CHAPTER - 1

INTRODUCTION TO FINANCIAL MODELLING AND

VALUATION

1.1 Introduction
Financial Modelling is the theoretical construction of a project, or a transaction in a spreadsheet
that which will actually act as the identification of the key drivers, variables and the set of
logical and quantitative relationship between them. Financial models are build and used to
determine or estimate the value of a company or a project by estimating the future cash flows.
Financial Modelling basically involves two important aspects that is historical analysis, and
forecasting. In the historical analysis we take into consideration the profit and loss account and
balance sheet of the company. On the basis of these reports we make certain analysis like ratio
analysis, common size analysis, and trend analysis. On the other hand forecasting or the future
projection of the company’s performance varies from company to company. It actually provides
clear information regarding the financial stability of a company at present. Financial models
are used by the companies as the decision making tools. Financial modeling helps the
company’s to take corrective decisions in the various stages like Mergers and Acquisition,
Raising of Capital, comparing the business with the competitors etc. It is very important to note
that the accuracy of the results relies on the inputs and the assumptions. Always the future
projections of the company may not be accurate or may not be the same as predicted/estimated
but the directions must be always accurate. Financial modelling is very helpful in determining
the actual cost of the new projects and also to make informed decisions, allocation of resources
of the organization.
Financial modelling and valuation are two key components of finance, and they play a vital
part in decision-making processes for organizations, investors, and financial analysts. Financial
modelling is the process of using accounting and financial data to create a mathematical
representation or model of a financial state or action in order to analyze and forecast
performance. For business decision-makers who need to make well-informed decisions based
on data-driven analysis, it is a crucial tool. The act of generating a mathematical picture of a
company’s financial status using past data and projections of future performance is known as
financial modelling. Financial modelling serves to assist decision-makers by revealing
information about a company’s financial performance.

1.1.1 Meaning of Financial Modelling

Financial modelling refers to the process of numerical representation of the company’s
activities in the past, present and determining/forecasting the future. Financial modelling helps
the business organization in taking the informed decisions. Financial modelling is the process
of building models in the excel spreadsheets and these models provides suggestions to the
companies with respect to the grade of risk which is associated with implementing certain
decisions.

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1.1.2 Meaning of Valuation
Valuation refers to the analytical process of determining the company’s worth of an asset or the
company itself. Valuation is an quantitative process of determining the fair value of an asset
and investments of the firm.
Valuation models are an integral part of financial modelling and are used to estimate the
intrinsic value of an asset or investment. Valuation models are an important tool for investors,
analysts, and financial professionals, as they help in making informed investment decision and
evaluating worth of an asset or investment.

1.1.3 Role of Valuation

❖ Risk Assessment
❖ For Decision making
❖ Taxation purpose
❖ Financial Reporting
❖ Mergers and Acquisition

1.1.4 Major Reasons for Valuation

Mergers and For Raising

Acquisition Capital by the
Start-ups.

Reasons

For Internal Closure of

Knowledge Business

(Figure 1.1 Reasons for valuation)

1.1.5 Company Valuation Approaches

(Figure 1.2 Company Valuation Approaches)

(Source: https://corporatefinanceinstitute.com/resources/valuation/valuation/ )

2
 Steps involved in
Financial Modelling
and Valuation

Purpose of
Building
Financial
Model

Presentation Collecting
of Analysis Information

Steps
Involved

Construct Determining
your the Key
Analysis Variables

Competitor
Information

(Figure 1.3 Steps involved in financial modelling)

1.2 Steps involved in Financial Modelling

Define purpose of building the Financial Model
The first step in the Financial Modelling and Valuation is to define the purpose of the building
a financial model. The company’s must have a clear objective before building a financial
model. The objective or the purpose to build a financial model can involve any of the following
❖ Investing in the Stocks
❖ Estimation of Future cash flows
❖ For valuation of the company
❖ Mergers and Acquisition
❖ Financial Planning and Analysis

Collecting Information
After identifying the objective/purpose of building a financial model the company has to
proceed with background research. It is very important for the company to gather accurate
information from the various reports like Company’s Interim reports, Annual Reports, and
Industry reports. The information collected from these various sources will be helpful for
building an accurate Financial Model.

3
Determining the Key Variables
The next step in building the Financial Model is to determine the Key drivers or the most
important factors of the company that which increases the value of the company and also has
the significant impact on the financial performance of the company.
For Example: If we take into consideration of the Food and Beverage industry then the key
drivers are like the number of units sold, the cost per unit and the Average price etc..

Competitor Information
After identification of the key drivers, the next step in building the financial model is to collect
the information of the peer company. The company has to collect the peer company’s financial
information to identify the areas where they are lagging behind and also to understand their
strengths and weakness. The company has to collect the information of the peer company with
regards to EBITDA, EPS, Gross Profit or Revenue. All these required information can be
collected from the peer company’s Annual Reports or the Quarterly reports.

Construct your Analysis/Model

The next step is to construct the Financial Model with the help of MS Excel or any other
financial modelling software. The financial model is to be build after performing the sensitivity
analysis i.e, altering the some of the assumptions to know how it’s going to affect the financial
statements. The constructed financial model must be able to project the Revenue and Expenses
of the company.

Presentation of Analysis/Model
Once the Financial Model is built, use the model to identify where the costs of the company
can be reduced and how to increase the revenue. The Financial Model can be used to make
informed decisions regarding Mergers and Acquisition, investment decisions, also helps in
financial planning and analysis.

1.2.1 Elements of Financial Model:

Simple and Estimation of

Easy to Risks and
Understand Uncertainities

Proper Focused on
communication
Key Drivers
of Information

(Figure 1.4 Elements of Financial Model)

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1.3 Tools Adopted

Microsoft Excel
Microsoft Excel is a spreadsheet program designed by Microsoft Corporation. It was first made
available for Macintosh in 1985 and for Windows in 1987. Microsoft Excel is a program that
which is used in order to store the data in a format called grid consisting of rows and columns.
In Excel, a Worksheet is normally referred to a spreadsheet. The combination of the
worksheets can be called as the Workbook. The Microsoft Excel allows users to record the data
in the spreadsheets in the form of tables.

