Multiple Approach

Pre-money valuation

Hyun-Han Shin
Previous Class

We have learned
• How to estimate the value of a startup using
1) Discounted Cash Flow Method
2) Multiple Method

Now, we are going to learn how to apply

these methods to a hypothetical startup
Practice Question

Example 1
• A startup requires 1 million dollars from VC
• Expected to earn 0.5 million dollars in 5years
• Comparable to companies with PE ratio of 20
• the VC’s required rate of return is 50%
• Shares outstanding is 1 million
Practice Question

Example 1
• A startup requires 1 million dollars from VC
• Expected to earn 0.5 million dollars in 5years
• Comparable to companies with PE ratio of 20
• the VC’s required rate of return is 50%
• Shares outstanding is 1 million
• How much ownership should the startup give
to the VC to persuade the VC to investment
in the startup?
Practice Question

Example 1
(1) New money from VC : 1,000,000 dollars
(2) Net income in 5 years : 500,000 dollars
(3) Comparable companies PER : 20 times
Investment horizon : 5 years
Shares outstanding (ShOut) : 1,000,000 shares
VC required rate of return : 50%
Practice Question

Example 1
To find the VC’s required ownership amount,
→ Need to find the startup’s future value & the
VC’s future value
Practice Question

Example 1
• The value of the startup in 5 years
= Comparable companies’ PE ratio X Expected
Earnings
= 20 X 0.5 million dollars
= 10 million dollars
Practice Question

Example 1
• VC’s Ownership
= 7,593,750 / 10,000,000
= 75.94%
Practice Question

Example 1
(1) New money from VC : 1,000,000 dollars
→ FV : 7,593,750 dollars
(2) Net income in 5 years : 500,000 dollars
(3) Comparable companies PER : 20 times
→ Value of company in 5 years
= (2) X (3)
= 10,000,000 dollars
→ VC’s Ownership: 75.94%
Practice Question

Example 1
• How many shares should the startup give to
the VC?
𝑵𝒆𝒘 𝒔𝒉𝒂𝒓𝒆𝒔 𝒕𝒐 𝒕𝒉𝒆 𝑽𝑪
𝑽𝑪′ 𝒔 𝑶𝒘𝒏𝒆𝒓𝒔𝒉𝒊𝒑 =
(𝑶𝒍𝒅 𝒔𝒉𝒂𝒓𝒆𝒔 + 𝑵𝒆𝒘 𝒔𝒉𝒂𝒓𝒆𝒔)
Practice Question

Example 1
𝑿
𝑽𝑪′ 𝒔 𝑶𝒘𝒏𝒆𝒓𝒔𝒉𝒊𝒑 =
(𝑺𝒉𝑶𝒖𝒕 + 𝑿)
• X = new shares
• ShOut = old shares
Practice Question

Example 1
𝑽𝑪′ 𝒔 𝑶𝒘𝒏𝒆𝒓𝒔𝒉𝒊𝒑
𝑿= ′
× 𝑺𝒉𝑶𝒖𝒕
𝟏 − 𝑽𝑪 𝒔 𝑶𝒘𝒏𝒆𝒓𝒔𝒉𝒊𝒑
Practice Question

Example 1
𝑽𝑪′ 𝒔 𝑶𝒘𝒏𝒆𝒓𝒔𝒉𝒊𝒑
𝑿= ′
× 𝑺𝒉𝑶𝒖𝒕
𝟏 − 𝑽𝑪 𝒔 𝑶𝒘𝒏𝒆𝒓𝒔𝒉𝒊𝒑
𝟕𝟓. 𝟗𝟒% × 𝟏, 𝟎𝟎𝟎, 𝟎𝟎𝟎
=
(𝟏 − 𝟕𝟓. 𝟗𝟒%)
= 𝟑, 𝟏𝟓𝟓, 𝟖𝟒𝟒 𝒔𝒉𝒂𝒓𝒆𝒔
 Multiple Approach

Post-money valuation

Hyun-Han Shin
Post-money valuation

Example 1
• Q) What price per share should VC agree to
pay?
• A) P = VC investment / VC's shares
= 0.32 dollars
Post-money valuation

Example 1
• Q) What is the pre-money valuation of the
firm?
• A) PreV = ShOut X P
= 316,872 dollars
Post-money valuation

Example 1
• Q) What is the founder's carried interest?
• A) Carried interest
= (New price) X (Shares owned)
= 316,782 dollars
Post-money valuation

Post-money valuation of the startup

= Pre-money valuation + The new investment
= 316,782 dollars + 1million dollars
= 1,316,782 dollars
Formula for post- & pre-money valuation

• Post-money valuation
= 𝒏𝒆𝒘 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
𝒕𝒐𝒕𝒂𝒍 𝒑𝒐𝒔𝒕 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕 𝒔𝒉𝒂𝒓𝒆𝒔 𝒐𝒖𝒕𝒔𝒕𝒂𝒏𝒅𝒊𝒏𝒈
×
𝒔𝒉𝒂𝒓𝒆𝒔 𝒊𝒔𝒔𝒖𝒆𝒅 𝒇𝒐𝒓 𝒏𝒆𝒘 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕

• Pre-money valuation
= 𝒑𝒐𝒔𝒕– 𝒎𝒐𝒏𝒆𝒚 𝒗𝒂𝒍𝒖𝒂𝒕𝒊𝒐𝒏 − 𝒏𝒆𝒘 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
Practice Question

Example 2
• Shareholders of Yonsei. Inc. own 100 shares
which is 100% of equity
• A investor makes a $10 million investment
into Yonsei. Inc. in return for 40 newly issued
shares
• The implied post- and pre- money valuation ?
Practice Question

