The fully revised new edition of the best-selling guide to using financial models to determine if a stock is over or undervalued
Written by the founder and CEO of the world-renowned New York School of Finance, Financial Modeling and Valuation provides clear and systematic guidance on accurately evaluating the soundness of a stock investment. This invaluable handbook equips investors with the tools necessary for understanding the underlying fundamentals of a rational investment and for making smarter investment decisions in any market environment.
Built around an in-depth case study of global retail leader Amazon, this fully updated Second Edition shows you how to analyze the financial standing of a company using the methods of Wall Street professionals. Step-by-step, you will learn to build the core three statements - income statement, cash flow statement, and balance sheet - as well as the three major supporting schedules required for complete company valuation and analysis. All line items are explained in clear language and include real-world tips and techniques for using them as tools for valuing and managing a business. This must-have guide:
- Features new and in-depth case studies based on Amazon that simulate real-world modelling and valuation
- Explains valuation techniques such as illustrative comparable company analysis, precedent transactions analysis, and discounted cash flow analysis
- Covers all essential applications of a model, including pricing a stock, raising debt, and raising equity
- Includes an introductory section describing the recent and dramatic shift of the entire retail industry
- Provides end-of-chapter questions, downloadable practice models, additional case studies, and common interview questions via a companion website
Financial Modeling and Valuation: A Practical Guide to Investment Banking and Private Equity, Second Edition is essential reading for finance professionals, venture capitalists, individual investors, and students in investment banking and related degree programs in finance.
Table of Contents
Preface xv
The Amazon Case Study xvi
How This Book Is Structured xvii
Part One
Financial Statements and Projections 1
Chapter 1
The Income Statement 3
Revenue 4
Cost of Goods Sold 4
Gross Profit 4
Operating Expenses 5
Other Income 6
EBITDA 6
Depreciation and Amortization 8
EBIT 8
Interest 9
EBT 9
Taxes 9
Net Income 10
Non-Recurring and Extraordinary Items 10
Distributions 11
Net Income (as Reported) 11
Shares 11
Earnings per Share (EPS) 12
Amazon’s Income Statement 12
Revenue 14
Getting to EBITDA 20
Digging up Depreciation 20
Cost of Goods Sold 23
Gross Profit 23
Fulfillment 25
Technology and Content 25
Marketing, General and Administrative,
Other Operating Expense (Income), Net 27
Total Operating Expenses 27
EBITDA 27
Beyond EBITDA 28
Depreciation and Amortization 28
EBIT 29
Other Income 30
Interest 31
EBT 31
Taxes 31
Net Income from Continuing Operations 32
Non-Recurring and Extraordinary Items 32
Net Income (after Non-Recurring Events) 33
Distributions 33
Net Income (as Reported) 33
Shares and EPS 34
Income Statement - Making Projections 35
Revenue 35
Cost of Goods Sold 40
Operating Expenses 45
Depreciation and Amortization 46
Other Income 49
Seven Methods of Projections 49
Interest Income 53
Taxes 53
Non-Recurring Events 55
Distributions 55
Equity Method Investment Activity 55
Dividends 57
Shares 57
Basic Shares Outstanding 57
Diluted Shares Outstanding and the Treasury Method 57
Earnings per Share 60
Chapter 2
The Cash Flow Statement 67
Cash from Operating Activities 67
Revenue 69
Cost of Goods Sold 69
Operating Expenses 69
Depreciation 69
Interest 69
Taxes 70
Cash from Investing Activities 71
Cash from Financing Activities 71
Financial Statement Flows Example 72
Amazon’s Cash Flow Statement 78
Cash from Operating Activities 78
Cash from Investing Activities 81
Cash from Financing Activities 82
Cash Flow Statement - Making Projections 84
Cash from Operating Activities 85
Depreciation and Amortization 85
Stock-Based Compensation 85
Other Operating Expense 88
Other Expense (Income) 90
Deferred Taxes 91
Changes in Operating Working Capital 91
Cash from Investing Activities 92
Proceeds from Property and Equipment Sales and Incentives 98
Items Based on Cash Available 98
Cash Flow from Financing Activities 101
Effect of Exchange Rate on Cash 101
Chapter 3
The Balance Sheet 107
Assets 107