How a Workbook look like:

(Figure 1.5 Workbook)

(Source: https://excelchamps.com/excel-basics/ )

1.3.1 Benefits of Microsoft Excel

❖ Storing of Data

❖ Graphical Representation of data

❖ Easy to make analysis

❖ Statistical Calculations

❖ More Secure

5
1.4 Components of Financial Modelling

(Figure 1.6 Components of financial modelling)

(Source: https://happay.com/blog/financial-modelling/ )

Income Statement
The Income statement refers to the statement that which focuses on the revenue, expenses,
gains and losses of an organization over the particular period usually on a monthly, quarterly,
or annual basis. It is one of the three major financial statements that which actually reports the
organizations financial performance over a period of time.

Balance Sheet
Balance sheet refers to the financial statements that which clearly states what a company owns
and owes, also reports the shareholders equity. Balance sheet projects the financial
position/condition of a company at a specific point of time, detailing assets, liabilities and the
equity.

Cash Flow Statement

Cash flow statement refers to the statement, where the cash inflows and cash outflows are
recorded. The cash flow statement helps the company to assess its ability to generate cash and
meet its financial obligation. The cash flow statement clearly projects how a business is making
money and how it is spending the money on the various operating, investing and the financing
operations.

Debt Schedule
The debt schedule is prepared by the company in order to estimate the amount of liability that
the business organizations owe to the outsiders. The debt schedule consists of a list of debts
which includes loans, bonds and leases etc.. The debt schedule helps the business organizations
in making informed and the strategic decisions regarding paying off the debt.

6
1.5 Benefits of Financial Modelling

Financial Modelling serves as a very powerful

tool that which effectively portray the functioning
of the organization to the management and the
stakeholders as well. The financial Models are
used for various purposes like financial analysis,
capital budgeting, informed decision making,
scenario planning, valuation, strategic planning
etc..

(Figure 1.7 Benefits of financial modelling)

(Source: https://images.app.goo.gl/d8H5QK7raj6RDjj87 )

1.6 Features of Financial Modelling

Assumptions
The financial models that which are to be built will always starts with a set of assumptions.
These assumptions are directed towards making estimation about the future financial variables.
These can actually include the revenue growth rates, inflation etc. These assumptions will act
as the foundation or the basis for the model’s calculation.

Forecasting
Based on the assumptions the financial models uses the logics or the mathematical formulas in
order to project the future financial statements. These projections or the forecasts can be used
to estimate the profitability of the various scenarios and investment opportunities as well.

Valuation
The financial models are also used for the valuation of the business. The financial models helps
to assess the worth of a company or the asset depending upon the various factors like discounted
rates, risk assessments etc..

Scenario Analysis
It is one of the important feature of the financial modellling where it allows testing of the
various assumptions to evaluate how the changes in the assumptions or the variables might
have an significant impact on the financial performance or the outcomes.

Budgeting and Planning

The financial models helps in budgeting and planning. The financial models also assist in
developing the financial goals and also provides for tracking the progress. The financial models
are flexible enough to make any changes as required in achieving the set goals.

7
 CHAPTER – 2
PROFILE OF THE TRAINING INSTITUTE

(Figure 2.1 Internshala Logo)

(Source: https://images.app.goo.gl/T6YMTWnMwE96b5DS8 )

2.1 About the Training Institute

Internshala, today has become a leading internship and training platform providing various
opportunities to the students and the professionals. The Internshala platform provides the wide
range of trainings on various topics like, Engineering, Business Management, Media,
Programming, Content writing, Digital Marketing, Web development and more.
Internshala was founded by Mr. Sarvesh Agarwal in the year 2010, but it has launched the
online trainings in the year 2014.
Internshala Trainings is a technology company which provides trainings to the learners or the
students with the relevant skills and the practical exposure that which can help the learners to
get the best possible start to the career or the upgradation of the skills for better development.
The training programs that are designed in Internshala are affordable, accessible and also
flexible to the learners across the globe. The learners can actually access to their respective
courses at anytime from anywhere with the help of the internet connectivity.
The training programs on the Internshala are created and conducted by the industry experts and
the professionals with the relevant experience in their respective fields. These trainings provide
learners with the practical knowledge and hands-on training, giving students the knowledge
and skills which helps to succeed in their career.

8
2.1.1 Vision of Internshala
Internshala is the company of a technology that which is dedicated to provide the students
with the relevant skills and the practical experience in order to help the students with the
greatest possible start in their professions.

2.1.2 Internshala Programs

2.2 Training programs

Programming Business Management Core Engineering
❖ Web Development ❖ Digital Marketing ❖ Auto CAD
❖ Python ❖ Advanced Excel ❖ VLSI Design
❖ C and C++ ❖ Business Analytics ❖ CATIA
❖ Core Java ❖ Tally ❖ STAAD Pro
❖ Ethical Hacking ❖ HR Management ❖ Arduino
❖ Software Testing ❖ SQL ❖ 3D Printing

Data Science Design Creative Arts

❖ Machine Learning ❖ UI/UX Design ❖ Creative Writing
❖ Advanced Excel ❖ Graphic Design ❖ Photography
❖ Deep Learning ❖ Video Editing ❖ Guitar
❖ Business Analytics ❖ Animation ❖ Calligraphy
❖ Tableau ❖ Digital Art ❖ Acting
❖ SAS Programming ❖ Adobe Illustrator

(Table 2.1 Internshala Training programs) 9

2.3 Bridge the Skill

(Figure 2.2 Reasons to pursue Financial Modelling course)

(Source: https://www.cfieducation.in/why-do-you-need-a-financial-modeling-valuation-
course/ )
• Internshala is a leading internship and training platform that which provides various
opportunities to the students and the professionals who are looking to upgrade their
skills and enhance their employability skills.

