statements is a good place to start
dont necessarily rely on the numbers, but it will provide you with useful signposts
Large non-recurring items will have their own line on the income statement. Note that Other
income (expense), net is either unusual or infrequent so usually exclude it.
EBITDA
Take your EBIT number and add back depreciation and amortization:
Usually you can take the numbers from the cash flow statement. However, always check
for non-recurring numbers embedded in the depreciation and amortization on the cash
flow statement
Non-recurring items could also be embedded inside COGS and SG&A (particularly if they
are small)
- Start by reading the Management, Discussion and Analysis (MDA) in the
comparison section between last year and this year. Also at the front of the
section, there is a summary of key numbers:
- Then look at the notes to the accounts often there can be more detail in the
notes to the income statement line items

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Recurring net income
Start with the reported net income and then clean for non-recurring items. You must also take
account of the impact on taxes:
If the company gives you the after-tax number for the non-recurring item ALWAYS take it.
Check the Managements Discussion and Analysis for the detail
Often the recurring numbers will be on an EPS basis so you have to gross up using the
relevant weighted average share number
Only if the after-tax number is not disclosed can you estimate it using the marginal tax
rate (the corporate tax rate for the company concerned)
- Look at the tax note for the corporate tax rate number dont use the effective
tax rate its an average tax rate and you are making a marginal adjustment
- Take the pre-tax number and multiply by (1-tax rate) to get the estimated after-
tax number
Last Twelve Months
In countries where companies report quarterly, we update the historical number each quarter.
Add the newest quarter(s) and subtract the oldest quarter(s). The quarterly reporting is designed
to help you. Other than the first quarter, you will see four income statement columns:
Newest quarter
Same quarter a year before
Newest year to date earnings
Year to date earnings a year before
10-Q disclosure:
10-K disclosure:

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To calculate the Last Twelve Months sales, take the year end and add the newest nine months of
revenues and subtract the oldest nine months of revenues:
Revenues
+ Year to December 31, 2014 7,421,768

+ 9 Months to October 4, 2015 5,477,404
- 9 Months to September 28, 2014 (5,411,741)
=Last Twelve Months (LTM) 7,487,431
Last Twelve Months is used for historical multiples, and particularly for credit analysis. Credit
analysis is focused on downside risk, and uses LTM numbers for debt capacity analysis, for
example: Total Debt / LTM EBITDA.
LTM multiples are also used for transaction comparables known as deal comparables. LTM
multiples are useful to compare across time as the relationship between the valuation date and
the earnings period (twelve months before) is always consistent. The relationship between the
valuation date and earnings for forward looking multiples is not consistent. As you move closer
to year end more of your earnings year will be historical and less will be forward. You can fairly
compare forward multiples for an industry at one moment in time, but over time you would not
be getting a fair comparison.

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How to do a trading comparable valuation basics

Trading comparables analysis is also known as relative value analysis on the trading floor. Just as
you would value a car or house, we can value companies by looking at similar corporations, in
the same industry, which are traded on a stock exchange. For each company follow these steps:
Step 1: Calculate diluted market capitalization

The diluted market capitalization is the value of the quoted shares and potential shares (stock
options and restricted stock units in the business). It does not include preference shares. Be
careful, do not include ADRs or GDRs as these are already included in the share count.
1. Find the last closing price of the stock. We use the prior closing price as this gives you an
auditing date. Never use the current trading price remember someone will always want to
check your work
2. Find the latest shares outstanding
From the regulatory news releases for shares outstanding
From the front page (the filing date on the front page is more recent than the balance
sheet date) of the 10-Q, 10-K, or annual report:
3. Find the stock options and restricted stock units from the notes to the accounts (usually the
information will only be in the 10-K or annual report, but sometimes you will also find the
information in the latest quarterly or interim reports. Be careful not to take the restricted
stock take only the restricted stock units as they are not already included in the share
count (as are the former).
For stock options, only take options which are in the money, i.e. where the current share price is
higher than the strike price of the options. Use the below formula to calculate the new shares.
This assumes that the proceeds the company receives from conversion of the options (the
exercise price) are used to repurchase shares in the market and hence reducing the number of
new shares that need to be issued:

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For restricted stock units, treat them as issued shares. We know not all of them will be
issued, as they have to meet the operational criteria before they become stock, however
without more detailed information it is too difficult to make an assessment
4. Add the latest shares outstanding to the net new shares for the options and the restricted
stock units. Only take the net new shares number if positive options can never be anti-
dilutive
5. Finally take your diluted shares outstanding and multiply by the last closing share price to
calculate your diluted market capitalization.

