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-APA FORMAT(  paragraphs are single-spaced ) - NO PLAGIARISM  - NEED PLAGIARISM REPORT - INTEXT CITATION  - QUESTION IS ATTACHED and SOURCE TOO - 1” margins 12 font size Times New Roman font style Portrait orientation Double spaced No paragraph indention in business writing; use only one space between paragraphs. Must be written thoroughly and in complete sentences. The writing report should be free of errors. The writing report should be written using APA guidelines EXAMPLE Step 1: Simulation Model: Warranty costs for camera Inputs Parameters of time to failure distribution of any new camera (Gamma) Desired mean 2.5 Desired stdev 1 Implied alpha 6.250 Implied beta 0.400 Warranty period 1.5 Cost of new camera (to customer) $400 Replacement cost (to company) $225 Discount rate 8% Simulation of new camera and its replacements (if any) Camera 1 2 3 4 5 Lifetime 2.442 NA NA NA NA Time of failure 2.442 NA NA NA NA Cost to company 0 0 0 0 0 Discounted cost 0.00 0.00 0.00 0.00 0.00 Failures within warranty 0 NPV of profit from customer $175.00 Simulation Results: Failures within warranty simulation results: NPV of profit from customer simulation results: Step 2: Week 5 Reflection This week I learned what a simulation model is and how a distribution model is used in running simulations. I learned that a distribution can be continuous (meaning all continuous values in a distribution range) or discrete (meaning a discrete set of values in a distribution range). I learned how to use the RISK tools in excel to run a simulation which I captured the output above. I learned about the flaw of averages and how it impacts simulations. I also learned how the input variables distribution varies allow for multiple simulation runs or scenarios. This week’s assignments took me about 8-10 hours. Output for NPV profit for Customer NPV of profit from customer / 1 Cell Model!B23 Minimum ($402.35) Maximum $175.00 Mean $139.49 Mode $175.00 Median $175.00 Std Dev $90.04 Skewness -2.6712 Kurtosis 10.3668 Values 1000 Errors 0 Filtered 0 Left X ($33) Left P 5.00% Right X $175 Right P 95.00% Dif. X $207.92 Dif. P 90.00% 1% ($224.94) 5% ($32.92) 10% ($28.27) 15% ($25.48) 20% $175.00 25% $175.00 30% $175.00 35% $175.00 40% $175.00 45% $175.00 50% $175.00 55% $175.00 60% $175.00 65% $175.00 70% $175.00 75% $175.00 80% $175.00 85% $175.00 90% $175.00 95% $175.00 99% $175.00 · What is Inventory Management? What is Investment Management? lease review the Simulation Example on a Camera Warranty. · Explain how inventory and investment management are related to this example regarding Discount rate/cost, Warranty period, NPV, etc.? FIN 5823 FINANCIAL MODELING ______________________________________________ Inventory and Investment Management Inventory Management What is inventory? Inventory is the raw materials, component parts, work-in-process, or finished products that are held at a location in the supply chain. Why do we care? At the macro level: Investment in inventory is currently over $1.25 Trillion (U.S. Department of Commerce). This figure accounts for almost 25% of GNP. Enormous potential for efficiency increase by controlling inventories Inventory is one of the biggest corporate assets ($). Sales growth: right inventory at the right place at the right time Cost reduction: less money tied up in inventory, inventory management, obsolescence Higher profit Why do we care? At the firm level: Why do we care? Each of Solectron’s big customers, which include Cisco, Ericsson, and Lucent was expecting explosive growth for wireless phones and networking gear….when the bottom finally fell out, it was too late for Solectron to halt orders from all of its 4,000 suppliers. Now, Solectron has $4.7 billion in inventory. (BW, March 19, 2001) “When Palm formally reported its quarterly numbers in June, the damage was gruesome. Its loss totaled $392 million, a big chunk of which was attributable to writing down excess inventory - piles of unsold devices.” (The Industry Standard, June 16, 2001) “Liz Claiborne said its unexpected earnings decline is the consequence of higher than anticipated excess inventories”. (WSJ, August 1993) How do you manage your inventory? How much do you buy? When? Soda