• Internshala platform offers a wide range of courses such as programming, Business

Management, Core engineering, Data Science, Design, Creative Arts and many more.

• Internshala training programs are delivered through a variety of modes, including video
lectures, Live sessions, and interactive sessions where the learners are allowed to
interact with their trainers through the discussion forums, online chat rooms all this
helps to create a collaborative learning environment.

• A course in financial Modelling and Valuation can teach us how to create a financial
models using various forecasting techniques, like Time series analysis.

• Financial modelling and valuation course also teaches to analyze the industry trends
and competitive dynamics that can impact an organizations financial performance.

• The knowledge on Financial Modelling and Valuation help the decision makers to
evaluate the potential outcomes and make informed decisions.

• Financial modelling provides valuable insights and suggestions to the companies with
respect to the grade of risk which is associated with implementing certain decisions.

10
2.4 Knowledge Enhanced for Learners and Tutors

(Figure 2.3 Knowledge enhanced for learners and tutors)

(Source: https://images.app.goo.gl/jan43tTfY1yw9D3L7 )

The Financial Modelling and Valuation course provides the learners and the tutors with the
necessary knowledge and skills to calculate the value of the company, analyzing investments,
and forecasting the financial statements.
The financial Modelling and Valuation course helps both the learners and the tutors in making
informed decisions on investments. Internshala offers courses on a wide range of subjects,
those includes Business Management, Programming, Digital Marketing, Data Science etc.
During the training program, Exercises, Quiz will be conducted and at the end of the modules
Assignment and Projects must be submitted. This will actually help the learners and the tutors
to understand the real-world situations.
The contents of the course offered by the Internshala can also be downloaded by the learners
and the tutors for their future reference. So the learners and the tutors can get access to the
information whenever needed.
The important benefit to the tutors is that they can grab the opportunity to showcase their
knowledge and skills they possess on the particular subject.

11
 CHAPTER - 3
TRAINING WORK UNDERTAKEN

3.1 Sequential Learning

Financial Modelling
Financial Modelling refers to the process of numerical representation of the company’s
activities in the past, present and determining/forecasting the future. Financial Modelling helps
the business organization in taking the informed decisions. Financial Modelling refers to the
process of building models in the excel spreadsheets and these models provides the suggestions
to the companies with respect to the grade of risk which is associated with implementing certain
decision.

Valuation
Valuation refers to the analytical process of determining the company’s worth of an asset or the
company itself. Valuation is an quantitative process of determining the fair value of an asset
and investments of the firm. Valuation models are an integral part of Financial Modelling and
are used to estimate the intrinsic value of an asset or investment. Valuation models are an
important tool for investors, analysts, and financial professionals, as they help in making
informed investment decision and evaluating worth of an asset or investment.

3.1.1 Course Objectives

❖ To accurately project the Business/Company’s future financial performance.
❖ For Designing and constructing the financial models
❖ To provide for informed decision making
❖ Demonstrating the speedy, structured and the accurate Excel skills
❖ Helps in predicting or determining the value of the company
❖ Provides for liquidity planning
❖ To learn practical financial skills
❖ To predict the trends of the company
❖ A practical tool for understanding and assessing the business

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3.1.2 Syllabus
The syllabus of the training program consists of topics ranging from Basics of Excel to
Building of Financial models of the company. The details regarding the various topics
covered in the training program of Financial Modelling and Valuation is clearly mentioned in
the following table.

Financial Modeling and Valuation – Syllabus

Sl.No Modules No of No of
Hours Videos
1 Understanding of Excel 10 13
❖ Basics of Excel
❖ Financial Modelling Tools
❖ Formatting and Conditioning
2 Investment Decision Technique 7 10
❖ Time value of money
❖ Present Value
❖ Net Present Value and Discount Rate
❖ Internal Rate of Return
❖ Payback Period
3 Application of Decision Technique 6 9
❖ Make V/s Buy
❖ Personal Finance
4 Financial Statement Analysis 15 25
❖ Introduction to Financial Statements
❖ Income Statement
❖ Balance Sheet
❖ Cash Flow Statement
❖ Coffee shop Example
❖ Case study – Hero MotoCorp
❖ Financial Statement Analysis
5 Valuation 12 23
❖ Introduction to Valuation
❖ Absolute Valuation of DCF Method
❖ Case Study – Hero MotoCorp
❖ Relative Valuation
Total 50 80

(Table 3.1 Financial Modelling and Valuation syllabus)

(Source: https://trainings.internshala.com/financial-modeling-course/ )

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3.2 Training Methodology

Internshala Trainings is a technology company which provides trainings to the learners or the
students with the relevant skills and the practical exposure that which can help the learners to
get the best possible start to the career or the upgradation of the skills for better development.
In Internshala training platform, the learners or the students will be given access to the live
recorded sessions/videos. They can get access to these sessions at any time.
The Financial Modelling and Valuation course is a 6 week training program consisting of 80
videos and the duration of the course was 50 hours.
The course consists of 5 modules, namely:
❖ Understanding of Excel
❖ Investment Decision Technique
❖ Application of Decision Technique
❖ Financial Statement Analysis
❖ Valuation
The training takes place in the chronological order i.e, only after the completion of the first
module we will be allowed to unlock the next module.
After the completion of each topic a quiz will be conducted and also at the end of every module,
Module test will be conducted. So the test conducted after the completion of each module will
be helpful for the learners/students to analyze their knowledge gained from the particular
module.
Once the module test is completed the students or the learners will be able to check the
questions they attempted are correct and which were incorrect. For both, the correct and
Incorrect answers the step by step explanation will be given, so that it will be helpful for the
learners to understand and gain more knowledge on the topics.
As the training is the recorded sessions it will not be possible for the learners to have direct or
face to face interactions with the tutors. But the learners/students can interact with the tutors
through the discussion forum and the chat session.
Whenever there is a doubt regarding the training topic the learners/students can pose their
questions in the discussion forum and can get the reply within 24 hours.
After the completion of all the 5 modules, there will be an assignment to be worked out and
should be submitted to the tutors in the prescribed format as they mention.
After the submission of the assignment, the learners/tutors will be allowed to take the final test,
which will be conducted for a duration of 45 minutes.
Once the final test is completed the learners/students will be awarded with the course
completion certificate.
In order to avail the certificate there is certain criteria to be fulfilled i.e, a minimum of 33% of
the marks must be scored by the learner/student in the final test.