Example 2
• The implied post-money valuation
= $10 million * (140 / 40)
= $35 million
100 existing shares + 40 new shares
Practice Question

Example 2
• The implied pre-money valuation
= post-money valuation – the amount of the
investment
= $35 million - $10 million
= $25 million
Practice Question

Example 2
• The initial shareholders will dilute their
ownership to 100/140 = 71.43%.
 Multiple Approach
Rounds of financing (1)

Hyun-Han Shin
Previous Class

Last class…
• we assumed that one round of financing was
sufficient until year five
• In reality, there are several rounds of
financings
Today Class

In this class…
• Learn what percent ownership should each
investor purchase at the time of the
financing
Practice Question

Example 1
• A startup requires 1 million dollars
• It is raised in three rounds
• The 1st round VC provides 0.5 million dollars
now and the discount rate is 50%
• Investment period of the 1st round VC is 5yrs
• The 2nd round VC provides 0.25 million
dollars in year 2 and the discount rate is 40%
• Investment period of the 2nd round VC is 3yrs
Practice Question

Example 1
• The 3rd round VC provides 0.25 million
dollars in year 4 and the discount rate is 30%
• Investment period of the 3rd round VC is 1yr
• The startup is expected to earn 0.5 million
dollars in year 5
• Comparable to companies with PE ratio of 20

• What is the final ownership for the VC of

each round?
Formula

The final ownership a given investor

𝑻𝒉𝒆 𝒇𝒖𝒕𝒖𝒓𝒆 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
=
𝑻𝒉𝒆 𝒕𝒆𝒓𝒎𝒊𝒏𝒂𝒍 𝒗𝒂𝒍𝒖𝒆 𝒐𝒇 𝒕𝒉𝒆 𝒔𝒕𝒂𝒓𝒕𝒖𝒑
Early-round VC’s retention ratio

To have these final ownership percentages,

• the early-round VC must purchase enough
shares now to make up for the dilution

• Early-round VC’s retention ratio

= 1 – total of future final % ownership
Practice Question

Example 1 (continued)
• The Round 1 VC’s retention ratio
= 1 - 6.86% - 3.25% = 89.89%

• The Round 2 VC’s retention ratio

= 1 - 3.25% = 96.75%

• The Round 3 VC’s retention ratio

= 1 - 0 = 100%
VC’s retention percent

The VC’s retention percent

𝑻𝒉𝒆 𝒇𝒊𝒏𝒂𝒍 𝒐𝒘𝒏𝒆𝒓𝒔𝒉𝒊𝒑 𝒂 𝑽𝑪 𝒘𝒊𝒍𝒍 𝒉𝒐𝒍𝒅 𝒂𝒕 𝑴𝒂𝒕𝒖𝒓𝒊𝒕𝒚
=
𝑻𝒉𝒆 𝒄𝒖𝒓𝒓𝒆𝒏𝒕 𝒐𝒘𝒏𝒆𝒓𝒔𝒉𝒊𝒑 𝒉𝒆 𝒐𝒓 𝒔𝒉𝒆 𝒉𝒐𝒍𝒅𝒔 𝒂𝒕 𝒊𝒏𝒗𝒆𝒔𝒕𝒎𝒆𝒏𝒕
VC’s retention percent

Investor’s retention percent

𝑭𝒊𝒏𝒂𝒍 % 𝒐𝒘𝒏𝒆𝒓𝒔𝒉𝒊𝒑
=
𝑪𝒖𝒓𝒓𝒆𝒏𝒕 % 𝒐𝒘𝒏𝒆𝒓𝒔𝒉𝒊𝒑

Current percent ownership

𝑭𝒊𝒏𝒂𝒍 % 𝒐𝒘𝒏𝒆𝒓𝒔𝒉𝒊𝒑
=
𝑹𝒆𝒕𝒆𝒏𝒕𝒊𝒐𝒏 %
Practice Question

Example 1 (continued)
• The Round 1 VC’s current % ownership
= 37.97% / (1 - 6.86% - 3.25%)
= 37.97% / 89.89% = 42.24%
Practice Question

Example 1 (continued)
• The Round 1 VC’s current % ownership
= 37.97% / (1 - 6.86% - 3.25%)
= 37.97% / 89.89% = 42.24%
• The Round 2 VC’s current % ownership
= 6.86% / (1 - 3.25%)
= 6.86% / 96.75% = 7.09%
Practice Question

Example 1 (continued)
• The Round 1 VC’s current % ownership
= 37.97% / (1 - 6.86% - 3.25%)
= 37.97% / 89.89% = 42.24%
• The Round 2 VC’s current % ownership
= 6.86% / (1 - 3.25%)
= 6.86% / 96.75% = 7.09%
• The Round 3 VC’s current % ownership
= 3.25% / (1 - 0)
= 3.25% / 100% = 3.25%
 Multiple Approach
Rounds of Financing (2)

Hyun-Han Shin
In this Class

We can find
• how many new shares each VC should
purchase at each round
Review

VC's Ownership
• = new shares / (old shares + new shares)
• = X / (ShOut+X)
• where X is new shares, ShOut is old shares
Review

VC's Ownership
• = new shares / (old shares + new shares)
• = X / (ShOut+X)
• where X is new shares, ShOut is old shares

New shares
• = % ownership / (1 - % ownership)
• = VC's Ownership * ShOut
(1 - VC's Ownership)
Practice Question

Example 1 (Continuing from last example)

• The Round 1 VC’s current % ownership is
42.24%
• The Round 2 VC’s current % ownership is
7.09%
• The Round 3 VC’s current % ownership is
3.25%
• Shares outstanding before Round 1 was
1,000,000 shares
Practice Question

Example 1
• The Round 1 VC should purchase
= 42.24% X 1,000,000 / (1 - 42.24%)
= 731,276 shares
Practice Question

Example 1
• Shares outstanding before Round 2
= 1,000,000 + 731,276
= 1,731,276 shares

• The Round 2 VC should purchase

= 7.09% X 1,731,276 / (1 - 7.09%)
= 132,123 shares.
Practice Question

Example 1
• Shares outstanding before Round 3
= 1,731,276 + 132,123
= 1,863,399 shares

• The Round 3 VC should purchase

= 3.25% X 1,863,399 / (1 - 3.25%)
= 62,595 shares.
Practice Question

Example 1
• Shares outstanding after Round 3
= 1,863,399 + 62,595
= 1,925,994 shares
Practice Question

Example 1
• What price per share should VC agree to pay?