Milk Toilet paper Gas Cereal Cash What Do you Consider? Cost of not having it. Cost of going to the grocery or gas station (time, money), cost of drawing money. Cost of holding and storing, lost interest. Price discounts. How much you consume. Some safety against uncertainty. Costs of Inventory Physical holding costs: out of pocket expenses for storing inventory (insurance, security, warehouse rental, cooling) All costs that may be entailed before you sell it (obsolescence, spoilage, rework...) Opportunity cost of inventory: foregone return on the funds invested. Operational costs: Delay in detection of quality problems. Delay the introduction of new products. Increase throughput times. Hedge against uncertain demand Hedge against uncertain supply Economize on ordering costs Smoothing Benefits of Inventory To summarize, we build and keep inventory in order to match supply and demand in the most cost effective way. Modeling Inventory in a Supply Chain… Warehouse Retail Supplier Home Depot “Our inventory consists of up to 35,000 different kinds of building materials, home improvement supplies, and lawn and garden products.” “We currently offer thousands of products in our online store.” “We offer approximately 250,000 more products through our special order services.” Different types of inventory models Multi-period model Repeat business, multiple orders Single period models Single selling season, single order Multiperiod model Key questions: How often to review? When to place an order? How much to order? How much stock to keep? orders Supply On-hand inventory Ordering costs Holding costs 14 Consider the following setting: customer demand is satisfied from on-hand inventory. For replenishment, we review our stocks on a periodic basis (say, every week) and place orders to an upstream supplier. There is a non-negligible lead time for replenishment. We refer to the total of on-hand stock (that can be used to meet customer demand) and the pipeline stock (inventory on the trucks) as the inventory position. To balance out inventory cost with customer service, we have three decisions to make: how often to review the stock, when to place a replenishment order, and how much to order. Together, these three decisions constitute an inventory control policy. Multiperiod model – The Economic Order Quantity Demand is known and deterministic: D units/year We have a known ordering cost, S, and immediate replenishment Annual holding cost of average inventory is H per unit Purchasing cost C per unit Supplier Demand Retailer What is the optimal quantity to order? Total Cost = Purchasing Cost + Ordering Cost + Inventory Cost Purchasing Cost = (total units) x (cost per unit) Ordering Cost = (number of orders) x (cost per order) Inventory Cost = (average inventory) x (holding cost) Finding the optimal quantity to order… Let’s say we decide to order in batches of Q… Number of periods will be D Q Time Total Time Period over which demand for Q has occurred Q Inventory position The average inventory for each period is… Q 2 Finding the optimal quantity to order… Purchasing cost = D x C Inventory cost = Ordering cost = D Q x S Q 2 x H So what is the total cost? TC = D C + + In order now to find the optimal quantity we need to optimize the total cost with respect to the decision variable (the variable we control) Which one is the decision variable? D Q S Q 2 H What is the main insight from EOQ? There is a tradeoff between holding costs and ordering costs Order Quantity (Q*) Cost Total cost Holding costs Ordering costs Economic Order Quantity - EOQ Q* = 2SD H Example: Assume a car dealer that faces demand for 5,000 cars per year, and that it costs $15,000 to have the cars shipped to the dealership. Holding cost is estimated at $500 per car per year. How many times should the dealer order, and what should be the order size? Receive order Time Inventory Order Quantity Q Place order Lead Time If delivery is not instantaneous, but there is a lead time L: When to order? How much to order? ROP = LxD Receive order Time Inventory Order Quantity Q Place order Lead Time Reorder Point (ROP) If demand is known exactly, place an order when inventory equals demand during lead time. D: demand per period L: Lead time in periods Q: When shall we order? A: When inventory = ROP Q: How much shall we order? A: Q = EOQ Example (continued)… What if the lead time to receive cars is 10 days? (when should you place your order?) 