14
3.2.1 Case Analyzed

In the Financial Modelling and Valuation course, the Case related to HERO-MOTOCORP
was analyzed. The financial statements of the year 2017 and 2018 were provided, where the
analysis was made from these two years financial statements comprising of the income
statement and the Balance Sheet. In the analysis we follow the step by step procedure to arrive
at the DCF value, Initially we have to reorganize the company’s financial statements, Build
forecasts, estimate the continuing value, calculate the Weighted average cost of capital, and
then finally we calculate the DCF Value, followed by the sensitivity analysis of the company.
The use of a company’s Balance Sheet, Income statement, and Cashflow statements
demonstrated how to comprehend a company’s financial situation in order to determine the
company’s value.

3.2.2 Training Assignment

After the completion of all the 5 modules the assignment file can be accessed and the
assignment will be completely based on the topic of the case analyzed. So in the Financial
Modelling and Valuation Course, The Hero-MotoCorp case was analyzed. Based on the
understanding of the case analyzed in the training program we will be able to solve the
assignment. After completion of the assignment, the assignment has to be submitted in the
prescribed format.

3.2.3 Number of Cases analyzed during training program

❖ Make V/s Buy Decisions in a Business

❖ Shutdown V/s Continue of a Business

❖ Personal Financial Decision {Buying & Renting decisions}

❖ Invest in a new plant or not, through Break-Even Analysis

❖ Calculations of Equated Monthly Installments

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3.3 Criteria for availing the training certificate

The Internshala, provides the course for 6 weeks i.e, for a duration of 50 hours. The learners
has to initially completely watch all the 80 videos and then submit the assignment later will be
able to take the final test. After completion of the test the learners will be eligible to avail the
course completion certificate from Internshala, but based on certain criteria:
The student has to initially complete watching all the recorded sessions in order to unlock the
final test.
After completion of each topic there will be a quiz. And after completion of the every module
a module test will be conducted.
Also during the training sessions some of the exercises will be given to the learners, which the
learners have to practice but need not to submit these files.
After the completion of all the modules the learners will have to take up the assignment, The
assignment will be completely based on the case analyzed.
Once the assignment is solved, the students have to submit this file in the prescribed format.
After the submission of the assignment, learners are now allowed to take the final test. The
final test will be conducted for the duration of 45 minutes.
In order to avail the course completion certificate, the learner/student must have to
compulsorily score a minimum of 33% of marks in the final test.

16
 CHAPTER – 4
OUTCOME OF TRAINING PROGRAM

4.1 Decision Making

Financial decisions are the most important elements in the field of finance and these decisions
will have the impact on the financial performance of the business organization. Financial
decisions are the critical aspects which has to be made by the individuals or the business
organizations. The main aim of each and every organization is to maximize the profits with the
minimum risk factor.
Financial Modelling helps in transforming the business decision making process into an
organized structure. There are different variables that will impact any business or organization,
by using excel each variable can be individually introduced into the model and the impact of
the variables can be studied in the overall decision making process.

4.1.1 Scenarios under Decision Making

❖ Scenario – 1 Make vs Buy Decision
India is a young economy and has growing middle class population consisting of families with
kids hence the demand for toys is ever increasing. So the entrepreneur has decided to invest in
a toy business as it is a profitable business.

(Figure: 4.1 Make vs Buy)

(Source: https://pin.it/7x1fpv5ch )

Here the entrepreneur did his analysis with the Net Present value and realized that it is a
profitable business. And the entrepreneur is faced with the another decision and that decision
is this toys can either be made i.e, manufactured by the entrepreneur in a factory or he can buy

17
it from outside, as there are a lot of Chinese toys that which are available in the Indian market,
those toys can be procured from China market and can be sold in the Indian Market.

4.1.2 Factors considered for Making

Cost – Manufacturing/Making of the toys in your facility might be cheaper than buying it
from a third party vendor.

Quality – When the products are manufactured at the factory, then you will have the better
control over the product quality.

Intellectual Property – Intellectual property rights stay with you, for instance let’s say you
make a toy that was not there in the market you get it patented, so those intellectual property
rights can be with you. If you have these rights you can price your products higher than the
competitors in the market.

4.1.3 Factors considered for Buying

Speed to Market – You don’t have to set up the factory, you can just get into an agreement
to buy the product and bringing it to market.

Lack of Technical Experience – You may lack technical experience to manufacture toys
so in this case buying may be easier.

No upfront investment required – There is no upfront investment required, for instance

there is no factory to be set up, you can just get into an agreement and buy the product.

Could be cheaper – At times buying can be cheaper than making/manufacturing things

yourself due to difference in market condition. For Example – We often hear that Chinese goods
are cheaper than locally manufactured goods.

4.1.4 Evaluation of the Scenario

Let’s evaluate this scenario whether we should make or buy these toys. Not every aspect of
business decision can be modelled through numbers but we can certainly model the financial
aspect.
Scenario 1 – Make
In this case there would be few costs involved,
❖ Fixed Cost – A fixed cost is something you have to incur before you start your venture.
For Example – In our case we need to have a Factory, machinery so these are the fixed
costs which you don’t have to incur on a regular basis. The reasonable cost to set up the
factory is Rs. 1 Lakh.

