Financial Modeling and Valuation

PAUL PIGNATARO is Founder of the New York School of Finance, a world leader in providing finance education to banks, firms, and universities throughout the world. He is also Managing Partner of Caterson Consulting, a consulting firm providing merger, acquisition, and private equity services. He is the author of the Investment Banking and Private Equity in Practice series of books. Previously, Paul worked at TH Lee Putnam Ventures, a $1 billion private equity firm affiliated with buyout giant Thomas H. Lee Partners, and at Morgan Stanley, where he worked on various transactions in the technology, energy, transportation, and business services industries.

• Preface xvThe Amazon Case Study xviHow This Book Is Structured xviiPart OneFinancial Statements and Projections 1Chapter 1The Income Statement 3Revenue 4Cost of Goods Sold 4Gross Profit 4Operating Expenses 5Other Income 6EBITDA 6Depreciation and Amortization 8EBIT 8Interest 9EBT 9Taxes 9Net Income 10Non-Recurring and Extraordinary Items 10Distributions 11Net Income (as Reported) 11Shares 11Earnings per Share (EPS) 12Amazon’s Income Statement 12Revenue 14Getting to EBITDA 20Digging up Depreciation 20Cost of Goods Sold 23Gross Profit 23Fulfillment 25Technology and Content 25Marketing, General and Administrative,Other Operating Expense (Income), Net 27Total Operating Expenses 27EBITDA 27Beyond EBITDA 28Depreciation and Amortization 28EBIT 29Other Income 30Interest 31EBT 31Taxes 31Net Income from Continuing Operations 32Non-Recurring and Extraordinary Items 32Net Income (after Non-Recurring Events) 33Distributions 33Net Income (as Reported) 33Shares and EPS 34Income Statement – Making Projections 35Revenue 35Cost of Goods Sold 40Operating Expenses 45Depreciation and Amortization 46Other Income 49Seven Methods of Projections 49Interest Income 53Taxes 53Non-Recurring Events 55Distributions 55Equity Method Investment Activity 55Dividends 57Shares 57Basic Shares Outstanding 57Diluted Shares Outstanding and the Treasury Method 57Earnings per Share 60Chapter 2The Cash Flow Statement 67Cash from Operating Activities 67Revenue 69Cost of Goods Sold 69Operating Expenses 69Depreciation 69Interest 69Taxes 70Cash from Investing Activities 71Cash from Financing Activities 71Financial Statement Flows Example 72Amazon’s Cash Flow Statement 78Cash from Operating Activities 78Cash from Investing Activities 81Cash from Financing Activities 82Cash Flow Statement – Making Projections 84Cash from Operating Activities 85Depreciation and Amortization 85Stock-Based Compensation 85Other Operating Expense 88Other Expense (Income) 90Deferred Taxes 91Changes in Operating Working Capital 91Cash from Investing Activities 92Proceeds from Property and Equipment Sales and Incentives 98Items Based on Cash Available 98Cash Flow from Financing Activities 101Effect of Exchange Rate on Cash 101Chapter 3The Balance Sheet 107Assets 107Current Assets 107Cash and Cash Equivalents 107Accounts Receivable 107Inventory 108Prepaid Expense 109Non-Current Assets 110Property, Plant, and Equipment (PP&E) 110Intangible Assets 110Liabilities 110Current Liabilities 110Accounts Payable 110Accrued Liabilities 111Short-Term Debts 111Non-Current Liabilities 111Long-Term Debts 111Deferred Taxes 111Amazon’s Balance Sheet 112Current Assets 113Non-Current Assets 113Operating Leases 114Goodwill 114Other Assets 114Current Liabilities 114Short-Term Debt 115Non-Current Liabilities 115Other Long-Term Liabilities 116Shareholders’ Equity 116Common Stock and Additional Paid-in Capital 117Treasury