10 365 D = R = 10 365 5000 = 137 So, when the number of cars on the lot reaches 137, order 548 more cars. Since D is given in years, first convert: 10 days = 10/365yrs Receive order Place order Lead Time ROP = ??? Stockout Point Unfilled demand Receive Receive order order Time Inventory Order Order Quantity Quantity Place Place order order Lead Time Lead Time If Actual Demand > Expected, we Stock Out To reduce stockouts we add safety stock Receive Receive order order Time Time Place Place order order Lead Time Lead Time Expected Lead-time Demand Inventory Level ROP = Safety Stock + Expected LT Demand Order Quantity Q = EOQ Expected LT Demand Safety Stock Service level Safety Stock Probability of stock-out Decide what Service Level you want to provide (Service level = probability of NOT stocking out) Service level Safety Stock Probability of stock-out Safety stock = (safety factor z)(std deviation in LT demand) Read z from Normal table for a given service level Caution: Std deviation in LT demand Variance over multiple periods = the sum of the variances of each period (assuming independence) Standard deviation over multiple periods is the square root of the sum of the variances, not the sum of the standard deviations!!! Average Inventory = (Order Qty)/2 + Safety Stock Receive Receive order order Time Time Place Place order order Lead Time Lead Time Inventory Level Order Quantity Safety Stock (SS) EOQ/2 Average Inventory How to find ROP & Q Order quantity Q = To find ROP, determine the service level (i.e., the probability of NOT stocking out.) Find the safety factor from a z-table or from the graph. Find std deviation in LT demand: square root law. Safety stock is given by: SS = (safety factor)(std dev in LT demand) Reorder point is: ROP = Expected LT demand + SS Average Inventory is: SS + EOQ/2 Example (continued)… Back to the car lot… recall that the lead time is 10 days and the expected yearly demand is 5000. You estimate the standard deviation of daily demand demand to be d = 6. When should you re-order if you want to be 95% sure you don’t run out of cars? Since the expected yearly demand is 5000, the expected demand over the lead time is 5000(10/365) = 137. The z-value corresponding to a service level of 0.95 is 1.65. So Order 548 cars when the inventory level drops to 168. Investment Evaluation 36 INVESTMENT EVALUATION Investment Evaluation 37 The Finance Function Financial Markets (Investors) Operations (Plant, Equipment, Projects, etc.) Financial Manager (1a) Raise Funds (1b) Obligations (Stocks, Debt, IOUs) (2) Investment (3) Cash from Operations (5) Dividends or Interest Payments The finance function manages the cash flow (4) Reinvest Investment Evaluation 38 The Finance Function Financial Markets Operations Financial Manager Investment Decision Financing Decision How much to invest and in what assets? Where is the $ going to come from? Capital Budgeting Finance focuses on these two decisions Investment Evaluation 39 Interaction between Financing & Investment Decisions Financial Markets Operations Financial Manager Investment Decision Financing Decision The interplay of the decisions determines the cost of capital Cost of Capital Characteristics of the Investment Investment Evaluation 40 The Finance Function The objective of the financial manager and the corporation is to MAXIMIZE THE CURRENT VALUE OF SHAREHOLDERS' WEALTH. (Taken literally, this means that a firm should pursue policies that maximize its today's quotation in the Wall Street Journal.) By making investing and financing decisions, the financial manager is attempting to achieve the following objective: Investment Evaluation 41 Investment Evaluation in 3 Basic Steps 1) Forecast all relevant after tax expected cash flows generated by the project 2) Estimate the opportunity cost of capital--r (reflects the time value of money and the risk) 3) Evaluation DCF (discounted cash flows) NPV (net present value) Accept project if NPV is positive Reject project if NPV is negative IRR (internal rate of return Accept project if IRR > r