Ethics of financial modeling12/31/14 3:10 PMHow to make a financial model

1. Purpose of analysis?2. Background reading on company3. Identify Key drivers (3 to 5)4. Gather Data for other companies5. Build analysis (make model in excel)6. Present your conclusion

Data gatheringStart with interim and annual reports (eg. 10k report)Google : [Company Name] investor relationslook for investor presentationsthird party firms release data on industries and firmsearch equity research on company normally issued by big banks (you can see the banks view on the companies future) can also get by signing up for a brokerage account scott trade, tdi (not always needed)can try interview management team to ask abou the future of the companychannel check is talk to suppliers and customers about the company you are interested in

Identifying the key drivers

Such as costs, prices, no. of units etc.

Gathering data on other companies

Building analysis

Revenue, expenses (always)Create full or partial financial statements

Conclusion

What is your recommendationBack up by no.sBest structure/ timing Powerpoint/oral

FINANCIAL MODELING IN REAL LIFE

Financial Modeling intro 12/31/14 3:10 PM

Money depreciates (not because of depreciation) NPV is a critical concept

NPV net present valueIRR internal rate of returnWACC weighted average cost of capital

WACC (discount rate) = normally 8 to 10%

Time-Value of Money12/31/14 3:10 PM

Where to put your money?

Method 1: Intrinsic value vs Asking price

Method 2: Returns vs. opportunity cost

Discount rate: your opportunity cost

Can be equity or debt investors (main two)

Need to consider the opportunity cost for all investors called Weighted average cost of capital (WACC)

Higher the risk, higher the discount rate (WACC) (higher potential returns satisfy investors)

NPV Net Present Value

What payoff in the future is worth to us today

Intrinsic value: calculate the NPV of all future cash flows, using the discount rate

Asking price < Intrinsic value (invest)

Asking Price > Intrinsic value (dont invest)

IRR Internal Rate of Return

Another type of discount rate , similar to WACC

Difference, You know WACC, but you SOLVE FOR the IRR

DEF: the discount rate at which the NPV is 0

Upfront investment + series of cash flows -> IRR

Series of cash flows + Discount rate (opp cost) -> Upfront investment (NPV)

Returns vs Opp cost (judging the investment)

Need to know the cash flows and asking price and the discount rate

IRR > WACC (invest)IRR < WACC (dont invest)

When juding project by IRR judge on project target discount rate not on whole company discount value

NPV: what a company/asset is worth TODAY

NPV: Givent he discount rate and cash flows, is it undervalued or overvalued? What should the asking price be?

IRR: Will you earn more money than yu could elsewhere

IRR: Given asking price, should we invest?

Valuation: NPV (more common); Acquisition/Buyouts: IRR (more common)

12/31/14 3:10 PM