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Step 2: Calculate Enterprise Value

Take your diluted market capitalization and convert it to Enterprise Value using the following
steps. Take the numbers from the latest balance sheet (either from the 10-Q (interim) or 10-K
(annual) whichever is the most recent:
1. Add non-controlling interests. Ideally you get a market value for the non-controlling interest,
but in its absence take the balance sheet number.
2. Add preference shares. These may be quoted, but if not take the balance sheet value.
3. Add debt. Take all debt, long-term, short-term, subordinated or senior. It doesnt matter if its
long or short-term they will still come after you if you dont pay!
4. Subtract cash and cash equivalents. There may be some restricted cash - in other words
cash which cant be taken out of the business, but ask your colleagues if you suspect this.
5. Subtract short-term investments. Again check if these are freely available to be paid out to
investors (airlines can be tricky in this respect).
6. Look to see if the company has any long-term financial investments. If the investments are a
portfolio of securities which bear no relation to the operational business, then subtract
them. If they are associates or equity method investments, then they are likely (but not
absolutely) to be related to the business. For simplicity ignore these.
7. Lastly, deduct any non-core assets. These are assets which are not related to the core
operations of the main business. For example, Nestle is primarily a food company, however
it also owns a big stake in the cosmetics company LOreal. Given our aim is to compare
companies, we would want to exclude the value of the LOreal investment as a non-core
item.

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Below is an example of a balance sheet:

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Step 3: Take key earnings numbers and calendarize where appropriate

Once you have calculated Equity value, Enterprise Value and the relevant earnings numbers, you
are ready to put the two together and calculate a set of multiples. Before we start there is one
further adjustment. Different companies have different fiscal year ends, which may well not be
the same as the calendar year end or even a quarter end. For example, many retail companies
have fiscal year ends in January after the holiday season has closed. We need to adjust for the
fact that companies have different fiscal year ends by calendarizing the earnings so all
companies earnings end at the same date. This way all the companies are on a level playing
field.
We do this by calculating a weighted average earnings year for all companies in the comparable
set. We normally do this so the earnings period ends at the calendar year end. So your multiples
will be Enterprise Value / one calendar year forward EBITDA.
For each company take 3 years of earnings: the current year, the prior year, and the future year.
Now calculate the weighting percentage for each period. The easiest way to do this is to calculate
the percentage of the Year based on months or days. For example:
Once you have calculated the percentages you can multiply through each year of earnings and
then add up the result. A quick way of doing this is using the sum product function:
Now you have a weighted average earnings number for each company which is consistent across
the Peer group. Use this weighted average earnings number to calculate your multiples.
Never calendarize last 12 months (LTM) earnings. Last 12 months earnings are simply the
earnings of the prior 12 months and they will be consistent for every company. There may be a
slight inconsistency between the companies if a company's year doesn't finish at the end of the
quarter but this generally is not material.

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Step 4: Calculate the range of multiples and ratios

Now you can calculate the multiples. Remember always keep the value number constant, never
change Enterprise value or Equity value. You can calculate several multiples for different
periods: last 12 months (LTM), calendar year 1 (forward), calendar year 2 (forward), calendar year
3 (forward).
You can also calculate different types of multiples, for example Enterprise value/Sales, Enterprise
value/EBITDA, Enterprise value/EBIT, Price/Earnings (P/E) and many more. Be careful to ensure
you match the earnings number correctly to the value number:
You will end up with a grid of different multiples for different periods for all the Peer group.
You'll see across the Peer group not all companies trade on the same multiple.

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There are two fundamental reasons why one company will trade on a higher multiple than
another. First, one company may have higher Return on Capital than its competitors. Second,
one company may be growing earnings at a faster rate than the Peer group. Both higher returns
and high growth rates mean a company will trade on a higher multiple. So you have to look at
multiples in Context of the operational ratios.
Step 5: Prepare footnotes and formatting for output

It is very important to make sure that you make clear and detailed footnotes for any adjustments
or sources that you have used in creating a multiples grid. The footnotes should be clearly
displayed at the bottom of the presentation page or spreadsheet. For example, you should
reference the source for the share prices. Below is an example of detailed footnotes that you
may see in a multiples grid:
Sources: Company filings, Equity Research

Notes: Market data as of 15/05/16.
1
Latest interim cash balance adjusted by additional $500mm for disposal of Energy Holdings on 1 st of March 2016.

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How to do a transaction comparable valuation - basics

Transaction comparables or Precedent transaction analysis is the most common method to
value a company for sale, alongside intrinsic valuation methods such as Discounted Cash Flow.
Unlike the stock market, the M&A market looks at prices paid for a controlling stake. Generally,
investors need an incentive to sell their holding so the buyer of a controlling stake will need to
pay a premium for control. Control is usually defined as more than 50% ownership. A common
premium range is between 20% and 40% although this varies according to the circumstances.
We look at two ways of establishing what to pay for a controlling stake in a business:
Historical premiums paid the price paid above the unaffected share price (the price
before rumours or deal announcement)
Enterprise Value / LTM EBITDA multiple paid at the time of the deal.
In both these cases the valuation metric is historical so getting the most recent transactions is
important.
Choosing the comparable transactions