Payback, Profitability Index ROA, ROFE, ROI, ROCE ROE EVA Investment Evaluation 42 Forecasting Cash Flows First, forecast all relevant after-tax expected cash flows Key is that cash flows must be (a) relevant, costs and income directly affected by the project, and (b) after-tax, cash into the owner’s pocket Investment Evaluation 43 Forecasting Cash Flows This is done by estimating operational parameters These are based on actual reported performance This represents a “best guess” about the company’s future performance Obviously, there is an uncertainty problem but history is used as a guide for what to expect in the future Investment Evaluation 44 Investment Evaluation Evaluating investments involves the following: 1) Forecast all relevant after tax expected cash flows generated by the project 2) Estimate the opportunity cost of capital--r (reflects the time value of money and the risk) 3) Evaluation DCF (discounted cash flows) NPV (net present value) Accept project if NPV is positive Reject project if NPV is negative IRR (internal rate of return Accept project if IRR > r Payback , Profitability Index ROA, ROFE, ROI, ROCE ROE EVA Investment Evaluation 45 1) Depreciation is not a cash flow, but it affects taxation 2) Do not ignore investment in fixed assets (Capital Expenditures) Do not ignore investment in net working capital Include only changes in operating working capital. Short-term debt, excess cash and marketable securities should not be accounted for. Separate investment and financing decisions: Evaluate as if entirely equity financed 5) Estimate flows on a incremental basis Forget sunk costs: cost incurred in the past and irreversible Include all externalities - the effects of the project on the rest of the firm - e.g., cannibalization or erosion, enhancement 6) Opportunity costs cannot be ignored Forecasting Cash Flows: The Ten Commandments Investment Evaluation 46 7) Do not forget continuing value (residual or terminal value) Liquidation value: Estimate the proceeds from the sale of assets after the explicit forecast period. (Recover investment in working capital, tax-shield or fixed assets but missing the intangibles and value of on-going business) Perpetual growth: Assume cash flows are expected to grow at a constant rate perpetually. 8) Be consistent in your treatment of inflation Nominal cash flows (including inflation) -- use a nominal cost of capital R Real cash flows (without inflation) -- use a real cost of capital r 9) Overhead costs 10) Include excess cash, excess real estate, unfunded (over-funded) pension fund, large stock option obligations, and other relevant off balance sheet items. Forecasting Cash Flows: The Ten Commandments Investment Evaluation 47 Forecasting Cash Flows Cash Flows from Operations Revenue - Cost of Goods Sold - Depreciation (may be in CGS) - Selling, General & Admin. = Operating Profit - Cash Taxes on Operating Profit = Net Operating Profit After Tax + Depreciation - Capital Expenditures - Increase in Working Capital = Cash Flow from Operations Investment Evaluation 48 Forecasting Cash Flows 1) Depreciation is not a cash flow, but it affects taxation Revenue - Cost of Goods Sold - Depreciation - Selling, General & Admin. = Operating Profit - Cash Taxes on Operating Profit = Net Operating Profit After Tax + Depreciation - Capital Expenditures - Increase in Working Capital = Cash Flow from Operations Investment Evaluation 49 Forecasting Cash Flows 2) Do not ignore investment in fixed assets. Revenue - Cost of Goods Sold - Depreciation - Selling, General & Admin. = Operating Profit - Cash Taxes on Operating Profit = Net Operating Profit After Tax + Depreciation - Capital Expenditures - Increase in Working Capital = Cash Flow from Operations Investment Evaluation 50 Forecasting Cash Flows 3) Do not ignore investment in net working capital. Revenue - Cost of Goods Sold - Depreciation - Selling, General & Admin. = Operating Profit - Cash Taxes on Operating Profit = Net Operating Profit After Tax + Depreciation - Capital Expenditures - Increase in Working Capital = Cash Flow from Operations Investment Evaluation 51 Forecasting Cash Flows There is an important distinction between the accounting definition of working capital and the economic/finance definition