Introduction

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 Point Addressed under the course

Chapter 1: Introduction to Financial

Modelling and Valuation
Chapter 2: Corporate Valuation
Chapter 3: Determining the value of the
firm
Chapter 4: Pro-Forma Financial
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Adane Y. (Msc in ACFN) 2
 Chapter One

Introduction to Financial
Modeling and Valuation
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 Components of the
Chapter
This chapter will addresses:
 Overview of excel functions for modeling
 Basic Financial Calculations using excel
 Present value and Net Present Value
 The IRR and Loan Tables
 Future values and Applications
 Introduction to valuation and valuation standards

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 1.1. An Over View of Financial
modeling
The model is usually characterized by
performing calculations and makes
recommendations based on that information. It
may financial or Non-financial.
 Financial Modeling is the construction of
spreadsheet models that illustrate a
company's likely financial results in
quantitative terms.
 Financial modeling is the process by which a
firm constructs a financial representation of
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 What is a financial
The output of a financial model is used for decision
model
making used for?financial
and performing analysis, whether
inside or outside of the company.
 Inside a company, executives will use financial models
to make decisions about:
 Raising capital (debt and/or equity)
 Making acquisitions (businesses and/or assets)
 Growing the business organically (e.g., opening new stores,
entering new markets, etc.)
 Selling or divesting assets and business units
 Budgeting and forecasting (planning for the years ahead)
 Capital allocation (priority of which projects to invest in)
 Valuing a business
 Financial statement analysis/ratio analysis
 Management accounting
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hat is a financial model used for?
Afinancial model isCon’d
simplyatool that’s built-inspreadsheet
softwaresuchas MSExcel toforecastabusiness’financial
perform anceintothefuture.
Theforecast is typicallybasedonthecompany’s historical
perform ance, assum ptionsaboutthefuture, andrequires
preparinganincom estatement, balancesheet, cashflow
statement, andsupportingschedules (knownas a3statement
model).
Fromthere, moreadvancedtypes of models canbebuilt suchas
discountedcashflowanalysis (DCFmodel), leveraged-buyout
(LBO), mergers andacquisitions (M&A), andsensitivityanalysis.
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What is a financial model used for?
The Model is used to summarize particular
Con’d
events for the end user such as investment
management returns or it may help estimate
market direction.

The Financial Model can simulate the effect

of specific variables so that the company can
plan a course of action should they occur.

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Who builds financial models? (jobs and career)
 There are many different types of
professionals who build financial models.
The most common types of career tracks
are investment banking, equity research,
corporate development,
TYPES OF FINANCIAL MODEL FP&A, and
accounting (due diligence, transaction
• There arevaluations,
advisory, various etc).
kinds of financial
models that are used according to the
purpose and need of doing it.
• Different financial models solve
different problems.
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• While majority of the financial models
concentrate on valuation, some are
created to calculate and predict risk,
performance of portfolio, or economic
trends within an industry or a region.
• The followings are examples of
• Amongdifferent types of Financial model, DCF
financial
M models
odel is themost important.
• It is baseduponthetheorythat thevalueof a
business is thesumof itsexpectedfuturefree
cashflow
11/25/2024 sd iscountedat anappropriaterate.
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 2. COMPARATIVE COMPANY
ANALYSIS MODEL:
 Also referred to as the “Comparable” or
“Comps”,
 It is the one of the major company
valuation analyses that is used in the
investment banking industry.
 In this method we undertake a peer group
analysis under which we compare the
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 3. Sum-Of-The Parts-Model
 It is also referred to as the break-up
analysis.
• This modeling involves valuation of a
company by determining the value of its
divisions if they were broken down and
spun off or they were acquired by
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 4. LEVERAGED BUY OUT (LBO) MODEL:

It involves acquiring another company

using a significant amount of borrowed
funds to meet the acquisition cost.
• This kind of model is being used
majorly in leveraged finance at bulge-
bracket investment banks and sponsors
like the Private Equity firms who want to
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 5.MERGER&ACQUISITION(M&A) MODEL:
• Merger &Acquisitions typeof financial Model includes the
accretionanddilutionanalysis.
• Theentireobjectiveof merger modelingis toshowclients
theimpact of anacquisitiontotheacquirer’s EPSandhow
thenewEPScompares withthestatus quo.
• Insimplewords wecouldsaythat inthescenarioof the
newEPSbeinghigher, thetransactionwill becalled
“accretive”whiletheoppositewouldbecalled“dilutive.”
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6. OPTION PRICING MODEL:
• On, to buy or sell the underlying
instrument at a specified price on or
before a specified future date”.
• Option traders tend to utilize different
option price models to set a current
theoretical value.
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 INTRODUCTION TO EXCEL:
 Excel is a spreadsheet program that is
used to record and analyze numerical data.
 Think of a spreadsheet as a collection of
columns and rows that form a table.
 Alphabetical letters are usually assigned to
columns and numbers are usually assigned
to rows.
 The point where a column and a row meet
is called a cell.
 The address of a cell is given by the letter
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 We all deal with numbers in one way or
the other.
 We all have daily expenses which we
pay for from the monthly income that
we earn.
 For one to spend wisely, they will need
to know their income vs. expenditure.
 Microsoft Excel comes in handy when
we want to record, analyze and store
such numeric data.
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• To run Excel, follow the following steps:
 Click on start menu
Point to all programs
Point to Microsoft Excel
Click on Microsoft Excel
Alternatively, you can also open it from the
start menu if it has been added there. You
can also open it from the desktop shortcut if
you have created one.