Transaction comparables or precedent transactions are typically used in M&A negotiations, and
are very helpful in setting a first stake in the ground, as these reflect the actual prices paid for
the companies or assets. However, information can be scarce and the number of true
comparables limited. Therefore, you would typically start with a larger, relevant set of
transactions within an industry, and out of these, benchmark against the most comparable
transactions. Some of the criteria would be similar to what you would look for in trading
comparables:
Acquisition of a controlling stake

Same industry
Same sub-segment of an industry
Similar size of transaction
Similar business model and client base, reflected in sales growth, margins and returns
(capital intensity)

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Every deal will be different so the qualitative aspects are also very important. Was there much
competitive tension in the process? More bidders mean a higher multiple and a large control
premium. How scarce was the company asset? Very scarce companies or once in a life-time
deals will often sell for high multiples. Was the buyer financial (Private Equity), or strategic
(Corporate)? Corporate buyers would be able to achieve more synergies and hence pay a higher
premium. Equity Research reports and news runs are usually helpful sources for further
background and context on the transactions.
Nature of the acquisition and consideration
An acquirer can either pay with cash or in shares:

A cash purchase for a quoted or non-quoted company, a subsidiary or assets of the
company;
A share exchange the acquirer offers their shares in exchange for the target shares of
the listed company. The target shareholders become part of the combined business;
A merger of equals normally two listed companies of a similar size come together in a
share exchange. However, as they share control, generally no control premium will be
paid.
Deal consideration can also be a mix of cash and shares. There are two types of M&A public
transaction structures:
Tender offers are often converted to Schemes of Arrrangement. Whereas a Scheme of

Arrangement typically takes longer to complete than a Tender Offer, it only requires 75%
acceptance threshold from the target shareholders, increasing deal certainty.

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Where you get the information from (US versus Europe)

Acquisition of public companies will be very well documented. You should be able to easily
capture all the information. However, the majority of deals are for private companies or
subsidiaries of larger businesses. If the acquirer is quoted, there should be adequate
information in their accounts. The following information hierarchy should be followed:
Regulatory filings
Financial statements / 10-Ks
Company presentations / press releases
M&A database providers, such as SDC (Thomson Financials)
Equity research reports
Press, such as Reuters
Calculating the control premium

Here are the key steps to completing your comparable transactions grid:
1. Run an M&A news search or SDC search for transactions in the chosen industry
2. Review and select the most comparable transactions from the list
3. For each relevant transaction, gather the input data:
Offer price for a publicly traded company
Equity value or EV for private company
Unaffected share price for publicly traded company
Date of Offer and Date of Completion
Diluted shares outstanding (for a share deal)
Total debt and debt equivalents
Cash and non-core assets
Recurring LTM EBITDA

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Historical Premia analysis

Control premium is only available for publicly listed companies, and is used when a controlling
stake is acquired, defined as:
Offer price per share
Unaffected Share price of Target
The unaffected share price is defined as the closing share price of the Target Company, the day
before the announcement or the day before any news or leaks surfaced in the press, affecting
the share price.
The payment, as mentioned earlier, can be in cash, in the acquirers shares or a mix. You would
typically calculate the premium on 1 day before announcement, 30 days volume weighted
average share price (VWAP) and 90 days VWAP. VWAP is defined as:

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Calculation of premium for a cash offer

This is simply defined as the Offer Price divided by the closing share price of the Target Company
on the last business day prior to the Offer. You may also calculate the premium on 1 month and
3 months Target Company share price, but here you would use the 1 months and 3 months
Volume Weighted Average Price (VWAP), as set out below:
Premia analysis for cash and share offer

In the event the Target shareholders will receive both Cash and the Acquirers shares as
consideration for selling their shares, the premium here will depend on the Offeror share price:
1-day Premium = Cash per share + (announced nb. of acquirer share per target share * acquirer
share price 1 day prior to the Offer) / Target share price 1 day prior to the Offer
30-days Premium = Cash per share + (announced nb. of acquirer share per target share * 30
days VWAP for Acquirer) / Target 30 days VWAP
Example: Shell, the global oil & gas company, announced on 8th of April 2015, its recommended
offer for BG Group, a leading UK based LNG, pursuant to a scheme of arrangement. The
announcement reads:
Under the terms of the Combination, BG Shareholders will be entitled to receive:
For each BG Share: 383 pence in cash; and 0.4454 Shell B Shares
Based on the Closing Price of 2,208.5 pence per Shell B Share on 7 April 2015 (being the last
Business Day before the date of this Announcement), the terms of the Combination represent:
a value of approximately 1,367 pence per BG Share;

a premium of approximately 50% to the Closing Price of 910.4 pence per BG Share on 7
April 2015; and
a value of approximately 47.0 billion for BGs entire issued and to be issued share
capital.

