Business Valuation using Financial Statements (BVFS)

Term 6, 2019-20, Hyderabad Campus

Instructor: Prof. Vaidya Nathan Class Timings: Please refer to ASA schedule
Affiliation: ISB
Email: vaidya_nathan@isb.edu Office Hours: Mondays 3-4 p.m. or by appointment

Course Description

Business Valuation using Financial Statements (BVFS) is an applied accounting and finance course. The
overall objective of this course is to provide you with a conceptual framework for analyzing financial statements to
do valuation analysis. An effective analysis incorporates an understanding of financial statements and “bread-and-
butter” finance.

The course is divided into three parts that feed into each other. The first part is about building a model that
lends itself to valuation analysis. The second part is about using financial statement metrics for valuation. In this
part, we discuss the different valuation techniques such as DCF and Relative Valuation. The third part is about
applying the valuation techniques discussed in part-2 to do valuation in different settings. In this part of the course,
we apply valuation techniques to different corporate finance settings such as in Start-ups and
LBOs/MBOs/MBIs/BIMBOs. In the first two lectures, we build the platform to do valuation of these different kinds
of business settings.

The course is taught in a flipped classroom environment (https://facultyinnovate.utexas.edu/flipped-

classroom). It brings real-world perspectives to help you understand and use the common approaches and
techniques for valuation used in an investment bank, a brokerage firm, or a corporate finance division of a
corporation. An example of this perspective is that of a ‘big-A’ analyst at an investment bank or brokerage firm
performing fundamental and relative valuation to decide on a buy or sell recommendation. The techniques covered
in the course are relevant for corporate finance managers and analysts for evaluating acquisitions and divestments,
restructurings, spin-offs, etc. and for analyzing the value generated by strategic resource allocation alternatives.
This course will be useful for those interested in careers in business consulting, corporate finance, investment
banking, investment management, or security analysis.
Learning Goals
Upon successful completion of this course you should be able to:
1. Develop pro-forma balance sheet and income statement including incorporation of relevant financial
metrics for valuation (Critical and Integrative Thinking).
2. Calculate Free Cash Flows to Equity (FCFE) and Firm (FCFF) using financial statements—both historical and
projected (Critical and Integrative Thinking).
3. Estimate firm’s cost of capital, and understand the practical difficulties and assumptions underlying its
estimation (Critical and Integrative Thinking).
4. Develop DCF valuation models and generate ‘football fields’.
5. Use Residual Income Valuation to do firm valuation (Critical and Integrative Thinking).
6. Generate equity and firm value estimates using relative valuation (Critical and Integrative Thinking).
7. Apply DCF and relative valuation techniques in corporate finance settings such as Leverage Buy-Outs
(Awareness of Global Issues affecting Business).
8. Assess valuation of a company from multiple perspectives (Critical and Integrative Thinking).
9. Put together a comprehensive report after performing a thorough valuation analysis of an Indian firm
based on a set of reasonably forecasted financials (Awareness and Working in Teams).
10. Be able to present valuation analysis of a firm concisely (Effective Oral Communication).

Pedagogy

Research suggests that students today are ‘active learners’ and therefore need a learning environment that
is more collaborative and experiential (Matulich et al 2008 1). Finance education in particular is identified as
transitioning from a ‘professor-centered’ orientation to a ‘process-based’ approach that emphasizes the need for
higher levels of interface with financial markets (Bigelow et al 2008 2). Experiential learning to finance education
as a process-based approach has continued to develop as a popular teaching method where student involvement
and the application of real-life financial market situations to concepts and theories are emphasized (John Yinger
and Nguyen-Hoang 20143). This course would therefore be taught in a ‘learn by doing’ framework because that is
how the skill set of business valuation using financial statements is acquired.

1
Matulich, E., Papp, R. and Haytko, D. (2008), “Continuous Improvement through Teaching Innovations: A Requirement for
Today’s Learners,” Marketing Education Review, 18 (1), 1-7.
2
Bigelow, J.D., J. Selzer, W. Buskirk, J. Hall, S. Schor, J. Garcia and K. Keleman (2008), “Management Skills in Action: Four
Teaching Models,” Journal of Management Education, 23 (February), 355-376.
3
John Yinger, Hoang P.N., (2014), “Education Finance Reform, Local Behavior, and Student Performance in Massachusetts”,
Journal of Education Finance, Summer 2014, Volume 40, No. 1.
Reference Texts

There are two reference texts for this course:

‘Investment Banking: Valuation, Leveraged Buyouts, and M&A + Valuation Models, Second Edition,
Joshua Rosenbaum, Joshua Pearl, Joseph R. Perella, Wiley Finance, 2013 [RPP].
‘Building Financial Models: The Complete Guide to Designing, Building, and Applying Projection
Models’ by John S. Tjia, Third Edition, McGrawHill, 2017 [JST].
All the readings indicated in the outline and the two reference texts are freely available online.