18
 ❖ Variable Cost - Variable cost is the cost that vary in relation to production or sales.
Variable cost increases when production or sales increases similarly decreases when
production/sales falls. It includes Raw materials/Supplies, Electricity, Laborers wages.
For Example – your machine could produce 1000 units, but are just producing 100 units
to begin with, then expenses will be only for 100 units. These costs will continue to
increase as the production increases. In this case let’s say the variable cost is Rs. 40 per
toy/unit.

❖ Salvage Value – Salvage value is the estimated value of an asset at the end of its
lifetime. It is used to calculate an asset’s yearly depreciation and is also known as
residual value or scrap value. For Instance, if 100000 worth of machinery is purchased,
after 5 years there would be some value you get, this value could be from a second hand
market, where you are able to sell this machinery and get that amount as part of your
cash inflow. You are able to sell the parts of the machine in the junk market they take it
as a raw material as steel, iron and they agree to give you Rs. 20000. Hence this 20000
is called the salvage value.

Scenario 2 – Buy
In this case all the cost is variable since you pay only for what you buy and there is no upfront
cost. So some of the variable cost include
❖ Price – The price that which you agree to pay to the supplier for Rs. X per unit.
❖ Transportation cost – Because the products are brought from the other place.
❖ Duties – Related duties such as import duties that which you pay to the government.
These are the certain variable costs associated with buying the products. In this scenario, let’s
say that the total variable cost is Rs. 55 per toy/unit, which is being paid to the supplier.

4.1.5 Building an Excel Model

(Table 4.1 Details about scenario 1)

(Source: https://trainings.internshala.com )

In this Make scenario Rs. 100000 spent in 1st year, and the variable cost is Rs. 40 per unit for
all the 5 years and units produced is 2000 every year and at the end of the 5 years the salvage
value of Rs. (20000).

19
 (Figure 4.2 Calculation of Present Value under Make scenario)
(Source: https://trainings.internshala.com )
Total Cost is calculated as,
TOTAL COST = FIXED COST + VARIABLE COST * UNITS PRODUCED
Let’s assume the cost of borrowing @ 10% (Discount Rate)
Discounting Factor is calculated as follows,
Year 1 = 1/1+10^1
Year 2 = 1/1+10^2
Year 3 = 1/1+10^3
Year 4 = 1/1+10^4
Year 5 = 1/1+10^5
There are 2 ways to calculate the present value
❖ Calculation of present value using Sum Function

(Figure 4.3 Calculation of Present Value using Sum function)

(Source: https://trainings.internshala.com )

20
 ❖ Calculation of present value using Sumproduct Function

(Figure 4.4 Calculation of Present Value using Sumproduct Function)

(Source: https://trainings.internshala.com )

(Table 4.2 Details about Scenario 2) (Source: https://trainings.internshala.com )

In the scenario let’s assume the Discount rate is 10%, Variable cost is Rs. 55 per unit and 2000
units are produced each year and the total cost is calculated as follows
TOTAL COST = VARIABLE COST * UNITS PRODUCED

(Figure 4.5 Calculation of Present Value under Buy scenario)

(Source: https://trainings.internshala.com )
In this Scenario,
❖ Discounting factor is calculated as same in the scenario 1
❖ Present value can be calculated in two ways i.e, by multiplying total cost and discount
factor or by applying Sumproduct function
❖ In the buy scenario, there will be no salvage value as there is no machinery involved
and we are procuring the toys from the third party

21
Decision Made
In this Make Vs Buy case, The present value of the cash outflows in the Buy scenario is higher
i.e, 4,16,987 than when compared with Make scenario i.e, 3,81,754. So it clearly indicates that
making/manufacturing of toys would be a better option rather than buying it from the vendor.

4.1.6 Summary
❖ The various factors that are to be considered in both Buy and Make scenarios.
❖ Various steps to be followed to build a financial model and to arrive at this decision.

4.2 Invest in new plant or not

In the above case, the decision has been made to manufacture the toys. Let’s assume that the
first manufacturing unit has been profitable and demand is being increasing and now the
entrepreneur is planning to set up a new plant. The sales department has shared the following
3 sales projections for the possible additional sales volume they expect.

(Table 4.3 Sales Projection) (Source: https://trainings.internshala.com )

The sales projection has been divided into 3 categories: Pessimistic, Realistic and optimistic.
And these projections are over the life of the plant. So now let’s evaluate at what sales volume
the plant will break-even whether it make sense to invest in setting up the plant or not.

(Figure 4.6 Break-even Analysis)

(Source: https://trainings.internshala.com )

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4.2.1 Break-even Analysis

❖ Break-even is a point at which there is no profit and no loss.

❖ The Y-axis represents the Revenue/cost and X-axis represents the number of
units/volume.
❖ Even at 0 units there is a fixed cost that is incurred because you would incur cost in
setting up the plant irrespective of the units produced.
❖ As you produce more units the variable cost associated with manufacturing increases
and variable cost starts at 0.
❖ Total cost = Fixed cost + Variable cost * Number of units
❖ As there is more and more sales, there will be increase in revenue
Total revenue = Sales Price * Number of units
❖ Sales cost is higher than the manufacturing cost, as it keeps increasing at some volume
total revenue will exceed the total cost.
❖ At the volume at which the total revenue exceeds the total cost is the Break-even point.
❖ Before Break-even the plant was incurring loss, beyond Break-even it starts generating
profit.

(Figure 4.7 Break-even Result)

(Source: https://trainings.internshala.com )

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4.3 Scenario – 2 Personal Finance Decision
In this second scenario of decision making let’s see how we can apply financial modelling in
investment decision techniques in our personal lives also through various scenarios.

4.3.1 Decision – Purchasing Vs Renting a car

So here we have a situation where we can either purchase a car for Rs. 5 lakhs or Rent a taxi
as and when we need it for day to day commute.