• Share price the Round 1 VC pays

= 500,000 / 731,276
= 0.68 dollars
Practice Question

Example 1
• What price per share should VC agree to pay?

• Share price the Round 1 VC pays

= 500,000 / 731,276
= 0.68 dollars
• Share price the Round 2 VC pays
= 250,000 / 132,123
= 1.89 dollars
Practice Question

Example 1
• Share price the Round 3 VC pays
= 250,000 / 62,595
= 3.99 dollars
• Terminal share price
= 10,000,000 / 1,925,994
= 5.19 dollars
Multiple Approach

Cash Flow

Hyun-Han Shin
Cash Flow

• Difference between # of dollars that came

in and # that went out

• Cash flow identity

Cash flow from assets = Cash flow to creditors
+ Cash flow to stockholders
Cash Flow from Assets

• Free cash flow

• Three components
• Operating cash flow
• Capital spending
• Change in net working capital
Cash Flow from Assets

• Free cash flow

• Three components
• Operating cash flow
• Cash generated from a firm’s normal business
activities
• Capital spending
• Change in net working capital
Cash Flow from Assets

• Free cash flow

• Three components
• Operating cash flow
• Capital spending
• Net spending on fixed assets
• Change in net working capital
Cash Flow from Assets

• Free cash flow

• Three components
• Operating cash flow
• Capital spending
• Change in net working capital
• Net change in current assets relative to
current liabilities for the period
Operating Cash Flow (OCF)

• We want to calculate revenues minus costs

• Do not include depreciation because no cash outflow
• Do include taxes because cash outflow

• Example 1
• EBIT = $1,000
• Depreciation = $100
• Taxes = $200
• OCF = $1,000 + $100 - $200 = $900
Operating Cash Flow (OCF)

• We want to calculate revenues minus costs

• Do not include depreciation because no cash outflow
• Do include taxes because cash outflow

• OCF is an important number

• Firm’s cash inflows from business operations are
sufficient to cover cash outflows
Operating Cash Flow (OCF)

• We want to calculate revenues minus costs

• Do not include depreciation because no cash outflow
• Do include taxes because cash outflow

• OCF is an important number

• Firm’s cash inflows from business operations are
sufficient to cover cash outflows

• Possibility of confusion
• In finance, OCF = EBIT + Dep - Taxes
• In accounting definition, OCF = Net income + Dep
Capital Spending

• Net capital spending

• Ending net fixed assets
= Beginning net fixed assets – Depreciation
+ Net capital spending
• Net capital spending = Ending net fixed assets –
Beginning net fixed assets + Dep
Net Capital Spending

Example 2
• Ending net fixed asset : $1,000
• Beginning net fixed asset : $900
• Depreciation $100

 Net capital spending

= $1,000 - $900 + $100
= $200
Capital Spending

• Net capital spending

• Net capital spending = Ending net fixed assets –
Beginning net fixed assets + Dep

• Net capital spending could be negative?

• YES!
• If firm sold off more assets than it purchased

• Capital spending called CAPEX (Capital expenditures)

Change in Net Working Capital

• Previous Slide
• NWC = Current asset – Current liabilities
Change in Net Working Capital

• Previous Slide
• NWC = Current asset – Current liabilities

• Walmart Example
• Fill the new store with new inventory
• Part of inventory financed by suppliers’ credit
• Not all of inventory can be sold within the credit
period
 Part of inventory should be financed by Walmart
 This is an increase in NWC
Change in Net Working Capital

• Previous Slide
• NWC = Current asset – Current liabilities

• Change in Net Working Capital (NWC)

= Ending NWC – Beginning NWC
Change in Net Working Capital

• Previous Slide
• NWC = Current asset – Current liabilities

• Example 3
• Change in Net Working Capital (NWC)
= Ending NWC – Beginning NWC
= $500 - $400
= $100
Cash Flow from Assets (CFFA)

• Calculate cash flow from assets

• Operating cash flow (OCF) = $900
• Net capital spending = $200
• Change in NWC = $100

 Cash flow from assets

= $900 - $200 - $100
= $600
Cash Flow to Creditors and Stockholders

• Net payments to creditors and owners during

the year
• Cash flow to creditors
• Interest paid – Net new borrowing
Cash Flow to Creditors and Stockholders

• Net payments to creditors and owners during

the year
• Cash flow to creditors
• Interest paid – Net new borrowing
• Example
• Interest paid = $100
• Beginning long-term debt = $400
• Ending long-term debt = $450
• Cash flow to creditor
= $100 – ($450-$400)
= $50
Cash Flow to Creditors and Stockholders

• Net payments to creditors and owners during

the year
• Cash flow to stockholders
• Dividends paid – Net new equity
Cash Flow to Creditors and Stockholders

• Net payments to creditors and owners during

the year
• Cash flow to stockholders
• Dividends paid – Net new equity
• Example
• Dividends paid = $600
• Beginning Equity = $1000
• Ending Equity = $1050
• Cash flow to stockholders
= $600 – ($1050 - $1000)
= $550
Cash Flow from Assets, Cash Flow to Creditors and
Stockholders