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Calculating the historic transaction multiples

Now that you have calculated the historic premium for the transaction, you can move on to
calculating the transaction multiple, typically EV/EBITDA. For some earlier stage companies, for
example in the technology sector, you will see EV/Sales and other relevant transaction metrics,
as some of the companies do not yet generate a profit. With the availability of additional
information, you may be able to do NTM (next twelve months).
Transaction multiples are used for both public and private companies. For private deals, where
you buy the assets or the Company is not listed, there will only be an Equity or Enterprise Value
and not a share price. And remember that your multiples are calculated at the time of
announcement and not today, using prices and earnings as of the time of the deal.
Step 1: Calculating the Enterprise Value

1. Calculate the fully diluted market capitalisation at the offer price as set out in Step 1, see
the section covering Trading Comparables
For options and restricted stock units see Step 1 of the section covering Trading
Comparables. Assume that these all vest as a result of the acquisition, and remember to
use the offer price as a strike price to calculate the additional shares issued
2. Calculate the Enterprise Value as set out in Step 2 of the the section covering Trading
Comparables
Step 2: Calculating LTM earnings and why you use LTM earnings
Transaction multiples are based on the Last Twelve Months financials for the Target Company,
which removes the uncertainty related to forecast financials, and allows comparison across time
as the relationship between the valuation date and the earnings power is consistent. See the
section covering Trading Comparables for how to calculate LTM financials. EBITDA, EBIT and
diluted EPS should exclude all non-recurring items.

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Never calendarize last 12 months (LTM) earnings, as these are simply the earnings of the prior 12
months and will be consistent for every company.
You can also show transaction multiples based on the Next Twelve Months (NTM), should you
have sufficient information. The NTM financials are often used to show a company's immediate
future performance, which is particularly relevant for companies in high growth industries, such
as technology, or for companies that have experienced recent transformational change (through
new business lines or markets) that are not fully reflected in the Last Twelve Months.
Step 3: Calculating the Transaction Multiples

Once you have calculated the EVs and your Earnings numbers, you can calculate the transaction
comparables, with the ones most commonly used being: EV/Sales, EV/EBITDA, EV/EBIT and P/E,
as set out in the grid below. Always remember that the Value must be consistent with the Value
number!
Transaction multiple: Value (EV or Offer price)
Value driver (Sales, EBITDA, EBIT or EPS)
SamsoniteacquiringTumi
Transactioncomparablesvaluation Datetransaction Unaffected Offer 1month Acquisition EV/
Acquirer Target Announced Completed Shareprice Shareprice Premium %cash %shares EquityValue EV LTMsales LTMEBITDA
SamsoniteInternational Tumi 03Mar16 Pending 17.96 26.75 48.9% 100.0% 0.0% 1,815 1,719 3.1x 14.0x
Coach,Inc. StuartWeitzmanHoldingsLLC 06Jan15 04May15 NA NA NA NA NA NA 574 1.8x NA
EssilorInternationalSA Costa,Inc. 08Nov13 31Jan14 17.34 21.50 24.0% 0.0% 100.0% NA 234.5 1.8x 14.2x
LVMHMotHennessyLouisVuitton LoroPiana 08Jul13 05Dec13 NM NM NA 0.0% 100.0% NM NM 4.3x 21.3x
SorosFundManagementLLC TrueReligionApparel,Inc. 10May13 30Jul13 25.20 32.00 27% 100% 0% 824 631 1.3x 8.0x
PPRSA PomellatoSpA 24Apr13 05Jul13 NA NA NA NA NA NA 456 2.4x NA
ApaxPartnersLLP ColeHaan 16Nov12 01Feb13 NA NA NA NA NA NA 570 1.2x NA
PVHCorp. TheWarnacoGroup,Inc. 31Oct12 13Feb13 51.91 69.57 34% 74% 26% 2,901 2,845 1.2x 10.0x
PAIPartnersSAS MarcolinSpA 15Oct12 05Dec12 NA NA NA 100% NA 269 364 1.6x 15.7x
AlldatainUSDmmunlessotherwisestated,asof06May16
Remember to include, in the footnotes, all sources of information, any assumptions, and any
adjustments made to EV, Equity value or the financials.

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How to do a discounted cash flow valuation - basics

Overview of a discounted cash flow valuation
A Discounted Cash Flow, normally called DCF, is a cash flow forecast discounted to todays
value. It is an intrinsic and not a relative valuation tool, and represents the modellers view of
value. A DCF valuation is focussed on cash, highly sensitive to the underlying assumptions and
produces an absolute value. It can be particularly helpful in valuing assets or divisions of
companies, where valuation comparables may be limited, as well as valuing synergies achieved
through acquisitions.
Here are the steps that you need to take to calculate a Companys value using a DCF:
1. Forecast Free Cash Flows to steady state (normally 10 years)

2. Calculate weighted average cost of capital (WACC)
3. Calculate terminal value (TV)
4. Discount cash flows to today
5. Walk from enterprise value to implied share price using the bridge