(Figure 4.8 Purchase Vs Renting a car) (Source: https://trainings.internshala.com )

The decision to purchase a car would include an upfront payment that is the cost of car is Rs.
5 Lakhs and cost for running this car including petrol and maintenance is Rs. 10/km. Similarly,
we have a situation where we can rent a car for that Rs. 20 per/km as the running expense the
rent that we pay. So now we have to decide whether we should purchase a car or Rent a car but
it will depend on how many kilometers we travel.

Building Excel Model

In case of purchasing the car,
Total Kilometers travelled = Kilometers travelled per month * Number of months * Life
of a car.

(Figure 4.9 Calculation of Kilometers travelled)

(Source: https://trainings.internshala.com )
Considering the kilometers travelled is 500kilometers/per month for a life of 5 years.
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Total Cost is calculated as,
In this case, if we were to purchase the car the cost would be Rs. 8 Lakhs provided 500
kilometers per month travelling.

Total cost = Purchase cost + Running Cost +Kilometers travelled

(Figure 4.10 Calculation of Total Cost)

(Source: https://trainings.internshala.com )

Renting a Car
Rent is calculated as,
Rent = Kilometers travelled * Rent per kilometer
In case of renting a car, our total cost would be Rs. 6 Lakhs provided rent per kilometer is Rs.
20.

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 (Figure 4.11 Calculation of Rent)
(Source: https://trainings.internshala.com )

4.3.2 Analysis
So in this scenario when we are travelling 500 kilometers per month, we can see that renting a
car makes more sense.

(Figure 4.12 Analysis of Purchase and Rent)

(Source: https://trainings.internshala.com )

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4.3.3 Decision Made
If we assume that the kilometers travelled is 1000 per month, then in this case actually
purchasing would make more sense over a life of 5 years. In this case the cost of purchasing
the car would be Rs 11 Lakhs whereas, renting the car would cost Rs. 12 Lakhs. So basically
what it really depends on is, if you are a heavy traveler buying a car makes more sense, and if
you are not a heavy traveler then renting a car would make more sense.

(Figure 4.13 Decision made between purchase and rent)

(Source: https://trainings.internshala.com )

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4.4 Cash Flows
Meaning: Cash flows are the earnings of the business organization/company by undertaking
the commercial and business activities. These cash flows can be of 2 forms i.e, Cash inflows
and Cash outflows.

4.4.1 Free Cash flows

Meaning: The free cash flow is the money that which is available to the business
organization/company in order to repay all the external liabilities.

Free Cash Flows to Firm (FCFF)

Meaning: Free cash flow to firm is the money leftover with the business
organization/company after paying all the operating expenses and the capital expenditure
expenses. The more free cash flows the company has the more it can allocate to pay dividends,
to pay the debts, and growth opportunities. Investors will always use the free cash flows to
measure whether the company has sufficient cash balance to pay for dividends and to buy back
the shares.
Free cash flows to firm = Cash flow from operating activity – Capital Expenditure

Free Cash Flow to Equity (FCFE)

Meaning: Free cash flow to equity is the cash flow that which is left for the equity
shareholders after the firm has paid and met all the financial obligations towards lenders
(Debenture holders, Preference shareholders, Dividends, Capital Expenditure and Working
capital needs).

4.4.2 Discounted Cash Flows (DCF)

Meaning: DCF approach involves forecasting the future cash flows and discounting the same
with the present value using cost of capital and business risk. The underlying principle of DCF
valuation is that each company generates cash flow and value of a company is the function of
the expected cash flow of that company. Company with higher cash flows should have higher
values than company with lower cash flows
Value of a company = FCF1/(1+r)+FCF2/(1+r)2+FCF3/(1+r)3+……+FCFn/(1+r)n
Where,
❖ FCFn – Free cash flow in year n
❖ r – Discount Rate
❖ n – Number of years

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4.5 Step by step method to arrive at DCF Valuation

❖ Reorganizing the company’s Financial Statements

❖ Building Forecasts
❖ Estimating continuing Value (Terminal Value)
❖ Calculate the Weighted average cost of capital (WACC)
❖ Calculating the DCF Value
❖ Sensitivity analysis
❖ Adjusting the DCF Value in order to get the equity value

4.5.1 Reorganizing the Company’s Financial statements

The free cash flows should measure the company’s operating performance. Therefore to
calculate free cash flows we must first reorganize the reported financial statements into new
statements that separate operating and non-operating items. We have to reorganize the financial
statements to come-up with financial items that we can forecast. We prefer free cash flow over
EBIT and Net profit, as EBIT takes into consideration the noncash expense such as depreciation
and amortization as these are only accounting entries and cash is not paid hence it should be
added back. And also EBIT does not include Capex and working capital changes these have an
impact on the cash flows and should be subtracted from EBIT. Similarly Net profit may contain
non-operating items that may not happen in future.
The annual reports of Hero MotoCorp is given @ https://www.heromotocorp.com . Here the
Hero Motocorp Company’s financial satetments are not in an organized manner, hence we have
to reoeganize the income statement, cash flow statement and balance sheet as operating and
non-operating items.

(Figure 4.14 Reorganized Income Statement) (Source: https://trainings.internshala.com )

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Working Capital and Cash Conversion Cycle
Working capital is calculated as:
Working capital = Accounts Receivable (AR) + Inventory - Accounts Payable (AP)
Accounts receivables represents the money that the customers owe to the business organization
and accounts payable represents the money that the business organization owes to the suppliers.
Inventory refers to the value of raw material, under processing and finished goods. If the
company’s accounts receivables increases at the end of the year it means that the firm collected
less money from its customers than it recorded in sales during the same year in the income
statement. On the other hand if the accounts payable were to increase it means a firm is able to
pay its suppliers more slowly and the value of inventory going up means more money is lockeed
up as raw material.
Cash Conversion Cycle (CCC) and forecasting change in working capital
CCC refers to how many days it takes for the company to convert inventory into cash.
CCC = DIO + DSO – DPO
Components of CCC
❖ Days Sales Outstanding(DSO): DSO means, on an average, how many days does it take
for you to collect money from your customers.
Days sales Outstanding = AR/Sales*365

