Capstone Studies in Finance

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Part 1: Valuation
Groups are expected to value their companies based on publically available information using one or
more valuation methodologies. The publically available information should include but is not limited to
the annual reports of the firm, any information releases to the ASX and publically available analyst
reports. The usual candidate methodologies for a valuation are trading or transaction multiples,
discounted cash flows (DCF), adjusted net present value (ANPV) and sum of the parts methods (SOTP).
While the process of valuation may be broken-down into steps in a number of ways, the following steps
may be helpful.

Step 1: Develop an understanding of the firm’s business. Some questions that you might consider
 What does the firm make, sell or do?
 How is the firm positioned in its industry?
 What is the regulatory environment for the firm?
 What are the drivers of firm value?
 What are the core risk factors for the firm?
Step 2: Justify the valuation methodology or methodologies selected.
 What are the benefits and limitations of the chosen method(s)?
 What assumptions underlie the chosen method(s)?
Step 3: Perform a due diligence analysis on the corporate information you have collected.
 Due diligence is the assessment of the quality of the information you have used. For
example, the financial data from DataAnalysis is better than that from company annual
reports because it is externally reviewed and consistent across companies and time.
 These are listed companies so their corporate accounts will have been audited
Step 4: Use the methodology or methodologies selected to generate a valuation of the firm.
 You analysis must be fully documented and explained.

 Does the firm’s position in the current economic cycle affect the firm’s value? If so, what
would the firm be worth in a “normal” or average position in the cycle?
Step 5: Sensitivity Analysis. Bearing in mind that there is no “correct” answer to the valuation
question, it is important to examine how sensitive is your valuation to the key drivers of value
and/or risk?

Rosenbaum, J. and J Pearl (2009). Investment Banking: Valuation, Leveraged Buyouts and Mergers and
Acquisitions, New York: Wiley-Finance. Part One.

Part 2: Capital Structure and Credit Risk Analysis
Assume that your group does credit analytics for a major commercial bank. The company valued in Part
1 has applied to the bank for an extension to its credit. Use your knowledge of the company to
determine the type of credit asked for. The group’s tack is to assess the available evidence on the credit
worthiness of the company, looking for possible weaknesses and trying to assess problems that might
arise in the future. The output of the analysis is a credit report detailing your analysis and a
recommendation on the application for the credit extension.
Your first port-of-call should be a classical credit analysis in which you look at both the borrower and the
credit proposed with the objective of deriving the probability of default by the borrower over the life of
the loan and estimating the amount of loss that the lender would suffer in the event of default. The
steps include:
 Review of the company’s balance sheets, profit and loss and cash flow statements to
identify trends and volatility in its business.
 Based on the evidence, define appropriate assumptions about the company’s financial
future over the life of the debt instrument. These assumptions should be cross-validated
will any available equity analysts reports.
 Determine the type of credit asked for and where this debt fits in the subordination
arrangements of the company.
 Project financial data on a pro forma basis over the life of the debt instrument. Also,
develop best and worst case scenarios. Compare these estimates with the financial
requirements for servicing the additional debt.
 Review the competitive position of the borrower within its industry and the
macroeconomic factors governing the performance of the industry as a whole. Use this
review to adjust your assumptions about the company’s financial future, if necessary.
 Evaluate the capability of the company’s executive management to achieving the cash
flows necessary to support the new debt.

 Recommend and present a synopsis of your reasons for granting the loan and if granted
on what terms.

Once you have completed a classical credit analysis, it is wise to cross-check you recommendations using
models based on accounting or market data. Since all the companies are listed, your group can also use
the information embedded in share prices to assist credit risk analysis. This involves using an expected
frequency of default model (EDF) such as Moody’s KMV model.

Altman, E.I. (1968). Financial Ratios, Discriminant Analysis and the Predictions of Corporate Bankruptcy,
Journal of Finance, 23(4), 589-609.
Caouette, J. B., E. I. Altman, P. Narayanan and R. Nimmo (2008). Managing Credit Risk, New York: John
Wiley and Sons.
Rosenbaum, J. and J Pearl (2009). Investment Banking: Valuation, Leveraged Buyouts and Mergers and
Acquisitions, New York: Wiley-Finance. Part Two.
deSevigny, A. and O. Renault (2005). Standard and Poor’s Guide to Measuring Credit Risk, New York:
Standard and Poor’s.

Part 3: Mergers and Acquisitions
At this point, your group should be very familiar with your company and what drives its success. It is
now time to consider a possible restructuring. The restructuring may be either from the sell-side, such
assets sales, a carve-out/spin-off, or from the buy-side, such a take-over of or merger with another listed
company. Your group must decide the best course of action given the facts you possess. By necessity,
the group’s view must be speculative, since there is no deal in-play.
 Outline the objectives for the M & A transaction identified by your group.
 Determine the buyer or seller universe (i.e., the potential counterparties to the
transaction). Possible criteria include:
1. Strategic fit and synergies
2. Financial capacity
3. Effects on demand or supply chain
4. Market position and regulatory concerns
 Revisit your valuation and re-assess it from a buyer’s or merger partner’s perspective.
Answer: What is in the deal for them?



 Understand and comment on the impact on each stakeholder in the transaction.
Regulators are implicit counterparties, so you much evaluate the effects of regulation on
the proposal.
 Determine your approach to the counterparties in the transaction. This will include
answering questions such as:
1. What method of sale should be used; for example auction or book build?
2. Should a hostile or friendly approach be used in a merger or takeover
3. If doing a takeover, should it be by bid or scheme of arrangement?
 Prepare a suggested financing package for the transaction.
1. How are assets to be sold? Is this an all cash deal or is financing provided?
2. What are the terms of the carve-out/spin-off? What inducements does the
parent company offer, if any?
3. Is the merger by cash, shares or is it a mixed deal? What are the dilution effects
of the deal?

 Prepare a teaser document for the document for the transaction. This one or two page
document should include a company overview, investment highlights and summary
financial information.
 In the end, should the company execute your group’s strategy?

Assessment Criteria:
You will be assessed on the basis of your prepared document and your final presentation. The
assessment will be subjective so it is appropriate that you have guidelines concerning what I am looking
for. These are given below:
 Completeness and clarity
 Understanding the value drivers and potential risks for the company
 Assessment and explanation of the fair value for the company:
o Appropriate assumptions, both financial and non-financial
o Reasonableness of projections
o Justification of assumptions and calculations
o Explanations of methodologies and deviations from established norms.
 Understanding and explanation of the potential risks of additional corporate leverage to the lender
of the new or subordinated debt.
 Explanation of the projects of the financial data for credit analysis
o Appropriate assumptions
o Reasonableness of projections
o Justification of assumptions and calculations
 Use and explanation of other credit risk methods.

 Assessment and explanation of funding decision
 Understanding and explaining the rationale of the M&A process and strategy
 Understanding the impact on each stakeholder in the transaction
 Analysis and explanation of the transaction strategy.
 Understanding and explanation of the issues surrounding the transaction, including but not limited
to regulatory issues and issues with possible interlopers.
 Ability to make and justify a final transaction recommendation. Should the firm go with your idea or
Note: Your finance must be correct. Financial errors will be penalized in all sections of the report.
 Clear and compelling delivery using the an appropriate presentation style
 Developing a clear narrative or story that leads to a final set of recommendations.
 Conciseness: Gets to the point and is not overly verbose.
 Effective use of media, in particular Powerpoint. This does not mean flashy transitions and
animation! The media you use must assist your story, not supplant it.
 Clarity over final recommendations and forceful advocacy of them.


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