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Step 1: Forecasting Free Cashflow to steady state

Free Cash Flow (FCF) represents the cash that a company generates from its operations and after
investments to maintain or expand its operating assets. Or put differently, the cash flows
generated by the operational business and available to pay all providers of finance (debt and
equity) after satisfying all investment requirements. The Cash flows are unlevered, i.e. free
from impact of financing decisions.
To calculate your FCF, use an existing model or forecasts, if this exists. Otherwise, construct the
FCF as set out below. There is no need to build an integrated set of P&L, Cash flow and Balance
sheet.
Free Cashflow
EBIT Adj. operating profit for non-recurring items
- Tax on EBIT EBIT * long run tax rate
= NOPAT or EBIAT Net operating profit after taxes
+ Depreciation & Amortization Non cash item Investments in the
- Capital Expenditure Investments in PP&E business to maintain
+/- Change in OWC Substract increase in OWC and add decrease or expand operating
+/- Other operating assets/liabilities asset base
= Free Cash Flow Cashflow produced by operations
NOPAT
Net Operating Profit After Tax (NOPAT) = EBIT * (1 Effective Tax rate).
Depreciation & Amortization
See the section on building a three statement model
Capex
Change in Operating Working Capital (OWC)
The Net OWC is defined as:
Receivables + Inventories + Other short term assets (such as Prepayments) (Payables + Accrued
Expenses + Other short term, non-interesting bearing liabilities).
Change in net operating working capital means cash out or in for a business. Cash decreases
when Receivables and Inventories increase, and also when your payables and liabilities reduce.
For the purposes of a stand-alone DCF valuation, you can forecast the net OWC from OWC/Sales.
When building integrated financial statements, as address in the three statement modeling
section, you will need to forecast the individual components of the OWC.

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Other Long Term Assets and Non-Current Liabilities
Constructing the Free Cashflows

We now have all the forecasted financials to construct the Free Cash Flows for the DCF. It is
important to sense-check your assumptions, and making sure that the key growth, profitability
and capital efficiency ratios make sense see below.
In steady state, which is what we are working towards for the later years, most of the ratios are
constant, and the cash conversion rates are increasing, reflecting a more mature business.

Intern Guide
Calculating Weighted Average Weighted Capital (include Capital Asset Pricing

Model)
To value the future cashflows today, we need to use a discount rate that:
reflects the time value of money
incorporates the inherent risk of the business (and cashflows)
reflects all investors (debt and equity)
is market based
The WACC is a measure of the weighted average expected return for the investors investing in
the company.
Step 1: Calculate the cost of debt

The cost of debt is the return or the yield required by the debt investors. This can be calculated
several ways depending on the debt:
1. Publicly traded debt: use the yield to maturity

2. Debt rated but not publicly traded: benchmark to similar credits (see below)
a. Alternatively ask the debt capital markets team for the benchmark and the spread
given the credit rating. The spread should be added to the risk free rate:
i. Cost of debt = Relevant Government Bond + Spread (basis points)
3. Debt not rated and not traded: review the Companys credit profile (debt/equity ratios) and
benchmark to companies with similar risk profile.
Try and always use market cost of debt. Balance sheet and Income Statement should be last
resort!

Intern Guide
Step 2: Calculate the cost of equity

The Cost of Equity is the expected return an investor would require given the risk he or she is
taking.
The most common model to calculate the cost of equity is the Capital Asset Pricing Model
(CAPM):
Risk Free Rate - r : use the yield on 10-year government bond. For example, UK 10-year
government bonds currently yield 1.46%
Beta - : is a measure of a stock's volatility in relation to the market. By definition, the market
has a beta of 1.0. A beta of less than 1 means that the stock will be less volatile than the market.
A beta of greater than 1 indicates that the security's price will be more volatile than the market.
You can get the company beta from Bloomberg (historic) or Barra Beta (forward looking)

Intern Guide
For a company that does not have a beta, find the betas for the Companys closest peer group.
The betas you find on Bloomberg or Barra Betas are levered, so these will reflect the respective
companies capital structure. You will therefore need to de-lever the betas for the companies
using their current capital structure, using the below formula, and then calculate the median of
the unlevered betas. This should reflect the operational risk of the peer group. Then re-lever the
(median) beta, using the long term, target capital structure of the Company. This may be
different from the Companys current capital structure.
A peer group analysis can give guidance as to expected long term capital structure:
Market Risk Premium - r : the expected differential return of the market over treasury bonds.
The Banks would normally have their own estimates of the Market Risk Premium that you can
use.

