Chapter 19
Valuation and Financial Modeling: A Case Study
I. Chapter Outline
The following chapter outline is correlated to the PowerPoint Lecture Slides. The PowerPoint slides
are referenced in bold. Alternative Examples to selected textbook examples are also available in the
PowerPoint Lecture Slides and are also referenced in bold.
19.1 Valuation Using Comparables (Slides 6–9)
• Table 19.1 Estimated 2005 Income Statement and Balance Sheet for Ideko Corporation
19.2 The Business Plan (Slide 14)
• Operational Improvements (Slides 14–16)
• Table 19.3 Ideko Sales and Operating Cost Assumptions (Slide 17)
19.3 Building the Financial Model (Slide 31)
• Interview with Joseph L. Rice, III
• Forecasting Earnings (Slides 31–34)
• Table 19.7 Pro Forma Income Statement for Ideko 2005–2010 (Slide 34)
19.4 Estimating the Cost of Capital (Slide 55)
• CAPM-Based Estimation (Slide 55)
58)
19.5 Valuing the Investment (Slide 65)
• The Multiples Approach to Continuation Value (Slides 66–69)
• Table 19.15 Continuation Value Estimate for Ideko (Slide 68)
• The Discounted Cash Flow Approach to Continuation Value (Slides 70–72, 78–80)
19.6 Sensitivity Analysis (Slides 91–94)
• Table 19.20 Sensitivity Analysis for KKP’s Investment in Ideko (Slide 92)
II. Learning Objectives
19-2 Identify the primary factors to consider when estimating the firm’s future cash flows.
19-4 Use the CAPM to estimate the equity cost of capital for a proposed project, using betas of
comparable firms.
19-6 Use the discounted cash flow method to estimate a continuation value for a firm or a project.
19-8 Discuss the use of IRR and cash multiples as alternative valuation metrics, and discuss the
drawbacks of those methods.
19-10 Describe the use of sensitivity analysis in evaluating the uncertainty of the value of the deal.
III. Chapter Overview
19.1 Valuation Using Comparables
Valuation using comparables may be used as a preliminary way to estimate the value of a firm. Table
19.1 shows the estimated end-of-year income statement and balance sheet for Ideko. Financial ratios
19.2 The Business Plan
KKP plans to make some changes to Ideko in order to improve their profitability. This section of the
19.3 Building the Financial Model
This section gives step-by-step instructions as to how to construct a pro forma income statement. The
19.4 Estimating the Cost of Capital
To value the investment, we assess its risk and estimate an appropriate cost of capital using the
CAPM. Using the comparable firms given before, the authors show how to estimate the equity cost of
19.5 Valuing the Investment
19.16 shows how the authors come to a final conclusion about the continuation enterprise value of
Ideko.
19.6 Sensitivity Analysis
In this final section, the authors emphasize that the analysis is based on estimates. It is important to
assess the uncertainty of the estimates and to evaluate the impact of an error in the estimates on the
Chapter 19 Appendix Compensating Management
This appendix discusses motivations for offering incentive based compensation to managers, how to
value that compensation, and its effect on the NPV of the project, as well as share value.
IV. Spreadsheet Solutions in Excel
The following Problems for Chapter 19 have spreadsheet versions of the problems available: 4, 5, 6,
7, 8, 9, 10.