relevant to cash flows forecast. The distinction is a direct result of the 4th commandment above: We need the operating working capital, not the operating and financial working capital. Investment Evaluation 52 Current assets include operating assets (above dotted line). However, excess cash and marketable securities not required for operations (below dotted line) are not operating working capital and accounted separately for value (see 10th commandment). Current liabilities include both operating liabilities (above the dotted line) and non-operating short-term debt (below the dotted line). Accounting Definition of Working Capital Accounts receivable Inventory Cash (required for operations) Excess Cash & marketable securities Accounts payable Accrued taxes Accrued wages short-term debt Working Capital = Current Assets - Current Liabilities Investment Evaluation 53 Forecasting Cash Flows 4) Separate investment and financing decisions Revenue - Cost of Goods Sold - Depreciation - Selling, General & Admin. = Operating Profit - Cash Taxes on Operating Profit = Net Operating Profit After Tax + Depreciation - Capital Expenditures - Increase in Working Capital = Cash Flow from Operations Evaluate as if entirely equity financed Ignore financing/ no interest line item Investment Evaluation 54 Forecasting Cash Flows 5) Estimate flows on an incremental basis Incremental = total firm cash flow - total firm cash flow Cash Flow WITH the project WITHOUT the project Forget Sunk Costs – costs incurred in the past and irreversible Include all effects of the project on the rest of the firm (e.g., cannibalization, erosion, enhancement, etc.) Investment Evaluation 55 Forecasting Cash Flows 6) Opportunity costs cannot be ignored What other uses could resources be put to? The cost of any resource is the foregone opportunity of employing this resources in the next best alternative use. Investment Evaluation 56 Forecasting Cash Flows 7) Do not forget continuing value (residual or terminal) Two approaches are available: Liquidation value: Estimate the proceeds from the sale of assets after the explicit forecast period. (Include the recovery of investment in working capital, tax-shield on the undepreciated fixed assets and any revenue from assets sale). This approach results in under-valuation since it misses the value of on-going business. It ignores the value of intangibles. Investment Evaluation 57 Forecasting Cash Flows Perpetual growth: Assumes that after time n cash flows are expected to grow at a constant rate perpetually. Year 1 CF1 Year 2 CF2 Year n CFn . . . Terminal Value Year n+1 & on CFn+1/(r-g) Investment Evaluation 58 8) Be consistent in the treatment of inflation Discount nominal cash flows with nominal cost of capital Discount real cash flows with real cost of capital Nominal Rate » Real Rate + Inflation Common Mistake: Nominal (inflation adjusted) discount rate used to discount real cash flows Bias towards short-term investment Nominal vs. Real Interest Rate 7% 4% 3% Nominal Inflation Real { Forecasting Cash Flows Investment Evaluation 59 Nominal vs. Real Cash Flows Note: Depreciation is based on historical costs and therefore is not adjusted for inflation Forecasting Cash Flows Investment Evaluation 60 Forecasting Cash Flows 9) Overhead costs Revenue - Cost of Goods Sold - Depreciation - Selling, General & Admin. = Operating Profit - Cash Taxes on Operating Profit = Net Operating Profit After Tax + Depreciation - Capital Expenditures - Increase in Working Capital = Cash Flow from Operations Do not forget overheads and other indirect costs that increase due to the project Investment Evaluation 61 Forecasting Cash Flows 10) Include excess cash, excess real estate, unfunded (over-funded) pension funds, large stock option obligations Year 1 CF1 Year 2 CF2 Year 3 CF3 Year 4 CF4 Year 5 CF5 Terminal CFn+1/(r-g) . . . PV(Operating Cash Flows) + Excess cash balance + Excess marketable securities + Excess real estate - Under-funded pension =Value of the FIRM Assets/Liabilities not required to support operations Investment Evaluation 62 Value of the Firm -Value of Debt =Value of Equity To calculate share price-divide by the number of shares outstanding Value of Equity Investment Evaluation 63 Investment