Intern Guide
WACC calculation Example for Tumi

Comparables Mkt.cap. EV %Debt %Equity BetaLev. TaxRate BetaUnlev.
Tumi 1,824 1,731 0.0% 105.3% 1.44 37.3% 1.44
Samsonite 4,368 4,306.2 0.0% 101.4% 0.81 28.4% 0.81

Burberry 7,638 6,973.4 0.0% 109.5% 1.35 21.0% 1.35
LVMH 82,792 95,111.0 13.0% 87.0% 1.05 33.3% 0.96
Median(excludingtarget) 0.96
Calculating Terminal value

The Terminal value reflects the continuing value of a company. Its the present value of all future
cash flows at a future point in time, when we expect stable growth rate forever.

Intern Guide
There are two approaches to calculating the Terminal Value:
TV = Terminal value
= FCF in final year of forecasting
w = WACC
g = growth rate in perpetuity
Using our example, well calculate the Terminal Value, showing both Perpetuity and the Multiple
based approach:

Intern Guide
Discounting to a deal date

Now that we have our Forecasts, the WACC and the Terminal Value, we can discount the
cashflows back to todays value:
In reality, cash flows happen evenly throughout the year, not the end of the year, so the formula
for the discount rate will now be:
1
1 0.5
Using our example again, we can now calculate our Discounted Cashflow Value:

Intern Guide
Enterprise Value to implied share price

Finally, we can use the EV to Equity bridge to get to an implied price per share:
Sensitivity tables
Sensitivity tables are helpful tool when it comes to the DCF valuation, as the valuation itself is
very sensitive to the underlying assumptions. You can establish sensitivity tables to any driver of
financials or value, provider that this is hardcoded, i.e. not a variable itself, and its the only driver
throughout the model. For example, the DCF value can be sensitized to the perpetual growth
rate used for the TV.

Intern Guide
How to prepare index graphs

Index graphs or benchmark graphs are typically used in marketing presentations or M&A
material to provide a picture of a Companys performance compared to its peers and the
relevant market indices.
Here are the steps to prepare index graphs:
1. Decide on the most relevant peer group

This would typically be 3 4 close trading comparables to the Company
You may also include a sector index, for example EuroStoxx Oil & Gas index
And the main index of the stock market in which the Company trades will provide
additional context of the trading environment, such as FTSE 100
2. Download the share prices for the Last Twelve Months for the Company, the selected trading
comparables, the regional sector index and the country index from providers such as
Factset, Capital IQ or Thomson Reuters
3. Download the volume traded for the Company
4. Rebase your prices to a 100 (or to the Companys share price)
In order to compare series of data over time, it is convenient to convert the data into an
index of change with a base period, lets say 100. Expressing the data as an index of
variability over time allows comparison of more than one collection of data.
The formula rebasing to a simple index is expressed as: P = Pt / Po x 100, as shown in the
below table.
Rebasing to a 100:
Date CompanyA CompanyB Index

01/04/2015 105 250 3,300
02/04/2015 106 255 3,500
03/04/2015 104 257 3,200
04/04/2015 108 253 3,250
05/04/2015 102 251 3,500
Rebasedto 100
CompanyA CompanyB Index
01/04/2015 100 100 100
02/04/2015 101 =B4/B3*$B$11 102 106
03/04/2015 99 =B5/B3*$B$11 103 97
04/04/2015 103 =B6/B3*$B$11 101 98
05/04/2015 97 =B7/B3*$B$11 100 106

Intern Guide
5. Once you have rebased your share prices, you can plot these into a Line Graph, with the
share prices on the X-axis, and the volumes traded for the Company on the Y-axis
Make sure to include very clear labels below the graph with name of the data series
Footnote source of the data and any assumptions or adjustments made
Check with your colleague whether you should use a code name for the Company
throughout the presentation
6. Annotate the share price performance of the Company over time to explain significant
changes or dates, for example: release of Q1 earnings or acquisitions.

Intern Guide
How to prepare benchmarking graphs

Benchmarking analysis often present both historic financials, to give a picture of past
performance, and forward looking financials. This information provides important context when
deciding upon a Companys peer group for trading comparables. As previously mentioned, you
would look at the following key metrics:
Size: Current Market Capitalization and LTM Sales

Growth: Sales, EBITDA and EPS
- Calculate future growth rates by using the Compounded Annual Growth Rates
(CAGRs)
Profitability: LTM EBITDA margin
Defined as LTM EBITDA/LTM Sales
Return: Return on Invested Capital (ROIC)
- Defined as LTM after tax EBIT
- Latest available Net debt + Equity (balance sheet data)
For calculation of the financials, see Benchmarking, section 1. Remember to calendarize the
earnings if some of the companies have different year end, in order to ensure comparability. For
the calculation, see Calendarizing earnings under section trading comparables.
LTMsales LTMEBITDA 5yearEPSgrowth

30.0 6.0 25.0%
25.0 5.0 20.0%
MMofUSD
MMofUSD
20.0 4.0
15.0%
15.0 3.0
10.0%
10.0 2.0
5.0 1.0 5.0%
0.0 0.0 0.0%

