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  • Nolen bootcamp

    1. 1. Boot Camp 1 Entrepreneurship Boot Camp “Running the Numbers” Jim Nolen Fin 394 – Harvest, Finance & Negotiation
    2. 2. Boot Camp 2 Entrepreneurship Boot Camp 1. If you do not have a strong accounting and finance background, find a study group with members who do, as much of the case study method occurs in the study groups. 2. Take Managerial Accounting or Financial Statement Analysis to improve your understanding of financial statements. 3. When analyzing a case, use the analytical frameworks provided in your course such as Porter and SWOT analysis and FIT framework
    3. 3. Boot Camp 3 Entrepreneurship Boot Camp  Put yourself in the position of the case’s decision-maker. Try to determine what the central issues are to the decision to be made and prioritize what is urgent and what is important.  Try to link these central issues to the financial statements and sort out the relevant data.
    4. 4. Boot Camp 4 Entrepreneurship Boot Camp  Examine the historical financial information.  Compound Annual Growth Rate (CAGR)  Gross and Net Margins  Common Form Balance Sheet  Ratios  Liquidity, Leverage, Coverage, Turnover, Profitability, and Return  The DuPont equation is a good tool to use.
    5. 5. Boot Camp 5 Entrepreneurship Boot Camp  Look at trends in these ratios (intracompany) and benchmark them against the industry or comparable firms (intercompany).  Compare the forecasted data to the historical data and look for inconsistencies  Look at the cash flow statement. Where are the sources of funds being generated and are they sustainable. What are the uses of funds. Follow the Money.
    6. 6. Boot Camp 6 Entrepreneurship Boot Camp  Is the cash flow of the company capable of servicing existing debt and to cover increases in working capital and capital expenditures to support the projected sales increase.  Assets are a function of sales and increase represent a use of funds  Capital requirements are a function of asset requirements and profitability and represent a source of funds.
    7. 7. Boot Camp 7 Entrepreneurship Boot Camp  Boil the numbers down to their smallest elements (unit economics) and use common sense. Look at revenue per employee or sales per sq. ft. Does this seem reasonable?  What growth rate would you have to assume to get to this market value?  What percent share of market would they have to have to make the projections?  Why is the seller selling and is there some window dressing going on?  Read the footnotes in the tables and look at the exhibits that would put a twist on the decision.
    8. 8. Boot Camp 8 Return on Assets (ROA)  Relates profitability to the assets (capital) employed. Uses some measure of Profitability divided by Total Assets. It can be calculated before or after taxes. Net Profit ROA = Total Assets
    9. 9. Boot Camp 9 Return on Equity (ROE)  Relates profitability (usually after tax) to the amount of owner’s capital employed and is affected by the level of debt used in the company. Net Profit ROE = Owner’s Equity
    10. 10. Boot Camp 10 DuPont Formula - ROA Return on Assets Profit Margin X Asset Turnover NET PROFIT SALES SALES X ASSETS
    11. 11. Boot Camp 11 RETURN ON EQUITY Profit Investment Financial Margin X Turnover X Leverage NET INCOME X SALES X ASSETS SALES ASSETS EQUITY Dupont Formula - ROE
    12. 12. Boot Camp 12 Short Term Cash Cycle Cash Raw Materials Inventory WIP Inventory Finished Goods Inventory Accounts Receivable Fixed Assets
    13. 13. Boot Camp 13 Short-Term Cash Cycle Production Cycle Cash CycleDays in A/P Order Materials (lag time, order vs carrying costs) Raw Materials Inventory Work-In- Process Inventory Finished Goods Inventory Collection of A/R Sale of Goods or Services Material Receipt Inventory Costs Pmt. for Materials Conversion Costs Labor, Equip. & Mfg. Overhead Inventory Costs Carrying Costs Selling & Credit Expenses Pmt. of A/P
    14. 14. Boot Camp 14 Cash Conversion Cycle Days in Raw Materials Inventory  Avg. Raw Materials Inventory x 365 Cost of Raw Materials Days Less: Days in Accounts Payable  Avg. Accounts Payable x 365 Cost of Goods Sold - Labor Days Plus: Days in WIP Inventory  Avg. WIP Inventory x 365 Cost of Goods Sold Days Plus: Days in Finished Goods Inventory  Avg. Finished Goods Inventory x 365 Cost of Goods Sold Days Plus: Days in Accounts Receivable  Avg. Accounts Receivable x 365 Credit Sales Days
    15. 15. Boot Camp 15 Value Drivers  Managers can directly affect the firm’s returns and firm value by:  Increasing Operating Profits (increasing revenues, decreasing costs, or employing operating leverage)  Increasing Asset Turnover - Improved working capital management and fixed asset utilization  Judicious use of financial leverage  Decrease Risk - maintaining liquidity and lowering variability through planning and diversification
    16. 16. Boot Camp 16 Valuation Models  Book Value  Appraised Book Value  Market Value  Prior Sales of Stock/Transaction Analysis  Comparable Market Value  Capitalization Models  Constant Growth Model  Discounted Cash Flow Model  Excess Earnings Model
    17. 17. Boot Camp 17 Comparable Market Value  Surrogate Market Value based on valuation benchmarks of similar publicly traded companies.  Price/Book Value  Price/Earnings  Price/Cash Flow  Price/Revenues  Price/EBITDA
    18. 18. Boot Camp 18 Comparable Market Value  Comparable Firms should be similar in:  Industry and Products  Management  Size and Geographic area  Accounting Methods  Risk and Return  Usually only publicly traded firm’s information can be found and do not meet the requirements above.