• Cash flow from Assets

• $600

• Cash flow to Creditors and Stockholders

• $50 + $550
 Multiple Approach

Cash Flow Calculation

Hyun-Han Shin
In This Class

Previous Class
• Balance Sheet
• Income Statement

This Class
• Calculate Cash Flow
Multiple Approach

Review

Hyun-Han Shin
Practice Question

Yonsei Corporation
2015
Sales $270,000
Cost of goods sold $150,000
Other expenses $8,000
Depreciation $18,000
Interest expense $12,000
Taxes $20,000
Dividends $16,000
Current assets $2,000
New equity $6,000
Long-term debt redeem $5,000
Increase in net fixed assets $25,000
Cash Flow to Investors

• Cash flow from assets = Cash flow to investors

• Cash flow from assets
= Cash flow from operation – Net capital spending –
Change in NWC
= Cash flow to investors
Multiple Method

Yonsei Corporation
• Comparable company’s PE ratio is 10
• Net income is $62,000

 The value of Yonsei Corp. is $620,000

= Net income x Comparable PE ratio
= $62,000 x 10
= $620,000
Value Estimation

Yonsei Corporation
• $620,000 : Estimated value for year 2018
• Discount rate : 50% per year
• What is the value in 2015?
Value Estimation

Yonsei Corporation
• $620,000 : Estimated value for year 2018
• Discount rate : 50% per year
• What is the value in 2015?

 Discount estimated value for 3 years

 Using PV function in excel
 PV(50%, 3, 0, -620000) = $183,704
PS Ratio

Yonsei Corporation
• Comparable company’s PSR is 3
• The value of Yonsei Corp
= Sales x PSR
= $270,000 x 3
= $810,000
If this is a value in 3 years
PV(50%, 3, 0, -810000)
= $240,000
Financial Ratio Analysis

Liquidity Ratio

Hyun-Han Shin
Financial Ratio

• Financial statements contain large

amounts of data
• Condense these data into a convenient
form
 Financial ratios
Categories of Financial Ratios

• Liquidity ratios
• Leverage ratios
• Efficiency ratios
• Profitability ratios
• Market value ratios
 Samsung Electronics Balance Sheet

Samsung Electronics Balance Sheet (KRW in billions)

Assets Liabilities and Shareholders’ Equity
Dec Dec Dec Dec
2015 2014 2015 2014
Current Assets : Current Liabilities :
Cash and Short Term Investments 71,493 61,817 Accounts Payable 6,187 7,915
Accounts Receivables 28,521 28,234 Total Current Liabilities 50,503 52,014
Inventories 18,812 17,318
Total Current Assets 124,815 115,146 Long-Term Debt 12,617 10,321
Fixed Assets: Stockholders’ Equity :
Net Property,Plant and Equipment 86,477 80,873 Common Stock and paid-in surplus 125,467 118,506
Intangible Assets 5,396 4,785 Retained Earnings 53,592 49,582
Total Stockholders’ Equity 179,060 168,088
Total Assets 242,180 230,423 Total Liabilities and Shareholders Equity 242,180 230,423
 Samsung Electronics Balance Sheet

Samsung Electronics Balance Sheet (KRW in billions)

Assets Liabilities and Shareholders’ Equity
Dec Dec Dec Dec
2015 2014 2015 2014
Current Assets : Current Liabilities :
Cash and Short Term Investments 71,493 61,817 Accounts Payable 6,187 7,915
Accounts Receivables 28,521 28,234 Total Current Liabilities 50,503 52,014
Inventories 18,812 17,318
Total Current Assets 124,815 115,146 Long-Term Debt 12,617 10,321
Fixed Assets: Stockholders’ Equity :
Net Property,Plant and Equipment 86,477 80,873 Common Stock and paid-in surplus 125,467 118,506
Intangible Assets 5,396 4,785 Retained Earnings 53,592 49,582
Total Stockholders’ Equity 179,060 168,088
Total Assets 242,180 230,423 Total Liabilities and Shareholders Equity 242,180 230,423
Samsung Electronics Income Statement

Samsung Electronics Income Statement (KRW in billions)

Dec 2015 Dec 2014
Sales 200,653 206,206
Cost of Goods Sold 104,803 112,415
Selling, General and Administrative Expense 48,548 47,622
Depreciation 20,931 18,053
Earning Before Interest and Taxed (EBIT) 26,372 28,115
Interest Expense 777 593
Taxes 6,901 4,440
Net Income 18,695 23,082

Common shares outstanding 145,944,681 149,927,080

Share Price (￦) 1,260,000 1,327,000
Liquidity Ratios

• Current Ratio

Current asset / Current liabilities

Liquidity Ratios

• Current Ratio

Current asset / Current liabilities

• Samsung Electronics in 2015

Current ratio = 124,815 / 50,503
= 2.47
Liquidity Ratios

• Current Ratio

Current asset / Current liabilities

• Higher current ratio implies

• Safety for suppliers or short-term creditors
• Inefficient use of current assets
Liquidity Ratios

• Current Ratio

Current asset / Current liabilities

• Samsung Electronics in 2014

Current ratio = 115,146 / 52,014
= 2.21
Liquidity Ratios

• Quick Ratio (or Acid Ratio)

(Current asset – Inventories) / Current liabilities

• Samsung Electronics in 2015

Quick ratio = (124,815 – 18,812) / 50,503
= 2.10
Liquidity Ratios

• Quick Ratio (or Acid Ratio)