MDLZ KHC GIS CAG TARGET HRL DF CPB SJM HSY WWAV KHC MDLZ GIS CAG TARGET HSY CPB SJM HRL WWAV DF KHC WWAV HRL MDLZ DF SJM CAG CPB TARGET HSY GIS
Comparablecompanies Comparablecompanies Comparablecompanies
LTMEBITDA/LTMsales EnterpriseValue
30.0% 140.0
25.0% 120.0 Show the companies
in consecutive order
20.0% 100.0
MMofUSD
15.0% 80.0
10.0%
5.0%
60.0 and always put the
40.0
0.0%
20.0 target company in a
0.0
KHC MDLZ GIS TARGET CAG CPB HSY SJM HRL WWAV DF
different colour
Comparablecompanies Comparablecompanies
The charts should always be sorted in descending order and the Company higlighted in a
different colour. Check with your colleague whether to use a code name for the Company.

Intern Guide
How to build a three statement model

Key standards
Following certain best practices when modelling will ensure a user friendly, well structured and
clear model:
Format
All assumptions should be clearly and separately presented. Never embed hardcoded
assumptions within formulas
All hard coded numbers should be shown in blue
All sheets should be formatted the same
Footnote all sources of information and any adjustments made to the financials
Structure
Use multiple sheets for input and output of financials, DCF, trading comparables and
transaction comps
All assumptions should be clearly and separately presented. Never embed hardcoded
assumptions within formulas
Formulas should link through to assumptions. Be mindful to have one key driver flowing
throughout the model and not in several places for a given financial or value, for
example the starting assumption for revenue growth or your perpetual growth rate to
calculate terminal value
Keep the model and the formulas as simple as possible. Break down complex
calculations in several steps.
Modelling steps
We will again use the example of Samsonite, the worlds largest luggage vendor.

Intern Guide
Step 1: Input historical data for income statement and balance sheet

Intern Guide
Step 2: Calculate Ratios and key metrics

The historical financials and ratios for the income statement, cashflow and balance sheet are
critical in selecting the right assumptions and forecasting out the financials. Below are the key
ratios and metrics per financial statement:
Income statement key metrics
Balance Sheet key metrics

Intern Guide
Step 2: Decide on the forecast assumptions

You will often have access to and be able to base your forecasts on equity research forecasting
the next 2-3 years, which, in our case, would be for the years 2016, 2017 and 2018. Your own
forecasts will be required from year 4, or 2019 and onwards. Be aware of non copyable formula
in the model!
When using brokers forecasts, select from the most recent and detailed brokers notes, and
construct a median for the key financials, such as Sales, EBITDA and EBIT.
Building the income statement and calculations

Build forecasts, from assumptions, for all line items except interest:
Revenues
Recurring revenues will be your main metric for growth. When brokers forecasts are available,
always use these, which typically give the next 2-3 years of sales.
Then, forecast out another 8 years so that you have 10 years of sales forecasts. Calculate the
implied growth rate from the sales forecasts from brokers, and trend towards steady state,
around 2.0% or 2.5% in year 10.
EBITDA
Use brokers forecasts for EBITDA for the next 2-3 years projections, if available, which takes you
to 2018 in the below model. From 2019, forecast EBITDA by keeping the EBITDA margin constant.

Intern Guide
EBIT
Use brokers forecasts for EBIT for the 3 first years. Thereafter, calculate EBIT by taking EBITDA
less Depreciation and Amortization. If Amortization is zero in your historic years, keep this at
zero going forward. In order to forecast EBIT from 2019, we will therefore need to forecast
Depreciation:
For the years of 2016, 2017 and 2018, for which brokers forecasts (in this case) are available,
calculate depreciation by taking EBITDA Amortization EBIT (as forecasted by brokers). For
2019 and beyond, calculate the Depreciation as a percentage of beginning Property, Plants &
Equipment (PP&E).
So we will need to forecast Net PP&E. For the historic net PP&E, take the book value from the
latest annual report. To forecast PP&E (do this yourself and not from brokers forecasts to ensure
your numbers tie up), use the following formula:
Beginning PP&E (year end 2015) + Capex (year 2016) Depreciation (year 2016) = End PP&E 2016
The missing component here is Capex, which you can forecast using Capex/Sales ratio. You
would typically keep this relatively constant from historic levels, unless you are forecasting a
period of significant investment. You can find the historic capex number in the cashflow
statement in the annual report.

