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ACC 345 Milestone One Guidelines and Rubric Overview: This milestone will help you to complete Section I of the final project

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ACC 345 Milestone One Guidelines and Rubric Overview: This milestone will help you to complete Section I of the final project. You will select the company you will examine and give the rationale for your choice. Prompt: Develop a report about specific public company’s valuation. Provide your audience with relevant context on the selected company, including the purpose of the valuation. Your goal is to set the stage for the analysis to follow. Use the Company List to select a company. Specifically, the following critical elements must be addressed: I. Company Background A. Purpose for valuation B. Date of valuation C. Percent ownership being valued D. Company history and business structure E. Description of facilities, major assets or equipment key to running the business F. Overview of management structure Rubric Guidelines for Submission: Your milestone should be completed using the Introduction Section of the Business Valuation Report template. Sources should be cited according to APA Style. Critical Elements Company Selection Company Background Articulation of Response Proficient (100%) Selects a company for analyzing the approach to company valuation Provides relevant information regarding the background of the selected company, including links to the financial statements that set the stage for analysis to follow Submission has no major errors related to citations, grammar, spelling, syntax, or organization Needs Improvement (75%) Selects a company for analyzing the approach to company valuation, but response contains errors or is illogical Provides context on the selected company, including links to the financial statements, but information is not relevant for setting the stage for analysis or is inaccurate Submission has major errors related to citations, grammar, spelling, syntax, or organization that negatively impact readability and articulation of main ideas Not Evident (0%) Does not select a company for analyzing the approach to company valuation Value 30 Does not provide context on the selected company, including links to the financial statements 50 Submission has critical errors related to citations, grammar, spelling, syntax, or organization that prevent understanding of ideas Total 20 100% Summary Business Valuation Report of Company ABC, Inc. Company ABC, Inc. Report Date, 20XX Contents INTRODUCTION ....................................................................................................................................................... 3 PURPOSE FOR VALUATION ........................................................................................................................................... 3 DATE OF VALUATION ................................................................................................................................................... 3 PERCENT OWNERSHIP BEING VALUED .......................................................................................................................... 3 Company history .................................................................................................................................................. 4 Description of facilities, major assets and equipment.......................................................................................... 4 Management structure ......................................................................................................................................... 4 Competition .......................................................................................................................................................... 4 Customers ............................................................................................................................................................ 4 Strengths and weaknesses .................................................................................................................................... 4 Ownership ............................................................................................................................................................ 4 Major shareholder transactions ........................................................................................................................... 4 Business risks ....................................................................................................................................................... 4 FINANCIAL ANALYSIS ........................................................................................................................................... 5 FINANCIAL ANALYSIS OVERVIEW.................................................................................................................................. 5 BALANCE SHEET ......................................................................................................................................................... 5 Liquidity and Debt-to-Equity Ratios ...................................................................................................................... 5 Normalization adjustments .................................................................................................................................... 5 Balance sheet horizontal analysis .......................................................................................................................... 5 Balance sheet competitor comparison ................................................................................................................... 