(Current asset – Inventories) / Current liabilities

• Samsung Electronics in 2015

Quick ratio = (124,815 – 18,812) / 50,503
= 2.10
Liquidity Ratios

• Cash Ratio

Cash / Current liabilities

• Samsung Electronics in 2015

Cash ratio = 71,493/ 50,503
= 1.42
Interval Measure

• Samsung was facing a strike

• Cash inflows began to dry up
• How long the business keep running?
 Interval measure
= Current assets / Avg daily operating costs
Interval Measure

• Samsung was facing a strike

• Cash inflows began to dry up
• How long the business keep running?
 Interval measure
= Current assets / Avg daily operating costs
Total cost = $104,803 billion Korean won
Avg daily cost = $104,803B/365 = 287.13 per day
Interval measure = $124,815 / 287.13 = 435 days
Interval Measure

Interval Measure
• Useful for newly founded or startup companies
• Indicates how long company can operate until
another round of financing
• Avg daily operating cost is often called burn rate
• The rate at which cash is burned in the race to
become profitable
Financial Ratio Analysis

Leverage Ratio

Hyun-Han Shin
Categories of Financial Ratios

• Liquidity ratios
• Leverage ratios
• Efficiency ratios
• Profitability ratios
• Market value ratios
Leverage Ratios

• Total Debt Ratio

• Debt-Equity Ratio
• Equity Multiplier
Leverage Ratios

• Total Debt Ratio

(Total assets – Total equity) / Total assets

Leverage Ratios

• Total Debt Ratio

(Total assets – Total equity) / Total assets

• Samsung Electronics in 2015

Total debt ratio
= (242,180 – 179,060) / 242,180
= 0.26
Leverage Ratios

• Debt-Equity Ratio

Total debt / Total equity

• Samsung Electronics in 2015

Debt-equity ratio = 63,120 / 179,060
= 0.35
Leverage Ratios

• Equity Multiplier

Total assets / Total equity

• Samsung Electronics in 2015

Equity multiplier = 242,180 / 179,060
= 1.35
Leverage Ratios

• Given any one of three ratios, you can calculate the

other two.
Leverage Ratios

• Given any one of three ratios, you can calculate the

other two.
• Different people mean different things by the term
debt ratio.
• Some mean a ratio of total debt
• Some mean a ratio of long-term debt only

 It is important to define what people mean

when they talk about debt ratio.
Leverage Ratios

• Times Interest Earned (TIE) ratio

EBIT / Interest
or Interest Coverage Ratio
Leverage Ratios

• Times Interest Earned (TIE) ratio

EBIT / Interest
or Interest Coverage Ratio

• Samsung Electronics in 2015

Interest coverage ratio = 26,372 / 777
= 33.94
Leverage Ratios

• Times Interest Earned (TIE) ratio

• EBIT : Not a really measure of cash
available to pay interest

 Cash available to pay interest

= EBIT + Depreciation + Amortization
No cash expenses
Leverage Ratios

• Cash Coverage Ratio

EBITDA / Interest

• EBITDA: Earnings before Interest, Tax,

Depreciation and Amortization
Leverage Ratios

• Cash Coverage Ratio

EBITDA / Interest

• EBITDA: Earnings before Interest, Tax,

Depreciation and Amortization

• Samsung Electronics in 2015

Cash coverage ratio = (26,372 + 20,931) / 777
= 60.88
Financial Ratio Analysis

Efficiency Ratio

Hyun-Han Shin
Categories of Financial Ratios

• Liquidity ratios
• Leverage ratios
• Efficiency ratios
• Profitability ratios
• Market value ratios
Efficiency Ratios

• Inventory Turnover

Cost of goods sold / Inventories

Efficiency Ratios

• Inventory Turnover

Cost of goods sold / Inventories

Efficiency Ratios

• Inventory Turnover

Cost of goods sold / Inventories

• Samsung Electronics in 2015

Inventory Turnover = 200,653 / 18,812
= 10.67
Efficiency Ratios

• Days’ Sales Inventory

365 days / Inventory turnover

• Samsung Electronics in 2015

Days’ sales inventory = 365 / 10.67
= 34.21
Efficiency Ratios

• Days’ Sales Inventory

365 days / Inventory turnover

• Samsung Electronics in 2015

Days’ sales inventory = 365 / 10.67
= 34.21
Efficiency Ratios

• Receivables Turnover

Sales / Accounts receivable

• Samsung Electronics in 2015

Receivables Turnover = 200,653 / 28,521
= 7.04
Efficiency Ratios

• Days’ Sales in receivables

365 days / Receivables turnover

• Samsung Electronics in 2015

Days’ sales in receivables = 365 / 7.04
= 51.85
Efficiency Ratios

• Total Asset Turnover Ratio

Sales / Total assets

• Samsung Electronics in 2015

Total asset turnover ratio = 200,653 / 242,180
= 0.83
Efficiency Ratios

• Other Ratios
• Net Working Capital (NWC) turnover ratio
• Fixed asset turnover ratio

 These ratios measure how much “work”

we get out of our working capital or fixed assets.
 As long as we can keep our sales, a high value is
preferred.
 Financial Ratio Analysis

Profitability Ratio
Market Value Ratio

Hyun-Han Shin
Categories of Financial Ratios

• Liquidity ratios
• Leverage ratios
• Efficiency ratios
• Profitability ratios
• Market value ratios
Profitability Ratios

• Profit Margin

Net income / Sales

• Samsung Electronics in 2015

Profit margin = 18,695 / 200,653
= 9.32%
Profitability Ratios

• Return on Asset (ROA)

Net income / Total assets

• Samsung Electronics in 2015

ROA = 18,695 / 242,180
= 7.72%
Profitability Ratios

• Return on Equity (ROE)

