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 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

Pignataro808893_ftoc.indd xi 07 Feb 2022 01:10:58 pm

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