5 INCOME STATEMENT ................................................................................................................................................... 5 Income statement vertical analysis ........................................................................................................................ 5 Profitability .......................................................................................................................................................... 5 Normalization Adjustments .................................................................................................................................. 6 Free cash flow ...................................................................................................................................................... 6 Dividend paying capacity ..................................................................................................................................... 6 ECONOMIC OUTLOOK............................................................................................................................................ 7 GENERAL ECONOMIC ANALYSIS................................................................................................................................ 7 Output (GDP) and economic consumption .......................................................................................................... 7 Monetary and trade policy ................................................................................................................................... 7 Policies and regulations ....................................................................................................................................... 7 INDUSTRY ANALYSIS ................................................................................................................................................. 7 Supply and demand .............................................................................................................................................. 7 Market share and competitive analysis ................................................................................................................ 7 Regulation ............................................................................................................................................................ 7 Employment issues ............................................................................................................................................... 7 Industry outlook ................................................................................................................................................... 7 BUSINESS VALUATION............................................................................................................................................ 8 VALUATION APPROACHES ........................................................................................................................................... 8 Asset Approach .................................................................................................................................................... 8 Income Approach ................................................................................................................................................. 8 Market Approaches .............................................................................................................................................. 8 SELECTED METHOD - INCOME APPROACH ................................................................................................................. 8 Prospective Analysis ............................................................................................................................................ 8 Discount rate ........................................................................................................................................................ 9 Valuation calculation ......................................................................................................................................... 10 DISCOUNTS AND PREMIUMS .............................................................................................................................. 11 DISCOUNT FOR LACK OF CONTROL.......................................................................................................................... 11 DISCOUNT FOR LACK OF MARKETABILITY .............................................................................................................. 11 FINAL CALCULATION OF VALUE ...................................................................................................................... 12 SOURCES .................................................................................................................................................................. 13 APPENDIX ................................................................................................................................................................ 14 BALANCE SHEET ....................................................................................................................................................... 14 INCOME STATEMENT ................................................................................................................................................. 