Net income / Total equity

• Samsung Electronics in 2015

ROE = 18,695 / 179,060
= 10.44%
Deriving the Du Pont Identity

• ROE = NI / TE
• Multiply by (TA/TA) and then rearrange
• ROE = (NI / TE) (TA / TA)
• ROE = (NI / TA) (TA / TE) = ROA * EM
Deriving the Du Pont Identity

• ROE = NI / TE
• Multiply by (TA/TA) and then rearrange
• ROE = (NI / TE) (TA / TA)
• ROE = (NI / TA) (TA / TE) = ROA * EM

• Samsung Electronics in 2015

ROE = (18,695 / 242,180)
x (242,180 / 179,060)
= 7.72% x 1.353 = 10.44%
Deriving the Du Pont Identity

• ROE = NI / TE
• Multiply by (TA/TA) and then rearrange
• ROE = (NI / TE) (TA / TA)
• ROE = (NI / TA) (TA / TE) = ROA * EM

• Multiply by (Sales/Sales) again and then

rearrange
• ROE = (NI / TA) (TA / TE) (Sales / Sales)
• ROE = (NI / Sales) (Sales / TA) (TA / TE)
• ROE = PM * TAT * EM
Using the Du Pont Identity

• Return on Equity (ROE)

(NI / Sales) x (Sales / TA) x (TA / TE)

• Samsung Electronics in 2015

ROE = (18,695 / 200,653) X (200,653 / 242,180)
x (242,180 / 179,060)
= 9.32% x 0.83 x 1.353 = 10.44%
Market value Ratios

• Price-Earnings Ratio (PER)

Price per share / Earnings per share

Market value Ratios

• Price-Earnings Ratio (PER)

Price per share / Earnings per share

• Samsung Electronics in 2015

• Earnings per share (EPS) = 128,097.03

PER = ￦1,260,000 / ￦ 128,097.03

= 9.84
Market value Ratios

• Market-to-Book Ratio (MB)

Market value per share / Book value per share

Market value Ratios

• Market-to-Book Ratio (MB)

Market value per share / Book value per share

• Samsung Electronics in 2015

• # of shares outstanding = 0.1459 (in billion)
MB = ￦1,260,000 / (￦ 179,060 / 0.1459)
= 1.03
 Financial Ratio Analysis

Financial Ratio Practice

Hyun-Han Shin
Common Financial Ratios
ROE = Profit margin x
Total asset turnover x
Equity multiplier
 Long-term Financial Planning

Simple Financial Planning Model

Hyun-Han Shin
In this class

Learn “how to make financial planning”

•  what the firm can accomplish by
developing a long-term financial plan

• The percentage of sales approach

Financial plan

Financial Plan
• A statement of what is to be done in the
future
• Growth as a financial management goal
Financial plan

Financial Plan
• Have a forecast balance sheet, income
statement, and statement of cash flows
, so called “pro forma statements”
• Generate these statements based on
projections of key items such as sales
Financial plan

• The projected balance sheet specify

changes in total fixed assets and net
working capital
• → the firm’s total capital budget
Financial plan

• When projected total assets will exceed

projected total liabilities and equity
•  Necessary some of new financing
• New equity or New debt : plug variable
Simple long-term planning models

Yonsei Corporation
Balance sheet
Assets 600 Debt 400
Equity 200
Total 600 Total 600

Yonsei Corporation
Income Statement
Sales 1500
Costs 1200
Net Income 300
Pro Forma – Income Statement

Sales Growth 20%

Yonsei Corporation
Pro Forma
Income Statement Income Statement
Sales 1500 Sales 1800
Costs 1200 Costs 1440
Net Income 300 Net Income 360
Pro Forma - Balance sheet

Yonsei Corporation
Balance sheet
Assets 600 Debt 400
Equity 200
Total 600 Total 600

All variables will grow by 20 %

Pro Forma
Balance sheet with dividend as plug variable ($ 320)
Assets 720 Debt 480
Equity 240
Total 720 Total 720
Pro Forma - Balance sheet

Yonsei Corporation
Balance sheet
Assets 600 Debt 400
Equity 200
Total 600 Total 600
All variables will grow by 20 %
If, retained earnings is the full $360
Pro Forma
Balance sheet with debt as plug variable ($240)
Assets 720 Debt 160 = 720 — 560
Equity 560
Total 720 Total 720
 Long-term Financial Planning

The percentage of sales approach

Hyun-Han Shin
Previous class

In the previous class

• Simple planning model
• NOT reasonable in reality
In this class

In this class
• Separate items that vary with sales from
items that do not vary with sales
• How much financing the firm will need to
support the predicted sales growth
 Financial plan

Financial Plan
• Have a forecast balance sheet, income
statement, and statement of cash flows
, so called “pro forma statements”
• Generate these statements based on
projections of key items such as sales
S
 1,840-555 = 1,285
: External Financing Needed
(EFN)
 1,840-555 = 1,285
: not possible without new financing
• Possible sources for EFN
1) Short-term borrowing
2) Long-term borrowing
3) New equity
Internal growth rate

• Next, find the growth rate that the firm

can maintain with internal financing only
• → internal growth rate
𝑹𝑶𝑨 × 𝒃
=
𝟏 − 𝑹𝑶𝑨 × 𝒃
,where b is plowback ratio or retention ratio
Example1

• Net income was 640 dollars and total assets

were 7,360 dollars
• ROA = 640/7360 = 8.70%
• Of the $640 dollars net income, $384
dollars was retained
• Plowback ratio (b) = 384/640 = 60%
• Internal growth rate
= 0.087 x 60% / (1 – 0.087 x 60%)
= 5.505%
Sustainable growth rate