Current Assets 107
Cash and Cash Equivalents 107
Accounts Receivable 107
Inventory 108
Prepaid Expense 109
Non-Current Assets 110
Property, Plant, and Equipment (PP&E) 110
Intangible Assets 110
Liabilities 110
Current Liabilities 110
Accounts Payable 110
Accrued Liabilities 111
Short-Term Debts 111
Non-Current Liabilities 111
Long-Term Debts 111
Deferred Taxes 111
Amazon’s Balance Sheet 112
Current Assets 113
Non-Current Assets 113
Operating Leases 114
Goodwill 114
Other Assets 114
Current Liabilities 114
Short-Term Debt 115
Non-Current Liabilities 115
Other Long-Term Liabilities 116
Shareholders’ Equity 116
Common Stock and Additional Paid-in Capital 117
Treasury Stock, Accumulated Other Comprehensive
Loss and Retained Earnings 117
Chapter 4
Depreciation Schedule 119
Straight-Line Depreciation 120
Accelerated Depreciation 121
Declining Balance 121
Sum of the Year’s Digits 122
Modified Accelerated Cost Recovery System (MACRS) 122
Deferred Taxes 125
Deferred Tax Asset 125
NOL Carryback Example 126
Deferred Tax Liability 127
Projecting Depreciation 129
Straight-Line Depreciation 129
Anchoring Formula References 133
Projecting Deferred Taxes 152
Chapter 5
Working Capital 155
Operating Working Capital 156
Amazon’s Operating Working Capital 158
Inventories 160
Accounts Receivable, Net and Other 162
Accounts Payable 163
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Accrued Expenses and Other 165
Unearned Revenue 166
Projecting Operating Working Capital 168
Receivables 168
Inventories 170
Accounts Payable 172
Accrued Expenses 174
Unearned Revenue 174
Operating Working Capital and the Cash Flow Statement 176
Changes in Inventory 178
Accounts Receivable 179
Changes in Accounts Payable 181
Changes in Accrued Expenses 182
Changes in Unearned Revenue 182
Chapter 6
Balance Sheet Projections 183
Cash Flow Statement Drives Balance Sheet vs.
Balance Sheet Drives Cash Flow Statement 183
Assets 185
Inventories 186
Accounts Receivable 188
Liabilities 192
Shareholders’ Equity 195
Balancing an Unbalanced Balance Sheet 196
NYSF Balance Sheet Balancing Method 201
Chapter 7
The Debt Schedule, Circular References, and Finalizing the Model 205
Debt Schedule Structure 206
Modeling the Debt Schedule 206
Short-Term Debt 206
Mandatory Issuances/(Retirements) and
Non-Mandatory Issuances/(Retirements) 210
Long-Term Debt 214
Debt Interest 214
Long-Term Lease Liabilities 216
Total Issuances/(Retirements) 219
Total Interest Expense 219
Cash Available to Pay Down Debt 220
Interest Income 224
Circular References 235
Circular Reference #Value! Errors 242
Automatic Debt Paydowns 243
Basic Switches 252
Finalizing the Model 252
Part Two
Valuation 277
Chapter 8
What Is Value? 279
Book Value 279
Market Value 279
Enterprise Value 280
Multiples 284
Three Core Methods of Valuation 286
Comparable Company Analysis 287
Precedent Transactions Analysis 287
Purchase Multiples 288
Discounted Cash Flow Analysis 289
Chapter 9
Discounted Cash Flow Analysis 291
Midyear vs. End-of-Year Convention 291
Unlevered Free Cash Flow 292
Weighted Average Cost of Capital (WACC) 300
Cost of Debt 301
Cost of Equity 301
Market Risk Premium 304
Beta 306
Levering and Unlevering Beta 307
Terminal Value 308
Multiple Method 308
Perpetuity Method 309
Amazon DCF Analysis 310
WACC 312
Cost of Equity 312
EBITDA Method 320
Perpetuity Method 322
Chapter 10
Comparable Company Analysis 327
Last Twelve Months (LTM) 329
Calendarization 330
Netflix as a Comparable Company 331
Netflix 2020 Year End 332
Revenue 333
Operating Expenses 335
Depreciation 335
Interest 337
Taxes 338
Non-Recurring Events 339
Earnings per Share (EPS) 339
Netflix Quarterly Income Statement 340
Netflix LTM Adjustments 345
Netflix Projections 345
Revenue 350
COGS 351
Depreciation 351
Interest 351
Taxes 352
Non-Recurring Events 353
Shares and Earnings per Share 353
Calculating Comparable Metrics 357
Market Value and Enterprise Value 360
Multiples 361
Chapter 11
Precedent Transactions Analysis 365
Identifying Precedent Transactions 365
Amazon Precedent Transaction Analysis 366
Chapter 12
Conclusion 375
52-Week High/Low 375
Comparable Company Analysis 376
Precedent Transactions 378
Discounted Cash Flow 379
Football Field 381
Appendix 1
Model Quick Steps 387
Appendix 2
Financial Statement Flows 389
Income Statement to Cash Flow 389
Cash Flow to Balance Sheet 390
Appendix 3
Excel Hotkeys 391
About the Author 393
About the WebSite 395
Index 397