15 INTRODUCTION Purpose for valuation Guidance: Assume the intended use is for the sale of a minority stake of the company you’re valuing. This should be stated in this section of the report. Assume the premise of value is that the business is a “going concern” as opposed to liquidation or other premise. Assume the standard of value is fair market value, as opposed to fair value, investment value, liquidation value or some other standard. This should be stated in this section. Date of valuation Guidance: Select a date that corresponds with your company’s most recent fiscal year end. For example, if your company’s annual report is on June 30, 20X9 then insert that here. Percent ownership being valued Guidance: You can choose anything less than 51% ownership because we will be applying discounts for lack of control and discounts for lack of marketability. 3 Company ABC, Inc. Brief History/Overview Guidance: This section should include an overview of the following: Company history Include a link to financial statements here Description of facilities, major assets and equipment Management structure Competition Customers Strengths and weaknesses Ownership Major shareholder transactions Business risks Guidance: Give a detailed description of each of the above sections by utilizing various sources – one of the best source to use will be the annual reports (10K) and EDGAR database, https://www.sec.gov/edgar/searchedgar/companysearch.html 4 FINANCIAL ANALYSIS Financial Analysis Overview Guidance: This section should provide an overview of the balance sheet, the major items present, the company’s capital structure, and any changes over time in these items. A common-size analysis (which is built in to your workbook) will help with this. Ask yourself questions such as, “Has the company taken on additional debt? If so, why?”, or “Does the company have a lot of Intangible Assets? If so, are they at risk for impairment?” Balance Sheet Liquidity and Debt-to-Equity Ratios Normalization adjustments Balance sheet horizontal analysis Guidance: Discuss any normalization adjustments you’ve made. Remember, normalization adjustments are changes to the balance sheet (or income statement) that smooth out or “normalize” any anomalies that the company may have experienced. An example would be expenses related to a corporate merger or restructuring. This helps you in your prospective analysis by not including any unusual expenses or income. Balance sheet competitor comparison Income Statement Guidance: Similar to the balance sheet write-up, discuss major line items and drivers of those line items. For example, are there increases in Cost of Goods Sold? If so, what are the drivers of those costs? Income statement vertical analysis Profitability 5 Normalization Adjustments Guidance: Discuss any normalization adjustments you’ve made. Remember, normalization adjustments are changes to the incomes statement (or balance sheet) that smooth out or “normalize” any anomalies that the company may have experienced. An example would be expenses related to a corporate merger or restructuring. This helps you in your prospective analysis by not including any unusual expenses or income. Free cash flow Dividend paying capacity 6 ECONOMIC OUTLOOK General Economic Analysis Guidance: Research the primary economy in which your company operates. Use the U.S. as the default if it’s a global firm, but try to incorporate any important global factors if a majority of its operations is abroad. Address the following factors from the rubric below: Output (GDP) and economic consumption Monetary and trade policy Policies and regulations Industry Analysis Guidance: Research your industry by reviewing a select group of your company’s peers. By reviewing the annual report of 2-3 competitors you will get an understanding of these items below. You may also search the web for scholarly articles on your chosen industry or recent industry reports. Focus on the items from the rubric below: Supply and demand Market share and competitive analysis Regulation Employment issues Industry outlook 7 BUSINESS VALUATION Valuation Approaches Guidance: Discuss the major approaches below even though you’ll only be calculating the Income Approach. Explain what they are and how they’re derived. Asset Approach Income Approach Market Approaches Selected Method - Income Approach Guidance: Explain the mechanics of the calculation below. Discuss your selection for the cells in yellow – annual growth rate, and percentage of revenue for Gross Profit and Operating Expenses. Prospective Analysis Company ABC Inc. Projected Income Statement (In millions) 2018 Revenue $ Growth $ 2.5% Gross profit Other income (expense) Interest income (expense) Other Percentage of revenue 0.0% $ - $ - $ - - - 5.0% - 0.0% $ 7.0% 5.0% - - 0.0% $ - 2.5% - - 0.0% $ 7.0% 5.0% - - Terminal 2.5% - - 0.0% $ 7.0% 5.0% - - 2022 2.5% - 5.0% - $ 7.0% - 5.0% - 2021 2.5% 7.0% - Percentage of revenue $ - 7.0% Operating expenses - 2020 2.5% - Percentage of revenue Net income - 2019 0.0% $ - 8 Discount rate Guidance: You do not have to explain each of these components or complete the “discount rate” section because it’s not required in the rubric. However, this is a key part of calculating the Income approach so it’s included for your knowledge. Note that they assign risk to different categories of the company. The risk-free rate is what a company would earn on a riskless government security. The equity risk premium is the risk above the risk-free rate one should expect on an equity security. The industry premium is the risk associated with a particular industry (i.e. manufacturing or retail). The specific company risk is a subjective amount applied by the valuation analyst based on his or her perception of the company’s risk. Company ABC Inc. Development of Discount Rate and Capitalization Rate Risk-free long term U.S. Government bond rate Equity risk premium Industry premium estimate Specific company risk Rate 2.6 % 6.0 1.5 3.0 Cost of equity (Discount rate) Less: Long-term sustainable growth rate 13.1 (2.5) Capitalization rate 10.6 % Note (A) (B) (C) (D) Sum of (A) - (D) (E) (A) Yield on the twenty-year U.S. Treasury bond as of December 31, 20XX, per the U.S. Treasury (B) Long-horizon expected