• Growth rate without external equity

financing and that maintains a constant
debt-equity ratio
• → sustainable growth rate
𝑹𝑶𝑬 × 𝒃
=
𝟏 − 𝑹𝑶𝑬 × 𝒃
,where b is plowback ratio or retention ratio
Example2

• Net income was 640 dollars and total equity

was 3,360 dollars
• ROE = 640/3360 = 19.05%
• Of the $640 dollars net income, $384
dollars was retained
• Plowback ratio (b) = 384/640 = 60%
• Sustainable growth rate
= 0.1905x 60% / (1 – 0.1905x 60%)
= 12.90%
Long-term Financial Planning

Review

Hyun-Han Shin
In this class…
In this class…
In this class…
In this class…
 Internal growth rate

• Next, find the growth rate that the firm

can maintain with internal financing only
• → internal growth rate
𝑹𝑶𝑨 × 𝒃
=
𝟏 − 𝑹𝑶𝑨 × 𝒃
,where b is plowback ratio or retention ratio
 Internal growth rate

• Next, find the growth rate that the firm

• Internal growth rate
can maintain with internal financing only
14.67% × 66.7%
• → internal growth rate = = 10.84%
1 − 14.67% × 66.7%
𝑹𝑶𝑨 × 𝒃
=
𝟏 − 𝑹𝑶𝑨 × 𝒃
,where b is plowback ratio or retention ratio
 Internal growth rate

• Next, find the growth rate that the firm

• Sustainable growth rate
can maintain with internal financing only
29.33% × 66.7%
• → internal growth rate =
1 − 29.33% × 66.7%
= 24.31%

𝑹𝑶𝑨 × 𝒃
=
𝟏 − 𝑹𝑶𝑨 × 𝒃
,where b is plowback ratio or retention ratio
 Internal growth rate

• Next, find the growth rate that the firm

can maintain with internal financing only
• → internal growth rate
𝑹𝑶𝑨 × 𝒃
=
𝟏 − 𝑹𝑶𝑨 × 𝒃
,where b is plowback ratio or retention ratio
 Internal growth rate

• Next, find the growth rate that the firm

can maintain with internal financing only
• → internal growth rate
𝑹𝑶𝑨 × 𝒃
=
𝟏 − 𝑹𝑶𝑨 × 𝒃
,where b is plowback ratio or retention ratio
 Internal growth rate

• Next, find the growth rate that the firm

can maintain with internal financing only
• → internal growth rate
𝑹𝑶𝑨 × 𝒃
=
𝟏 − 𝑹𝑶𝑨 × 𝒃
,where b is plowback ratio or retention ratio
 Example2

• Net income was 640 dollars and total equity

was 3,360 dollars
• ROE = 640/3360 = 19.05%
• Of the $640 dollars net income, $384
dollars was retained
• Plowback ratio (b) = 384/640 = 60%
• Sustainable growth rate
= 0.1905x 60% / (1 – 0.1905x 60%)
= 12.90%
 Pro Forma Statements

Pro Forma Statements

Hyun-Han Shin
Historical Financial Statements

Samsung Electronics (KRW in billions)

Balance Sheet Income Statement
December 31, 2015 For year ended December 31, 2015
Assets 242,180 Debt 63,120 Sales 200,653
Fixed 91,873 Long-term 12,617 COGS 104,803
SG&A 48,548
Equity 179,060 Dep 20,931
Total 242,180 Total 242,180 EBIT 26,372
Interest 777
Taxes 6,901
Net income 18,695
Pro Forma Balance Sheet

Initial Assumptions
• Sales will grow at 5% in 2016~2020
at 1% in 2021~

• Fixed asset ratio = Fixed asset / Asset

• Samsung’s 5 year average = 0.39

• Long-term debt to asset

= Long-term debt / Asset
• Samsung’s 5 year average = 0.06
Samsung Pro Forma Balance Sheet

Period End Date 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18 31-Dec-19 31-Dec-20 31-Dec-21

Asset 242,180 254,288 267,003 280,353 294,371 309,089 312,180

Fixed Asset 91,873 98,735 103,672 108,855 114,298 120,013 121,213

Long-term Debt 12,617 14,604 15,334 16,101 16,906 17,751 17,929

Pro Forma Income Statement

Initial Assumptions
• Sales will growth at 5% in 2016~2020
at 1% in 2021~

• Cost per sale = Cost / Sales

• Cost = COGS +SG&A
• Samsung’s 5 year average = 0.78

• Depreciation per fixed asset

= Dep / Fixed asset
• Samsung’s 5 year average = 0.21
Pro Forma Income Statement

Initial Assumptions (Cont.)

• Interest rate
= Interest expense / Long-term debt
• Samsung’s 5 year average = 0.06

• Effective tax rate = Taxes / EBT

• EBT = EBIT – Interest expense
• Samsung’s 5 year average = 0.22
 Samsung Pro Forma Income Statement

Period End Date 31-Dec-15 31-Dec-16 31-Dec-17 31-Dec-18 31-Dec-19 31-Dec-20 31-Dec-21

Sales 200,653 210,686 221,220 232,281 243,896 256,090 258,651

Cost 153,350 163,469 171,642 180,224 189,235 198,697 200,684

Dep 20,931 21,123 22,179 23,288 24,452 25,675 25,931

EBIT 26,372 26,095 27,400 28,770 30,208 31,718 32,036

Interest 777 859 902 948 995 1,045 1,055

Taxes 5,560 5,838 6,130 6,437 6,759 6,826

6,901

Net Income 18,695 19,675 20,659 21,692 22,776 23,915 24,154

Pro Forma Statements

Free Cash Flow

Hyun-Han Shin
Previous Class

• Samsung Electronics
• Historical Financial Statements
• Pro Forma Balance Sheet
• Pro Forma Income Statement
Previous Class
• Historical Financial Statements