Project

The project is based on Lyman’s Think-Share pedagogical best practice. The purpose of this group project
is to give you the opportunity to revise techniques in Business Valuation using Financial Statements discussed in the
course and demonstrate the learning on a topic chosen by you. You demonstrate the learning by valuing a
corporation incorporated in India. The Think-Share valuation project is compelling in that it encourages enhanced
student understanding, and higher levels of student thinking and learning. The optimal team size is five. You are
jointly required to do a valuation of an Indian firm to consolidate and reflect on the course learnings. The specific
firm that you choose for your project is up to you. However, I strongly suggest that you to select a company in an
industry/sector in which at some of the team members in your group have interest. The most obvious choice would
be to choose a firm related to the industry/sector where any of you may have worked in the past. I am interested in
your application of valuation fundamentals than institutional details about the firm.

The project presentation is scheduled in the last class of the course and has a weightage of 10%. You must
hand in a written report (15%) on the valuation of the firm and a financial model (5%) of the valuation. The
combined weightage of the project is 30%. The deadline for submission of the model and the report is 11:55 p.m.
on 24 December 2019 and for submission of the presentation is 4 p.m. on 25 December 2019. While what you
choose to discuss in the written report is up to you, here are some common minimum things that I would expect:
1. You must include a clear introduction with an executive summary covering the salient aspects of your
valuation analysis.
2. You must use the different valuation techniques discussed during the course. I would expect you to
model the valuation of the company using similar techniques and templates as taught in the course.
3. You must report the different estimated fair value for the firm using different valuation techniques.
4. You must comment on differences in the valuation between the various techniques and where these
differences come from.
5. You must identify the key assumptions in your valuations including inputs that may possibly change
your valuation significantly. You need to submit the valuation model in .xlsx format, the valuation
report in .docx format and the presentation is .pptx format.
 6. You must clearly identify those pieces that contribute to financial statement metrics such as industry
growth drivers, which come from a published source such as industry reports.
7. Your report must be around 3000 words (+/- 300 words). You can have additional supporting
appendices and tables, which do not count towards the word limit.

Evaluation of BVFS Project Write-up

Guidelines (Total Score: 15) Points
Background of the company and industry 2
Valuation of the company using one or multiple methods 2
Accuracy of Valuation Methodology 2
Valuation Rationale and Reason (Arguments for/against) 3
Consistency in Valuation methodologies 3
Organization, Structure of Report, Clarity, Sentence Structure, Grammar 2
Sources and Referencing wherever possible 1

In-Class Exercise

Research has demonstrated that doing exercise in class provides students with (a) ‘think time’—a period to reflect
on the financial statement valuation learnings of the course, (b) ‘behavioral rehearsal time’—a period to practice
and demonstrate the learning. Most classes will have an in-class exercise that needs to be submitted at the end of
the class. You are supposed to continue to work on the model in the next class when the exercise spans more than
one lecture. Please bring your laptops to class for all the lectures. The in-class exercise has a weightage of 30%.

Grading Components
Component Weightage
Class Participation 20%
In-class Assignments 30%
Take-home Assignments 20%
Project Write-up and Model 20%
Project Presentation 10%

Attendance & Punctuality

Learning is an interactive process. ISB students are admitted partly based on the experiences they bring to the
learning community and what they can add to class discussions. Therefore, attendance is an important aspect of
studying here. The ISB expects students to attend all class sessions in every module. However, if due to completely
unavoidable reasons a student is forced to miss a class session. The school policy is:
 If a student misses 20% of sessions in a course; there will be no grade penalty.
If a student misses 30% of sessions in a course, s/he will obtain a letter grade lower than that awarded by
the faculty for that course.
If a student misses 40% of sessions in a course, the student will receive a letter grade that is two levels lower.
If a student misses 50% of sessions or more in a course, the student will receive an ‘F’ grade for that course.
I choose to base 20% of the course grade on class participation, which includes an attendance component of 10%.
If you find it necessary to miss a class or make a late submission, you must seek permission from the Academic
Associate in advance. In case of illness, the Academic Associate may also require a letter of confirmation from a
qualified doctor. Voluntary activities such as job interviews, business school competitions, travel plans, joyous family
occasions. Late arrival is disruptive to the learning environment; so you have to be in class before the scheduled
time. Class and Exam schedules are posted on the PGP intranet site. Any change in the class schedule is notified in
advance. For more details, please refer to the ISB attendance policy in the ATRIUM.

Class Participation

Class participation is encouraged and is a significant component in the final grade evaluation. Class participation
covers all aspects of attendance such as punctuality and conduct in class, rather than simply participation in
discussions. Speaking up and participating meaningfully in discussions help but are neither necessary nor sufficient
to assure a high score for this component.