Evaluation Evaluating investments involves the following: 1) Forecast all relevant after tax expected cash flows generated by the project 2) Estimate the opportunity cost of capital--r (reflects the time value of money and the risk) 3) Evaluation DCF (discounted cash flows) NPV (net present value) Accept project if NPV is positive Reject project if NPV is negative IRR (internal rate of return Accept project if IRR > r Payback , Profitability Index ROA, ROFE, ROI, ROCE ROE EVA Investment Evaluation 64 Evaluation Methods: NPV Net Present Value (NPV) is the sum of all cash flows adjusted by the discount rate Example: Future cash flows are discounted “penalized” for time and risk Investment Evaluation 65 Evaluation Methods: NPV Net Present Value (NPV) is the sum of all cash flows adjusted by the discount rate Example: Investment Evaluation 66 Evaluation Methods: IRR As the discount rate increases, the PV of future cash flows is lower and the NPV is reduced Example: Internal rate of return (IRR) is the discount rate that sets the NPV to zero IRR: Discount rate at which the project has a NPV of zero Investment Evaluation 67 Calculation of IRR The IRR is the r that solves Decision Rule: Accept the project if IRR > Opportunity Cost of Capital Investment Evaluation 68 Evaluation Methods: NPV vs. IRR NPV is a measure of absolute performance, whereas IRR measures relative performance: 1) Independent Projects Accept if NPV > 0 Accept if IRR > Opportunity Cost of Capital Investment Evaluation 69 Evaluation Methods: NPV vs. IRR 2) Mutually Exclusive Projects (Ranking) Problems with IRR: A) Scale B) Timing of Cash Flows: Bias against long-term investments Highest (NPVa, NPVb, NPVc) Highest (IRRa, IRRb, IRRc) Obviously, the return in absolute dollars must be considered Preference for CF early! But, it depends. Investment Evaluation 70 The ranking of the projects depends on the discount rate A is a LT project and when discount rate ­ PV ¯ B is a ST project and when discount rate ­ PV ¯ drops less Evaluation Methods: NPV vs. IRR Investment Evaluation 71 Other Evaluation Methods Payback: How long does it take for the project to payback? Problems: No discounting the first 3 years Infinite discounting of later years Biases against long-term projects. ROA (return on assets) ROI (return on investment) ROFE (return on funds employed) ROCE (return on capital employed) ROE = } Earnings Investment = Problems: Investment not valued at market Earnings vs. cash flows Net Income Shareholders’ Equity Book Value Profitability Index: PV/I. Problem: Biases against large-scale projects. Investment Evaluation 72 Use of Capital Budgeting Rules in Practice. 548 500 ) 000 , 5 )( 000 , 15 ( 2 * = = Q Time Time Inventory Inventory Level Level Order Order Quantity Quantity But demand is rarely predictable! Demand??? But demand is rarely predictable! Time Inventory Level Order Quantity Demand??? X X Inventory at time of receipt Receive Receive order order Time Time Inventory Inventory Level Level Order Order Quantity Quantity Place Place order order Lead Time Lead Time Actual Demand < Expected Demand ROP Lead Time Demand Actual Demand < Expected Demand X Inventory at time of receipt Receive order Time Inventory Level Order Quantity Place order Lead Time ROP Lead Time Demand ROP = Expected Demand Average Time Time Inventory Inventory Level Level Order Order Quantity Quantity If ROP = expected demand, service level is 50%. Inventory left 50% of the time, stock outs 50% of the time. Uncertain Demand If ROP = expected demand, service level is 50%. Inventory left 50% of the time, stock outs 50% of the time. ROP = Expected Demand Average Time Inventory Level Order Quantity Uncertain Demand 2 SD EOQ H = ( ) LTD stddevinLTdemandstddevindailydemanddaysi nLT LT = s=s 168 ) 36 ( 10 65 . 