Samsung Electronics (KRW in billions)

Balance Sheet Income Statement
December 31, 2015 For year ended December 31, 2015
Assets 242,180 Debt 63,120 Sales 200,653
Fixed 91,873 Long-term 12,617 COGS 104,803
SG&A 48,548
Equity 179,060 Dep 20,931
Total 242,180 Total 242,180 EBIT 26,372
Interest 777
Taxes 6,901
Net income 18,695
Previous Class

Initial Assumptions
• Sales will grow at 5% in 2016~2020
at 1% in 2021~

• Fixed asset ratio = Fixed asset / Asset

• Samsung’s 5 year average = 0.39

• Long-term debt to asset

= Long-term debt / Asset
• Samsung’s 5 year average = 0.06
Assumptions

Additional Assumptions
• NWC to Sales
= Chg in NWC / Sales
• Samsung’s 5 year average = 0.26

• Weighted average cost of capital (WACC)

: 12%
 Pro Forma Statements

EFN and Growth Rate Review

Hyun-Han Shin
Pro Forma Financial Statements

Yonsei Corporation
Balance Sheet
Current assets 10,000 Debt 18,000
Fixed assets 30,000 Equity 22,000
Total 40,000 Total 40,000

Income Statement
Sales 13,000
Costs 9,000
Taxable Income 4,000
Tax (40%) 1,600
Net Income 2,400
Dividend payout ratio 30%
Pro Forma Financial Statements

If Sales growth 20%

Pro Forma Income Statement
Sales 15,600
Costs 10,800
Taxable Income 4,800
Tax (40%) 1,920
Net Income 2,880
Dividend 864
Retained Earnings 2,016

Balance sheet
Current assets 12,000 Debt 18,000
Fixed assets 36,000 Equity 24,016
EFN 5,984
Total 48,000 Total 48,000
Pro Forma Financial Statements

If Sales growth 20%

Pro Forma Income Statement
Sales 15,600
Costs 10,800
Taxable Income 4,800
Tax (40%) 1,920
Net Income 2,880
Dividend 864
Retained Earnings 2,016

Balance sheet
Current assets 12,000 Debt 18,000
Fixed assets 36,000 Equity 24,016
EFN 5,984
Total 48,000 Total 48,000
EFN

If Yonsei decides to plug EFN using debt

Balance sheet with debt as plug variable

Current assets 12,000 Debt 26,000

Fixed assets 36,000 Equity 22,000

Total 48,000 Total 48,000

Internal Growth Rate

Internal growth rate

ROA 6.00%
Retention ratio 70%
Internal growth rate 4.38%

• Retention ratio = 1 – Dividend payout ratio

𝐑𝐎𝐀 × 𝐑𝐞𝐭𝐞𝐧𝐭𝐢𝐨𝐧 𝐫𝐚𝐭𝐢𝐨

• Internal growth rate =
𝟏−(𝐑𝐎𝐀 × 𝐑𝐞𝐭𝐞𝐧𝐭𝐢𝐨𝐧 𝐫𝐚𝐭𝐢𝐨)
Pro Forma Financial Statements

If Sales growth 4.38%

Pro Forma Income Statement
Sales 13,570
Costs 9,395
Taxable Income 4,175
Tax (40%) 1,670
Net Income 2,505
Dividend 752
Retained Earnings 1,754

Balance sheet
Current assets 10,438 Debt 18,000
Fixed assets 31,315 Equity 23,754
EFN 0
Total 41,754 Total 41,754
Sustainable Growth Rate

Sustainable growth rate

ROE 10.91%
Retention ratio 70%
Sustainable growth rate 8.27%

𝐍𝐞𝐭 𝐈𝐧𝐜𝐨𝐦𝐞
• ROE =
𝐄𝐪𝐮𝐢𝐭𝐲
𝐑𝐎𝐄 × 𝐑𝐞𝐭𝐞𝐧𝐭𝐢𝐨𝐧 𝐫𝐚𝐭𝐢𝐨
• Sustainable growth rate =
𝟏−(𝐑𝐎𝐄 × 𝐑𝐞𝐭𝐞𝐧𝐭𝐢𝐨𝐧 𝐫𝐚𝐭𝐢𝐨)
Sustainable Growth Rate

Sustainable growth rate

ROE 10.91%
Retention ratio 70%
Sustainable growth rate 8.27%

𝐍𝐞𝐭 𝐈𝐧𝐜𝐨𝐦𝐞
• ROE =
𝐄𝐪𝐮𝐢𝐭𝐲
𝐑𝐎𝐄 × 𝐑𝐞𝐭𝐞𝐧𝐭𝐢𝐨𝐧 𝐫𝐚𝐭𝐢𝐨
• Sustainable growth rate =
𝟏−(𝐑𝐎𝐄 × 𝐑𝐞𝐭𝐞𝐧𝐭𝐢𝐨𝐧 𝐫𝐚𝐭𝐢𝐨)
Pro Forma Financial Statements

If Sales growth 8.27%

Pro Forma Income Statement
Sales 14,075
Costs 9,744
Taxable Income 4,331
Tax (40%) 1,732
Net Income 2,598
Dividend 780
Retained Earnings 1,819

Balance sheet
Current assets 10,827 Debt 18,000
Fixed assets 32,480 Equity 23,819
EFN 1,488
Total 43,307 Total 43,307
Total Debt Ratio

• Original total debt ratio

Total debt / Total assets
= 18,000 / 40,000
= 45%

• Pro forma total debt ratio

(Total debt + EFN) / Total assets
= (18,000 + 1,488) / 43,307
= 45%