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The following image shows you how to do this:

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1.2.Basic Financial Calculations using excel:
 This part aims to give you some
finance basics and their Excel
implementation.
 If you have had a good
introductory course in finance,
this section is likely to be at best
a refresher.
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The concept of present value
Almost all financial problems are centered on
finding the value today of a series of cash
receipts over time .
• The cash receipts (or cash flows, as we will
call them) may be certain or uncertain.
• The present value of a cash flow (CFt)

Present value= ∑ 𝑪𝑭𝒕 means that CF1 +

anticipated to be received at time t is,

(𝟏+𝒓)𝒕 (𝟏+𝒓)1
CF2+ CF3…….. CFn

(𝟏+𝒓)2 (𝟏+𝒓)3…. (𝟏+𝒓)n

• The basic concept in present value
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• Opportunity cost is the return which would
be required of an investment to make it a
viable alternative to other, similar
investments.
• In the financial literature there are many
synonyms for opportunity cost, among
them: discount rate, cost of capital, and
interest rate.
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1.3 Present Value and Net Present Value
Both of these concepts are related to the value
today of a set of future anticipated cash flows.
• As an example, suppose we are valuing an
investment which promises $100 per year at the
end of this and the next 4 years.
• We suppose that these cash flows are risk free:
There is no doubt that this series of 5 payments of
$100 each will actually be paid.
• If a bank pays an annual interest rate of 10% on a
5-year deposit, then this 10% is the investment ’ s
opportunity cost, the alternative benchmark return
to which we want to compare the investment.
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Cont’d….
• Using the Excel PV function.
This function computes the present
value of a series of constant
payments.
 PV(B2,5,-100) is the present
value of 5 payments of 100 each
at the discount rate in cell B2.
 The PV function returns a
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The Difference Between Excel ’s PV and NPV
The above spreadsheet may leave the
Functions
misimpression that PV and NPV perform
exactly the same computation. But this
is not true-whereas NPV can handle any
series of cash flows, PV can handle only
constant cash flows:

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 1.4. The Internal Rate of Return (IRR)
andofLoan
The internal rate Tables
return (IRR) is defined as
the compound rate of return which makes the
NPV equal to zero:
To illustrate, consider the example given
below: A project costing 800 in year zero
returns a variable series of cash flows at the
end of years 1–5 are 200,250,300,350,400.
The IRR of the project is………

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Loan Tables and the Internal Rate of
Return(Cont’d)

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 The loan table divides each of
the cash flows of the asset into
an income component and a
return-of-principal component.
 The income component at the
end of each year is IRR times
the principal balance at the
beginning of that year. Income
= IRR *Principal @ beg.
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1.5. Future values and applications
We start with a example :
Suppose you deposit 1,000 in an account
today, leaving it there for 10 years. Suppose
the account draws annual interest of 10%.
FV = 1 000* (1+10% )^10
• How much will you have = 2, 593. 74 at the end of 10
years?

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Future values and Applications(Cont’d)

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Now consider the following, slightly more
complicated, problem:
• Again, you intend to open a savings
account. Your initial deposit of 1,000 today
will be followed by a similar deposit at the
beginning of years 1, 2, … , 9. If the
account
FV earns
= 1 000* 10% per
(1+10% year, how
)^10+1 000*much
will you have
(1+10% in the
)^9 +1 account
000* (1+10% at )^8+
the start of
year
1 000*10?
(1+10% )^7+....... 1 000*
To calculate:
(1+10% )^1
= 17,531.17
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An Excel function : Excel has a function FV which
gives this sum. The dialog box brought up by FV is
the following:

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We note three things about this
function:
 For positive deposits FV returns a negative
number. This is an irritating property of this
function, which it shares with PV and PMT. To
avoid negative numbers, we have put the
Pmt in as − 1,000.
 The line Pv in the dialog box refers to a
situation wherein the account has some initial
value other than ZERO When the series of
deposits is made. In the above example, this
has been left blank, which indicates that the
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