return of large stocks over risk free securities, U.S. Equity Risk Premium (6.0%) (C) SIC code XX, 1.5% (D) Appraiser's judgement concerning company-specific risk (E) Estimated long-term growth rate based on inflation, Federal Reserve Bank of Philadelphia 9 Valuation calculation Guidance: Discuss the mechanics of the calculation below. Provide your reasoning for the amounts chosen for the items in yellow (Depreciation, Capital expenditures, and Debt Reduction). Company ABC Inc. Discounted Cash Flow Method (In millions) Projected for Years Ending December 31, 2018 2019 2020 2021 Forecasted Net Income Plus: Depreciation Less: Capital expenditures Debt reduction $ Net Cash Flow $ - $ - $ - $ - $ - Present value of cash flows $ - $ - $ - $ - $ - - $ - $ - $ - Terminal Value 2022 $ - $ - - - - - - - - - - - - $ - $ 10.6% Capitalized terminal cash flow $ - Net present value of terminal cash flow, discounted into perpetuity $ - Discount rate: 13.1% Terminal period cash flows Capitalization rate: 10.6% ÷ Net present value - five years ending YE: 2022 Net present value of terminal cash flow $ - Total indication of value (rounded) $ - 10 DISCOUNTS AND PREMIUMS Discount for Lack of Control Guidance: You may choose a default discount amount of 15% or if you want to justify a higher or lower amount then you may do so. The following factors below should be considered in this discussion. Explain why each of these factors could only be done by a party with majority control and why a lack thereof could affect the value. Ability to appoint or change management Ability to determine management compensation and perquisites. Able to negotiate and consummate mergers and acquisitions. Can liquidate, dissolve, sell out or recapitalize the company. Able to declare and pay cash dividends. Able to decide what investments to hold and to sell. Block any or all of the above actions. Discount for Lack of Marketability Guidance: Similar to the DLOC, you may choose a default value. Use 25% or if you want you may justify a higher or lower amount. The following factors should be considered because these factors affect a company’s liquidity, which in turn affects its marketability. Suggested factors that should be considered: Company’s Dividend Policy Nature of the Company Company Management Amount of Control to be Transferred Restrictions on Transferability of Stock Holding Period for Stock Company’s Redemption Policy Costs Associated with a Public Offering Note: In practice there is a lot of effort spent on determining these discounts, but due to a lack of free resources and time it is impractical to require that in this course. 11 FINAL CALCULATION OF VALUE Guidance: Summarize the table below and what it is telling the reader. Company ABC Inc. Final Computation of Value As of December 31, 2018 Income Approach: Discounted Cash Flow Method Indicated Value of Equity Weight $ Weighted Value (rounded) $ Indicated value with voting rights Less: DLOC (Discount for Lack of Control) Marketable, minority value Less: DLOM (Discount for Lack of Marketability) $ 100 % - 15.0% - 25.0% - Nonmarketable, minority value $ - Value of a one-percent interest $ - 12 SOURCES The following sources were used to derive the conclusions in this report and the ultimate calculation of value: • Current and historical financial statements were obtained for years ended: • Industry data from: • Economic data from: • Other sources: 13 APPENDIX Balance Sheet Company ABC Inc. Balance Sheets December 31, 2014 through 2018 2014 2015 2016 2017 2018 Common-size analysis 2015 2016 2017 2014 2018 Assets Current Assets Cash Accounts receivable, net Inventory Other current assets Total current assets $ - $ - $ - $ - $ - - % - % - % - % - % Property, plant & equipment - - - - - - - - - - Other assets Receivables from life insurance trusts Other assets Total other assets - - - - - - - - - - - - % - % - % - % - % % - % - % - % - % Total Assets $ - $ - $ - $ - $ Liabilities and Stockholders' Equity Current Liabilities Notes payable - stockholders Accounts payable Accrued expenses & other current liabilities Current portion of debt and leases Total current liabilities $ Long-Term Liabilities Payable to shareholder Long-term debt and lease obligations Total long-term liabilities Total Liabilities Stockholders' Equity Common stock Additional paid in capital Retained earnings Other comprehensive income (loss) Total Stockholders' Equity $ - $ - $ - $ - $ - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - $ - $ - $ - $ % - % - % - % - % 14 Income Statement Company ABC Inc. Statements of Income December 31, 2014 through 2018 2014 Sales Cost of Sales $ 2015 - $ 2016 - $ 2017 - $ 2018 - $ Common-size analysis 2015 2016 2017 2014 - - % - % - % - 2018 % - Gross Profit - - - - - - - - - - General & administrative expenses - - - - - - - - - - Operating Income - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Other Income (Expense) Interest (expense) Gain (loss) on sale of assets Other Normalization adjustments Non-recurring items Excess wages Legal Settlement Other Net income $ - $ - $ - $ - $ % - % - % - % - % % 15 To begin follow these steps: 1. Enter the numbers from your company's balance sheet and income statement for each year, starting with the most recent year through the prior five years (Example: if the most recent is 2017 then go back through 2013). 2. Ratios auto-calculate but you may wish to make an adjustment if necessary. You will only use the ratios for explanatory or analysis purposes in your report. There is nothing more to do with them in this workbook. 