❖ Days Payable Outstanding(DPO): DPO means, on an average, how many days credit
do you get from your suppliers.
Days Payable Outstanding = AP/COGS*365

❖ Days Inventory Outstanding(DIO): DIO means, on an average, how many days does
the company have to hold its inventory before it can be sold.
Days Inventory Outstanding = Inventory/COGS*365

4.5.2 Building Forecasts

The next task in building the DCF Model is to project all the items that are included in free
cash flow calculation in future years. Start the forecast with EBIT, Depreciation, Plant property
and equipment and Working capital over the short run which is typically first 5 years we
forecast each financial item that impact any of these items such as Sales, COGS, Gross margins,
Selling expenses, accounts receivables, accounts payables, Capital expenditure, inventory and
so on.

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 (Figure 4.15 Building Forecasts) (Source: https://trainings.internshala.com )
P&L Assumptions
In order to find out the future forecasted profits and how it will affect the company is done on
the basis of 3 main assumptions i.e,
❖ Optimistic Scenario
❖ Base Scenario
❖ Pessimistic Scenario
Optimistic Scenario: Optimistic scenario is the positive situation, where everything is
assumed to go according to the plan and also the business operations meet the expectations. In
the optimistic scenario there will be better revenue forecasts, lower expenses etc..
Base Scenario: Base scenario is actually the situation where the company will operate as
expected. Usually the assumptions made in this scenario matches with the historical patterns
as well as the current market condition.
Pessimistic Scenario: Pessimistic scenario is the situation where the company will do worse
than anticipated, where there will be an increase in the costs, lower revenue estimates etc..

(Figure 4.16 Calculation of the 3 cases) (Source: https://trainings.internshala.com )

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4.5.3 Estimating Continuing Value (Terminal Value)
To calculate the value of cash flows beyond 5 years we use continuing value formula in order
to arrive at terminal value. Beyond a point say after 5 years (in Hero MotoCorp case)
forecasting the individual key drivers on a year by year basis becomes impractical, Instead use
a perpetuity based continuity value such that,
Value of operations = Present value of free cash flow during explicit forecast period +
Present value of continuing value
Continuing Value (as of year n) = FCFn (1+g)/(1+r) + FCFn (1+g)2/(1+r)2 + …….
FCFn = Free cash flow in year n
g = Fixed rate at which FCFn is expected to grow year on year
r = Cost of capital
Common Ratio or Decay Rate = (1+g)/(1+r)
There are 2 techniques to calculate the continuing value
❖ Perpetuity growth rate
❖ Exit Multiple Methods
The Perpetuity growth rate approach is nothing but forecasting a company’s cash flow for a
specific time frame and then assuming that these cash flows would increase continuously. The
long-term economic growth projections for the pertinent market or industry serve as the
foundation for the perpetual growth rate.
The exit multiple approaches entails calculating the cash flows of a corporation.

(Figure 4.17 Calculation of Terminal value) (Source: https://trainings.internshala.com )

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4.5.4 Calculate the Weighted average cost of capital (WACC)

In order to calculate the present value of future cash flows we need the discount rate and for
DCF Valuation the cost of capital is used as the discount rate. A company with higher cost of
capital would have a higher discount factor resulting in lower valuation. The reason cost of
capital is used as discount factor is because the return on the operations should be higher than
the cost of capital. Else one is better of using this capital somewhere else say deposit in the
bank to earn interest instead of investing it in the business. The cost of capital is also called as
Hurdle rate or the opportunity cost that a project must earn for it to be worthy of the investment.

Cost of Debt (Kd)

If a business borrow the entire capital money from the bank in the form of loan or debt in this
case the cost of capital is simply the interest rate that business has to pay on the debt. So here
the interest rate is the cost of debt which is also the cost of capital, since the entire capital is in
the form of a debt.

Cost of Equity (Ke)

If the business has borrowed some money from the bank and some money was invested by the
owner himself in return of ownership of the company. The money borrowed from bank is
referred to as debt and money invested in the business by the owner/investors in return for the
ownership is referred to as equity. There is no direct cost associated with equity but there is an
opportunity cost associated with this investment i.e, if the owner has invested this money in
FD in a bank, he would have got certain return and he is forgoing that opportunity by investing
in this business. The other factor which influences the cost of equity is riskiness of the business
in which the money is being invested. For a riskier business you would expect higher return
and hence it would have a higher cost of equity.
Cost of equity = Rf + Beta * (Rm – Rf)

Where,
Rf = Risk free rate
Rm = Market risk premium

Weighted average cost of capital (WACC)

For the business which has both debt and equity in its capital structure we simply take the
average of cost of debt and cost of equity. Formula to calculate WACC is

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WACC = D/D+E * Kd(1-Tm) + E/D+E * Ke
D = Debt
E = Equity
D+E = Total capital
Ke = Cost of equity
Kd = Cost of debt
Tm = Marginal tax
The marginal tax is the cost shield for the cost of debt. We can notice that how the cost of the
debt has been reduced by the factor of 1 – Tm, it is because the interest that we pay for the debt
is an expense which gets deducted before taxes are paid and this results in the business having
to pay lesser tax and save money for business. Due to this the real cost of the debt of the
business is less than what it actually pays to the lender and this factor 1 – Tm reflects that.

(Figure 4.18 Calculation of WACC) (Source: https://trainings.internshala.com )

4.5.5 Calculating the DCF Value

Under DCF valuation, we estimate the value of the company on the basis of its future cash
flows and that are discounted to the present value. Once we have Weighted average cost of
capital (WACC), we use it to discount the future cash flows to arrive at the value of the
company. Here in this step we are going to discount the free cash flows to the present and also
discount the terminal value to the present, now with these two things if we sum them up we are
going to get the Enterprise value.