Intern Guide
We can now construct our P&L without forecast interest. We are leaving interest blank until the
end due to circular nature of formula:
Effective tax rate
The tax rate to be used to calculate tax on EBIT for your NOPAT, should be the long term
effective tax rate for the Company, or often used: the corporate tax rate in the country of
incorporation. Realised tax rate in a given year can be affected by one-off items and will not
provide an accurate long term assumption.
The Income tax expense is calculated taking Earnings before tax * the Effective tax rate
Calculating the balance sheet items

Build forecasts for all line items, except for cash, revolver and long term debt. Remember to
sense check and stress year 1 before copying over.
Operating Working Capital
Operating Assets

Intern Guide
Operating Liabilities
Property, Plant & Equipment
This is also set out above, under P&L calculations, for the purpose of calculating depreciation.
Long term Investments, Goodwill and Other Intangibles
For simplicity, we are keeping these items constant, so no change year on year.
Other Long Term Assets and Non-Current Liabilities
Other Long Term Assets and Non-Current Liabilities can be forecasted as a % of Sales, using
historic metrics as the basis, as set out below:

Intern Guide
Equity
We have assumed no dividends paid. Check the MD&A statements and historic dividend policy to
make a reasonable assumption about dividend policy.
We can now pull together the balance sheet without the cash, revolver and long term debt:
This shows an excess cash position of 139.2million in 2016.

Intern Guide
Building Net debt and Interest Calculations
First, we will need to calculate the Cash available for Debt Service
This ties in with balance sheet, which shows 139.2 million in excess cash, or cash available for
debt service, assuming no revolver or long term debt.

Intern Guide
Lets now introduce 150million debt in 2016.
Calculating the cash flow statement

With the interest calculations done, you should now allow it to flow through to the Income
Statement, which will feed through to the Cashflow Statement, by turning on the one Switch that
has been included in the Income Statement under interest:
CircularSwitch 1

Intern Guide
You can complete your cash flow
Balancing the balance sheet

And make sure that your balance sheet balances:

Intern Guide
Circularity
Following the structure laid out above to construct your three financial statements will allow you
to sense check and manage the circularity in the model well. The circularity comes from interest
payments, which feed into the cashflow from net income, which feeds into the balance as cash:
Prepare for hand-off

Intern Guide

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The Intern Guide

Intern Guide Contents

info@fe.training 1 2016 Financial Edge Training

Sensitivity tables .................................................................................................................................... 31

info@fe.training 2 2016 Financial Edge Training

How to prepare a benchmarking of an industry

Key performance areas include:

info@fe.training 3 2016 Financial Edge Training

Benchmarking grid example

Enterprise Market 5year LTM Grossdebt/

TheKraftHeinzCompany 132,350.4 95,086.4 19.1% 22.4% 3.1% 6.9x

Mean 10.9% 13.9% 11.0% 3.7x

Notes: Ensure you have a place for your footnotes to reference

info@fe.training 4 2016 Financial Edge Training

info@fe.training 5 2016 Financial Edge Training

Recurring net income

Last Twelve Months

info@fe.training 6 2016 Financial Edge Training

+ Year to December 31, 2014 7,421,768

info@fe.training 7 2016 Financial Edge Training

How to do a trading comparable valuation basics

Step 1: Calculate diluted market capitalization

info@fe.training 8 2016 Financial Edge Training

info@fe.training 9 2016 Financial Edge Training

Step 2: Calculate Enterprise Value

info@fe.training 10 2016 Financial Edge Training

Below is an example of a balance sheet:

info@fe.training 11 2016 Financial Edge Training

Step 3: Take key earnings numbers and calendarize where appropriate

info@fe.training 12 2016 Financial Edge Training

Step 4: Calculate the range of multiples and ratios

info@fe.training 13 2016 Financial Edge Training

Step 5: Prepare footnotes and formatting for output

Sources: Company filings, Equity Research

info@fe.training 14 2016 Financial Edge Training

How to do a transaction comparable valuation - basics

Choosing the comparable transactions

Acquisition of a controlling stake

info@fe.training 15 2016 Financial Edge Training

Nature of the acquisition and consideration

An acquirer can either pay with cash or in shares:

Tender offers are often converted to Schemes of Arrrangement. Whereas a Scheme of

info@fe.training 16 2016 Financial Edge Training

Where you get the information from (US versus Europe)

Calculating the control premium

info@fe.training 17 2016 Financial Edge Training

Historical Premia analysis

Offer price per share

Unaffected Share price of Target

info@fe.training 18 2016 Financial Edge Training

Calculation of premium for a cash offer

Premia analysis for cash and share offer

Under the terms of the Combination, BG Shareholders will be entitled to receive:

a value of approximately 1,367 pence per BG Share;

info@fe.training 19 2016 Financial Edge Training

Calculating the historic transaction multiples

Step 1: Calculating the Enterprise Value

info@fe.training 20 2016 Financial Edge Training

Step 3: Calculating the Transaction Multiples

Transaction multiple: Value (EV or Offer price)

Value driver (Sales, EBITDA, EBIT or EPS)

Transactioncomparablesvaluation Datetransaction Unaffected Offer 1month Acquisition EV/

Coach,Inc. StuartWeitzmanHoldingsLLC 06Jan15 04May15 NA NA NA NA NA NA 574 1.8x NA

LVMHMotHennessyLouisVuitton LoroPiana 08Jul13 05Dec13 NM NM NA 0.0% 100.0% NM NM 4.3x 21.3x