# FINANCIAL MODELLING

Explain what free cash flow is ?

Any money left over after a business has paid operational and capital expenses is free cash flow. Free cash flow is the money an enterprise generates after a business leader or accountant has considered the outflows that support the business’ operations.

Which techniques would you employ to forecast revenue?

A crucial measure of a company’s financial performance is its ability to forecast revenue. Candidates may acknowledge a variety of methods for predicting revenue, such as:

• Straight-line techniques, which gauge the rate of constant growth
• Approaches to simple linear regression that compare an independent and dependent variable
• Moving average techniques are used to evaluate repeated forecasts.

What is IRR?

Internal Rate of Return is referred to as IRR. It is among the best methods and is frequently employed in investment projects. The IRR is the rate of return at which all cash inflows and outflows from any project have a zero net present value (NPV).

What do you mean when you say “working capital”?

Working capital is essentially the cash on hand for daily operations in any business. The following formula can be used to determine working capital: Current Assets – Current Liabilities equals working capital.

Describe DCF.

Discounted Cash Flow is referred to as DCF. This is the most accurate method of estimating the firm’s value at the time of an acquisition or financing. Future cash flows are given a net present value calculation in DCF.

What Is The difference between NPV and XNPV?

The fundamental distinction between NPV and XNPV is that the former assumes that the cash flows arrive at equal intervals, whereas the latter assumes that they don’t.

What are the various techniques of company valuation?

The techniques or methods of determining the valuation of any company are:

• Discounted Cashflow Method
• Asset Approach
• Market Value Business Valuation Method
• Debt Financing

What is a beta?

The market (systematic) risk metric beta. The capital asset pricing model (CAPM) uses beta to calculate the cost of equity. Beta quantifies a stock’s return volatility in relation to an index. Therefore, a beta of 1 is more volatile than 1, and it has a return volatility equal to that of the index.

What do you use for the discount rate in a DCF valuation?

If you are forecasting free cash flows to the firm, you normally use the Weighted Average Cost of Capital (WACC) as the discount rate. If you are forecasting free cash flows to equity, you use the cost of equity.

What do you mean by WACC?

A financial metric called weighted average cost of capital is used to calculate a company’s capital costs. Due to the fact that the cost of financing the capital is a fairly logical price to put on the investment, it is most frequently used to provide a discount rate for a financed project. The discount rate used in a DCF valuation model is determined using WACC. What is NPV?

Net Present Value is known by the abbreviation NPV. As the name implies, it is used to determine the present value of all cash flows produced by a project, whether they are positive or negative. In other words, it is the difference between a project’s present value of cash inflow and outflow.

What’s the difference between enterprise value and equity value?

The value of the business that can be attributed to all investors is called enterprise value. Only the portion of the company that belongs to shareholders is represented by equity value. Market equity value plus market net debt value are included in enterprise value (as well as other sources of funding if used such as preferred shares, minority interests, etc.).

What is Terminal Value?

Terminal Value or TV is the value of any investment at the end of the investment period. This will usually assume a constant interest rate for the period. Terminal value is calculated with the use of either an exit multiple or the perpetual growth method.

Terminal Value = ( FCFnx ( 1+g ))/(WACC – g)

When Would You Not Use A Dcf In A Valuation?

If the company’s cash flows are unstable or unpredictable, or if debt and working capital have very different functions, you shouldn’t use a DCF. You wouldn’t use a DCF for companies like banks and financial institutions because they do not reinvest debt and working capital makes up a significant portion of their balance sheets.

How do you calculate the cost of equity?

Although there are several competing models for calculating the cost of equity, the capital asset pricing model (CAPM) is the one that is most frequently used. The CAPM relates a security’s anticipated return to how sensitive it is to the market as a whole. It goes like this:

Cost of equity (re) = Risk free rate (rf) + β x Equity risk premium (rm-rf)

What do you mean by risk-free rate?

Theoretically, the risk-free rate should reflect the yield to maturity of a government bond with a maturity equal to the duration of each cash flow being discounted. The current yield on 10-year U.S. Treasury bonds has become the preferred proximate for the risk-free rate for US companies in practice due to the lack of liquidity in long-term bonds.

How do you calculate ERP?

The excess returns from stock investments over the risk-free rate are measured as the ERP or equity risk premium (rm-rf). Practitioners frequently compare historical spreads between standard index returns and the yield on 10-year Treasury bonds when applying the historical excess returns method.

What do you mean by a relative valuation approach?

The idea of comparing the price of an asset to the market value of comparable assets is known as relative valuation, also known as valuation using multiples or relative valuation

The cost of debt or the cost of equity, which is typically higher?

Since the cost of taking on debt (interest expense) is tax deductible, providing a tax shelter, the cost of equity is higher than the cost of debt. The cost of equity is typically higher because, unlike lenders, equity investors are last in line for liquidation and do not receive fixed payments.

What does sensitivity analysis mean in terms of financial modelling?

Sensitivity analysis is a well-defined tool used in financial modelling to examine the effects of various independent variable values on a particular dependent variable in a given scenario. As a result, a financial analyst might want to investigate how changes in factors like the cost of goods sold and labour costs may affect a company’s profit margin. The profit margin can be tested using sensitivity analysis to test various combinations of values for these variables.