1 137 = + = ROP Actual B. Operating Income1998199920002001200220032004 1Sales1,356.1 1,535.0 1,660.0 1,759.6 1,865.2 1,958.4 2,056.4 2Operating Costs(1,143.2) (1,304.8) (1,402.7) (1,478.1) (1,566.7) (1,645.1) (1,727.3) 3Depreciation(67.5) (77.0) (83.0) (80.0) (75.0) (70.0) (65.0) 4EBIT 145.4 153.3 174.3 201.5 223.4 243.3 264.0 5Taxes(50.6) (61.3) (69.7) (80.6) (89.4) (97.3) (105.6) 6EBIAT94.8 92.0 104.6 120.9 134.1 146.0 158.4 Actual C. Cash Flows from Operations1998199920002001200220032004 7EBIAT94.8 92.0 104.6 120.9 134.1 146.0 158.4 8Depreciation67.5 77.0 83.0 80.0 75.0 70.0 65.0 9Changes in WC(87.7) (30.3) (75.0) (19.9) (21.1) (18.7) (19.6) 10Capital Investment(59.7) (46.2) (48.4) (50.0) (50.0) (50.0) (50.0) 11Free Cash Flows14.9 92.4 64.2 131.0 137.9 147.4 153.8 ProForma ProForma Sample Corporation VALUATION Basic Parameters Sample Corporation Basic Parameters Basic Parameters for Corporate Valuation Line Description Value Company Name: Sample Corporation Year (Last Actual): 1998 Rates: Risk-free Rate(rf) 5.25% Debt Yield/Return on Debt (rd) 7.90% Market Risk Premium (MRP) 7.40% Company's Beta (B) 1.10 Return on Equity (re) 13.39% Financial: # of Shares Outstanding 22,900,000 Long-term Debt Outstanding 217,300,000 Stock Price 35.00 Tax Rate 35.00% Weighted Average Cost of Capital (WACC) 11.63% Valuation Per Share 50.15 Yellow denotes some discretion required in estimation Blue denotes readily available fact from public sources &L&"Arial,Bold Italic"&14Corporate Valuation Model&"Arial,Regular"&10 &A &L&11Raviv&RPage: &p of &n File: &f Date: &d Historical Performance Sample Corporation Past Financial Performance Actual Projected E. Historical Performance (Value Line) 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 1 Sales ($ millions) 429.0 448.7 458.8 511.6 545.3 588.2 712.8 862.3 906.3 1,356.1 1,535.0 1,660.0 2 G Sales Growth (%) 4.6% 2.3% 11.5% 6.6% 7.9% 21.2% 21.0% 5.1% 49.6% 13.2% 8.1% 3 Operating Costs 358.6 374.7 387.2 428.2 454.2 483.5 590.2 689.8 722.3 1,143.2 1,304.8 1,402.7 4 P Operating Margin (%) 16.4% 16.5% 15.6% 16.3% 16.7% 17.8% 17.2% 20.0% 20.3% 15.7% 15.0% 15.5% 5 D Depreciation 17.0 18.4 22.5 28.6 30.3 33.0 37.3 45.0 49.2 67.5 77.0 83.0 6 Net Profit 36.9 39.5 34.9 39.4 40.9 47.1 55.6 79.3 81.6 74.6 76.8 84.7 7 T Income Tax Rate 34.8% 35.0% 35.0% 34.0% 34.0% 36.0% 36.8% 38.4% 39.5% 39.9% 40.0% 40.0% 8 Net Profit Margin (%) 8.6% 8.8% 7.6% 7.7% 7.5% 8.0% 7.8% 9.2% 9.0% 5.5% 5.0% 5.1% 9 Working Capital 138.3 137.6 141.4 152.2 157.9 183.4 193.2 206.2 149.2 236.9 260.0 335.0 10 W Working Capital Increase (%) -3.6% 37.6% 20.5% 16.9% 59.4% 7.9% 8.7% -129.5% 19.5% 16.9% 60.0% 11 Debt 20.5 20.2 19.8 26.0 25.2 23.5 25.6 30.6 24.5 428.2 440.0 440.0 12 Capital Spending Per Share 0.72 1.15 0.93 0.74 0.72 0.76 1.13 1.31 0.86 1.38 1.10 1.15 13 Outstanding Shares (millions) 42.34 42.87 43.44 45.21 44.12 44.79 45.38 45.59 45.77 43.27 42.00 42.10 14 C Capital Expenditures 30.5 49.3 40.4 33.5 31.8 34.0 51.3 59.7 39.4 59.7 46.2 48.4 &L&"Arial,Bold Italic"&14Corporate Valuation Model&"Arial,Regular"&10 &A &L&11Raviv&RPage: &p of &n File: &f Date: &d WACC Calculation Weighted Average Cost of Capital Calculation for Sample Corporation Market Value of Equity Current Share Price 35.00 Outstanding Shares 22,900,000 Total 801,500,000 Market Value of Debt (use book as proxy) 217,300,000 Firm Value 1,018,800,000 Debt 217 Debt + Equity 1,019 21% Equity 802 Debt + Equity 1,019 79% Using CAPM to estimate the cost of equity (re) as follows: re = rf + (Beta * Market Risk Premium) rf = 5.25% Beta = 1.1 Market Risk Premium = 7.40% re= 13.39% Therefore the Weighted Average Cost of Capital is as follows: WACC = [(D/(D+E))*rd*(1-t)]+[(E/(D+E))*re] D/(D+E) = 21% rd = 7.90% t (tax rate) = 35% E/(D+E) = 79% re = 13.39% WACC 11.63% &L&"Arial,Bold Italic"&14Corporate Valuation Model&"Arial,Regular"&10 &A &L&11Raviv&RPage: &p of &n File: &f Date: &d Valuation Worksheet Sample Corporation VALUATION Actual ProForma A. Operating Parameters 1998 1999 2000 2001 2002 2003 2004 2005 Terminal S Sales Growth (%) 49.6% 13% 8% 6% 6% 5% 5% 5% P Operating Profit Margin (%) 15.7% 15.0% 15.5% 16.0% 16.0% 16.0% 16.0% 16.0% T Tax Rate (%) 39.9% 40.0% 40.0% 40.0% 40.0% 40.0% 40.0% 40.0% D Depreciation ($) 67.5 77.0 83.0 80.0 75.0 70.0 65.0 65.0 C Capital Expenditure ($) 59.7 46.2 48.4 50.0 50.0 50.0 50.0 50.0 W Working Capital as % of Sales (%) 19.5% 16.9% 60.0% 20.0% 20.0% 20.0% 20.0% 20.0% Excess Cash - 0 Market Value of Debt 217.3 # of Outstanding Shares 22.9 Perpetual Growth Rate 5.0% Sample Corporation VALUATION Actual ProForma B. Operating Income 1998 1999 2000 2001 2002 2003 2004 2005 Terminal 1 Sales 1,356.1 1,535.0 1,660.0 1,759.6 1,865.2 1,958.4 2,056.4 2,159.2 2