    19. 19. Boot Camp 19 Capitalization of Earnings The Present value of $300 into Perpetuity at a 20% required rate of return is equal to: $300 PV = .20 = $1,500
    20. 20. Boot Camp 20 Earning’s Adjustments Normalization of Earnings  Excessive Compensation  Tax Strategies  Excessive lease expense paid to owners  Personal expenses paid by the business  Non-Recurring Income or Expenses  Extraordinary Income or Expenses
    21. 21. Boot Camp 21 Capitalization Models  Constant Growth Model Projected Earnings Year 1 Equity Cap. Rate - Growth Rate  All valuation models would add back surplus cash or undeveloped assets to the value of the cash flows.
    22. 22. Boot Camp 22 Constant Growth Model  What is the value of an equity stream projected to be $100 in year 1 and expected to grow at 10% per year assuming the investor’s required rate of return is 20%? PV = $100 = $1,000 .20 - .10
    23. 23. Boot Camp 23 Equity Capitalization Rate Required Rate of Return (Opportunity Cost)  Risk Free Rate  Treasury Bill or Treasury Bond  + Market Risk Premium  + Unique Risk of the Company  Variability of Sales and Income, Small Firm Size  Key Man, Lack of Succession, Concentration of Sales  Market and Financial Risk
    24. 24. Boot Camp 24 Equity Capitalization Rate  Risk Premium is based upon the analysis and experience of the appraiser. Assuming a risk free rate of 6%, then the equity cap rate with the risk premium would range:  Low risk 15% - 20%  Medium Risk 20% - 30%  High Risk 30% - 50%
    25. 25. Boot Camp 25 Discounted Cash Flow (DCF) Firm FCF1 FCF2 FCF3 FCFn  Value = (1+r) 1 + (1+r) 2 + (1+r) 3 +.... (1+r) n  Where FCF is “free cash flow and “r” is the required rate of return (weighted average cost of capital)  Market value of the debt is then subtracted from this firm value to arrive at the value of the equity of the company.
    26. 26. Boot Camp 26 Free Cash FlowT NOPAT (EBIT x (1-T)) + Depreciation and Amortization - Increase in Net Working Capital* - Capital Expenditures Free Cash FlowT * Increase in W/C is the spontaneous assets and liabilities only (A/R, Inv, A/P and Acc. Exp), not CA-CL.
    27. 27. Boot Camp 27 Discounted Cash Flow  Projected earnings or cash flow  Usually forecast 5 years into the future.  Assume a residual value at the end of year 5  Can use the constant growth model or comparable value YR 1 2 3 4 5 Residual FCF $100 $200 $300 $400 $500 $5,500 PVIF@20% .833 .694 .579 .482 .402 .402 PV = $83 $139 $174 $193 $201 $2,211 DCF Firm Value = $3,001
    28. 28. Boot Camp 28 Residual Value  Residual Value was calculated as follows: Year 5 FCF x (1+g) $ 500 x (1+.10) WACC - g .20 - .10 Residual Value = $5,500
    29. 29. Boot Camp 29 Discounts  Lack of Marketability  Minority Interest  Liquidity
    30. 30. Boot Camp 30 Lack of Marketability/Liquidity  Discounts range from 10% to over 50%, but studies of court cases found the average discount for lack of marketability is 35%. Thus, if the surrogate market value or capitalized value of the company were $1 million, the value after this discount would be $650,000 at 35% discount.  Do not use for book value technique.
    31. 31. Boot Camp 31 Minority Interest Discount  A minority block of stock is worth less than controlling interest since the minority stockholder can not influence the decisions of the company.  Conversely, a majority interest has more value than a minority interest and a control premium may be appropriate.  An additional discount (on top of the marketability discount) for minority shares should be applied.
    32. 32. Boot Camp 32 Minority Interest Discount  The discount for minority interest can range from 10% to 25%.  The combined discount for lack of marketability and a minority block of stock often total 50% to 60%.  This explains why publicly traded companies trade at higher multiples than small firms as they exhibit liquidity.
    33. 33. Boot Camp 33 Minority Interest Discount  When using comparable market value, the valuation benchmarks of public companies already assume a minority block of stock is trading so no discount is applied to comparable market value technique, but is applied to the capitalization of income technique.
    34. 34. Boot Camp 34 Venture Capital Method  Venture Capitalists generally will apply a comparable or industry price/earnings multiple (p/e ratio) to projected earning in year 5 (the exit point) to get a surrogate market value, then discount that value to the present at their required return (30-60+ %).  This present value is the pre-money value and when added to the capital raised, produces the post-money valuation.