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 (Figure 4.19 Calculation of DCF Value) (Source: https://trainings.internshala.com )
DCF valuation is used to calculate an investments value based on its anticipated future cash
flows. Firstly we must have to estimate the cash flows for each year of the investments in order
to arrive at the DCF value. Then, with the help of the discount rate we need to reduce each
years cash flows to its present value.
Discount rate is the rate of return needed by the investors to make up for the risk that they are
incurring. The risk profile of the investment, market conditions, and the investors desired return
are often taken into account when determining the discount rate.

4.5.6 Sensitivity analysis

(Figure 4.20 Sensitivity analysis) (Source: https://trainings.internshala.com )

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Throughout DCF valuation we make several assumptions, these assumptions can be about the
forecast we have made of various line items or that of growth factor to arrive at the continuing
value etc. The DCF is impacted by the assumptions. The final number that we arrive at a
company’s value can be wide sensitive to these assumptions a slight change in those
assumptions can vastly change the valuation number. Hence it is important to perform a
sensitivity analysis for all those assumptions by imagining different scenarios and see how the
valuation number changes as you change that particular assumption. Sensitivity analysis helps
us understand reasonableness of the assumptions. For instance you can make an optimistic
average or an pessimistic assumption of terminal growth rate or revenue growth and see what
valuation you arrive at for each of the scenarios. This will make your analysis and valuation
more robust and you would be able to make better decisions.

4.5.7 Adjusting the DCF Value in order to get the equity value
DCF gives us the enterprise value of future operations we need to add current cash and other
non-operating assets and subtract debt from the DCF value to arrive at the equity value of the
company which when divided by the total number of shares outstanding gives us per share
value of the company that we can compare with the market share price.
Equity Value = DCF Value + Cash + Other non-operating assets – Debt
Per share value of the company = Equity value / Total number of shares outstanding

(Figure 4.21 Adjusted discounted cash flow) (Source: https://trainings.internshala.com )

We can also value the company’s equity alone by detecting the net debt from the DCF Value
due to the fact that the debt holders have a claim on the company’s assets and cash flows before
equity holders, the debt value has increased, the value of debt needs to be taken into account
when arriving at the equity value.
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 CHAPTER – 5
CONCLUSION

5.1 Conclusion

Financial Modelling is an essential tool for companies of all sizes and industries, since it offers
a framework for forecasting and decision making. For the finance team of a firm, financial
modelling is the crucial task. Using a reliable financial model, we can better comprehend the
company’s financial situation and make more informed strategic decisions. Financial
Modelling and Valuation are essential for business and finance instruments. Building
mathematical models to depict the financial performance and the potential growth of a business
or investment is known as financial modelling. Spreadsheet programmes like Microsoft Excel
have gained popularity, making the financial modelling easier for non-experts to use and also
enabling the organization to carry out internal financial analysis and planning. The financial
modelling is an effective method for evaluating and projecting the financial assets, projects,
and businesses. Excel’s adaptability and user friendly design is a potential tool for financial
modelling. The scope of financial modelling includes – Investment analysis, corporate finance,
mergers and Acquisitions, Risk management, valuations etc.. The emergence of the big data,
machine learning, and artificial intelligence in recent years has enabled the development of the
more complex financial models that can analyze enormous amount of data in real-time and
provide insights into the market patterns and hazards that were previously difficult to detect.

With the help of the software, customers can create models that are specially tailored to their
businesses and markets, giving them a more precise basis for decision making. The financial
models helps the business organizations to make informed decisions in various scenarios like
Make Vs Buy, Purchase Vs Rent, Shut down Vs Continue etc.. Where the models give clear
information regarding the working of the business in all the scenarios and you can opt for the
option which is most convenient and profitable to the organization. The features of financial
modelling includes – completeness, logical, flexibility, transparency, accuracy, presentability.
The accuracy, dependability of any financial model you develop are important including the
most recent and the appropriate data as well as employing proper assumptions and techniques
for the analysis of such data, financial modelling helps in making investment decision
technique, and application of decision techniques for the investors to make decision to invest
or not in a particular company, and also make decisions relating the mergers and acquisitions
of the firm etc.. There are various benefits of financial modelling, it includes – improved
decision making, Better planning, accurate financial budgets and forecasts, Improved and in-
depth understanding of a business organization, periodic review of performance. For the
companies and the investors looking to maximize their returns and meet their financial
objectives, the implementation of the financial investment decisions is essential. In order to
make wise financial investment decisions, one must first find possibilities that fit their goals
and risk tolerance. Then they must assess those opportunities using a variety of tools and
methods, including financial modelling and valuation.

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The company’s cashflows i.e, cash inflows and cash outflows are calculated using a cash flow
model, Cash flow statement refers to the statement, where the cash inflows and cash outflows
are recorded. The cash flow statement helps the company to assess its ability to generate cash
and meet its financial obligation. The cash flow statement clearly projects how a business is
making money and how it is spending the money on the various operating, investing and the
financing operations. Planning and predicting the sources and the uses of the cash is done
through the discipline of cash flow modelling. Its ultimate goal is to provide a framework that
enables the most effective, efficient, and economical use of available cash as well as the
maximization of the free cash flow. Free cash flow is the cash generated by the operating cash
flow less capital expenditure. The cash flows are divided into 3 parts namely – Cash flow from
operations, Cash flow from investing activities, Cash flow from financing activities. Many
analysts and investors use cash flow model as a filter to determine if a company has properly
completed its financial statements or not since the balance sheet and cash flow statement will
reveal any discrepancies in the cash position. A cash flow model is helpful in raising awareness
of a company’s financial situation and ability to continue operating under challenging
circumstances.
Overall, the financial modelling aids in decision making, uncertainty reduction, and financial
performance for the business organization. It is very important to remember that the accuracy
and dependability of the inputs are absolutely essential because the financial modelling is only
as good as the assumptions and facts that were used to build it.

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