Course Policies
1. Late project report submission is not accepted as you have adequate time and notice in advance.
2. Failing to demonstrate honesty and integrity will result in a grade of ZERO for that deliverable.
3. You are held responsible for all announcements regarding class.
4. ASA attendance policy applies.
Coding scheme for ALL course work
What kinds of collaborative activities are allowed? What material can be referred to?4
References/ Can I discuss general Can I discuss specific Can I refer to Can I refer to the
Coding concepts and ideas issues associated with external case-study solutions
5
Scheme relevant to the the assignment with material? or problem set
assignment with others? solutions?
others?
0N Y Y Y Y

When in doubt, the student should contact the instructor for clarifications.

4 Any referencing needs to be accompanied with appropriate citations.

5 A non-exhaustive list includes journal articles, news items, databases, industry reports, open courseware.
Schedule

Session Topic Sub-topics

1. Introduction to Introduction to Valuation and Integrated Financial Statements
Valuation and Importance and uses of valuation
Analytical Financial Valuation: Truths vs. Myths
Statements Creating the first integrated financial statement valuation
model (assumptions, use of historical data for projections and
building forecasted financial statements)
Projection of Revenues, COGS, SG&A and other Income
Statement and Balance Sheet items
How to create an interlinked Financial Statement model
Balance Sheet Method
Resolve circularity in financing need and excess cash

Reading: Basic Valuation and Accounting Guide by HSBC, July 2012

Reading: JST Chapters 7 & 8

2. Cash Flow Method of Cash Flow Method of Balancing

Balancing Working with Balance Sheet Balancing Numbers
Liabilities: Revolver (Short-term Debt), Equity
Assets: Excess Cash (Surplus Funds), Dividend Pay-Out
Cash Flow Balancing Method
Cash Flow from Operations
Cash Flow from Investment
Cash Flow from Financing
Surplus funds & financing need from cash flow statement

Reading: JST Chapters 9 & 10

3. Analytical ISBS for Analytical Financial Statements for Valuation

Valuation Expanding Income Statement Items
Revenue Projections
Cost Projections
Detailed Debt financing requirements
Calculate cost of debt
 Depreciation for under Income Tax Act and Companies Act
Deferred Tax Liability

Reading: JST Chapter 11

4. Calculating Cost of Fundamental Valuation: FTE, Free Cash Flow to Equity Valuation
Equity Capital for Flow to Equity Method
different leverages Calculating Beta
Beta with constant amount of debt
Leverage rebalancing frequency

Reading: The Assumptions and Math behind WACC and APV

Calculations by Richard Stanton and Mark S. Seasholes. Available here:
https://papers.ssrn.com/Sol3/papers.cfm?abstract_id=837384

5. Weighted Average Cost Weighted Average Cost of Capital and Valuation

of Capital and Valuation
Beta with constant proportion of debt
Beta and Leverage
Cost of Debt change with Leverage
Cost of Capital and Leverage
Resolving circularity between WaCC and Equity Value
Effect of Leverage on Firm Value
How to incorporate time varying financial leverage

Reading: Estimating the Cost of Capital—A Practical Guide to Assessing

Opportunity Cost by Credit Suisse, October 2013.

6. Fundamental Valuation: Fundamental Valuation: Enterprise Value

Enterprise Value and Free Cash flow to Firm
FTE Firm Valuation: Cost of Capital Approach
Calculate steady state cash flow for TV
Fundamental Valuation: Flow-to-Equity Method
Flow to Equity Method
Free Cash Flow to Equity Valuation

Reading: JST Chapter 15, RPP Chapter 3

7. Valuation of LBOs & Valuation of LBOs & MBOs
MBOs Background on LBOs/MBOs/MBIs/BIMBOs
IRR and Structure of LBOs
LBO deal economics: Entry Multiple, Exit Multiple, Money
Multiple
Typical LBO Candidate
LBO Financing
LBO/MBO versus Recapitalization

Reading: RPP Chapters 4 & 5

8. Comparable Valuation Fundamental Principles of Relative Valuation

Use of Relative Valuation
Standardized Values and Multiples
Basic steps to using Multiples
Reconciling Relative and DCF valuations
Comparable Valuation (AD Chapters 18 and 20)
PE and PEG Multiples
Price to Book Value
Price to Sales and EV/Sales Multiple
EV/EBITDA & EV/EBIT Multiples
EV/NOPLAT, EV/Invested Capital, EV/Capacity Unit
How each of the above is linked to DCF?

Reading: Valuation Multiples: A Primer by UBS, November 2001.

Reading: RPP Chapter 1

9. Valuation for Start-ups: Valuation for Start-ups: Caselets of Indian Start-ups

Caselets of Indian Start- Investment Valuations of Seed- and Early-Stage Ventures
ups Startup Pre-money Valuation
Is Valuation a Key Issue in Funding Startups?
Fundability and Valuation of Startups
Venture Capital Valuation of Pre-revenue Companies
Valuation Divergence
Valuation of Indian Start-ups
 Reading: Valuing Pre-revenue Companies, Kauffman Foundation, July
2007.

10. Project Presentation Student Project Presentation

Each Group 10 minutes