Stock, Accumulated Other ComprehensiveLoss and Retained Earnings 117Chapter 4Depreciation Schedule 119Straight-Line Depreciation 120Accelerated Depreciation 121Declining Balance 121Sum of the Year’s Digits 122Modified Accelerated Cost Recovery System (MACRS) 122Deferred Taxes 125Deferred Tax Asset 125NOL Carryback Example 126Deferred Tax Liability 127Projecting Depreciation 129Straight-Line Depreciation 129Anchoring Formula References 133Projecting Deferred Taxes 152Chapter 5Working Capital 155Operating Working Capital 156Amazon’s Operating Working Capital 158Inventories 160Accounts Receivable, Net and Other 162Accounts Payable 163Pignataro808893_ftoc.indd xi 07 Feb 2022 01:10:58 pmAccrued Expenses and Other 165Unearned Revenue 166Projecting Operating Working Capital 168Receivables 168Inventories 170Accounts Payable 172Accrued Expenses 174Unearned Revenue 174Operating Working Capital and the Cash Flow Statement 176Changes in Inventory 178Accounts Receivable 179Changes in Accounts Payable 181Changes in Accrued Expenses 182Changes in Unearned Revenue 182Chapter 6Balance Sheet Projections 183Cash Flow Statement Drives Balance Sheet vs.Balance Sheet Drives Cash Flow Statement 183Assets 185Inventories 186Accounts Receivable 188Liabilities 192Shareholders’ Equity 195Balancing an Unbalanced Balance Sheet 196NYSF Balance Sheet Balancing Method 201Chapter 7The Debt Schedule, Circular References, and Finalizing the Model 205Debt Schedule Structure 206Modeling the Debt Schedule 206Short-Term Debt 206Mandatory Issuances/(Retirements) andNon-Mandatory Issuances/(Retirements) 210Long-Term Debt 214Debt Interest 214Long-Term Lease Liabilities 216Total Issuances/(Retirements) 219Total Interest Expense 219Cash Available to Pay Down Debt 220Interest Income 224Circular References 235Circular Reference #Value! Errors 242Automatic Debt Paydowns 243Basic Switches 252Finalizing the Model 252Part TwoValuation 277Chapter 8What Is Value? 279Book Value 279Market Value 279Enterprise Value 280Multiples 284Three Core Methods of Valuation 286Comparable Company Analysis 287Precedent Transactions Analysis 287Purchase Multiples 288Discounted Cash Flow Analysis 289Chapter 9Discounted Cash Flow Analysis 291Midyear vs. End-of-Year Convention 291Unlevered Free Cash Flow 292Weighted Average Cost of Capital (WACC) 300Cost of Debt 301Cost of Equity 301Market Risk Premium 304Beta 306Levering and Unlevering Beta 307Terminal Value 308Multiple Method 308Perpetuity Method 309Amazon DCF Analysis 310WACC 312Cost of Equity 312EBITDA Method 320Perpetuity Method 322Chapter 10Comparable Company Analysis 327Last Twelve Months (LTM) 329Calendarization 330Netflix as a Comparable Company 331Netflix 2020 Year End 332Revenue 333Operating Expenses 335Depreciation 335Interest 337Taxes 338Non-Recurring Events 339Earnings per Share (EPS) 339Netflix Quarterly Income Statement 340Netflix LTM Adjustments 345Netflix Projections 345Revenue 350COGS 351Depreciation 351Interest 351Taxes 352Non-Recurring Events 353Shares and Earnings per Share 353Calculating Comparable Metrics 357Market Value and Enterprise Value 360Multiples 361Chapter 11Precedent Transactions Analysis 365Identifying Precedent Transactions 365Amazon Precedent Transaction Analysis 366Chapter 12Conclusion 37552-Week High/Low 375Comparable Company Analysis 376Precedent Transactions 378Discounted Cash Flow 379Football Field 381Appendix 1Model Quick Steps 387Appendix 2Financial Statement Flows 389Income Statement to Cash Flow 389Cash Flow to Balance Sheet 390Appendix 3Excel Hotkeys 391About the Author 393About the WebSite 395Index 397