3. Create your prospective analysis by changing the growth rate for Revenue, the percentage of Revenue for Gross Profit and Operating expenses, and then add Other Income or expense items. You can do this in the cells highlighted in yellow. This will give you your projected net income, which you will then use to discount to present value on the "dcf" tab later. The default number for Revenue in the prospective analysis is the most recent year's Revenue number plus 2.5%. You may change it. 4. On the "discount rate" tab you are welcome to leave the number as is or go through and make adjustments. In most cases you will need access to data that is unavailable or requires a paid subscription, which is why you're allowed to keep the default values. If you're able to obtain any of those figures then you may use them. The detail was provided to expose you to the concepts, but not actually require the research since it may be cost prohibitive. 5. The "dcf" tab feeds your projected Net Income figures from the "prospective analysis" tab. To that number you will add back depreciation since it's a non-cash item and then subtract expected capital expenditures or and planned debt reductions. You may estimate these if you're unable to find any projection by the company. It is not required that these be fully accurate since you don't have access to management's plans. Enter those numbers in the yellow highlighted cells. You shouldn't have to change any other cells in that tab. 6. On the last tab, "valuation summary", the only values you need to change are the cells in yellow for the DLOC and the DLOM. You may leave these as the default values since these also require access to data that may be only acquired via subscription or purchase. If you're able to find material supporting a change in those values then you're free to do so. The goal in introducing them in this manner is to get you exposed to the concepts, not the actual calculation as that is beyond the scope of this course. Consider these factors when working through the model: 1. The financial statements you encounter in the annual report will look differently than they do in this model. Categories will be different than what you find in the annual report, so just use your best judgement when classifying them and if you need to lump certain costs together then do so. (Example: your company shows Cost of Sales of $100k, G&A of $50k, and Marketing expense of $10k. Combine the G&A and Marketing in the single line on the income statement called "General, Administrative and other non-operating expenses" in the amount of $60k. This places Marketing into the "Other" catch all category. 2. You may insert any "Key Assumptions" that you want to convey using the space below the balance sheet, income statement, or prospective analysis. This could be anything from combining certain line items to explaining apparent anomalies. 3. Make sure to net your interest income and expense on the income statement. So in some years you may have a positive balance and a negative in others. 4. The "Normalization adjustments" listed on the "income statement" tab are referring to the adjustments discussed in module three. To recap - Normalization adjustments are changes that you as an analyst can make in order to "normalize" any anomalies or non-recurring items that may have been reported in the financial statements. For example, if your company was exposed to a natural disaster and you know management does not expect that type of major expense in the future then you can add it back under this section. Another example would be a class-action lawsuit that resulted in a major settlement. While companies are always subject to lawsuits, one tha results in a material settlement may be removed if it's unexpected to occur again in the near future. adjustments discussed bject to lawsuits, one that Company ABC Inc. Balance Sheets (in millions) December 31, 2015 through 2019 2015 2016 2017 2018 2019 Common-size analysis 2016 2017 2018 2015 2019 Assets Current Assets Cash and cash equivalents Accounts receivable, net Inventory Other current assets Total current assets $ - $ - $ - $ - $ - - % - % - % - % - % Property, plant & equipment, net - - - - - - - - - - Other assets Intangibles Other assets Total other assets - - - - - - - - - - - - % - % - % - % - % % - % - % - % - % Total Assets $ - $ - $ - $ - $ Liabilities and Stockholders' Equity Current Liabilities Accounts payable Accrued expenses & other current liabilities Current portion of debt and leases Total current liabilities $ Long-Term Liabilities Long-term debt and lease obligations Other long-term liabilities Total long-term liabilities Total Liabilities Stockholders' Equity Common stock, less treasury Additional paid in capital Retained earnings Other comprehensive income (loss) Total Stockholders' Equity $ - $ - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - $ - $ - $ - $ - $ - $ - $ - % - % - % - % - % $ *Key Assumptions: - $ - $ - $ - $ - Company ABC Inc. Statements of Income (in millions) December 31, 2015 through 2019 2015 Sales Cost of Sales $ 2016 - $ 2017 - $ 2018 - $ 2019 - $ Common-size analysis 2016 2017 2018 2015 - - % - % - % - 2019 % - Gross Profit - - - - - - - - - - General, administrative and non-operating expenses - - - - - - - - - - Operating Income - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - Other Income (Expense) Interest (expense) Gain (loss) on sale of assets Other Normalization adjustments Non-recurring items Legal settlements Other Net income, before tax *Key Assumptions: $ - $ - $ - $ - $ % - % - % - % - % % Company ABC Inc. Financial and Operating Ratios December 31, 2015 through 2019 2015 2016 Liquidity Ratios Current Ratio Quick Ratio Working Capital - - Activity Ratios Receivable Turns Days in Receivables Revenues/Working Capital Revenues/Fixed Assets Revenues/Total Assets Inventory Turns Days in Inventory Payables Turns Days in Payables - - Coverage/Leverage Ratios Fixed Assets/Equity - - Profitability Ratios Return on Equity Return on Total Assets Net Profit on Revenues - - 2017 2018 2019 - - - - - - - - - - - - Company ABC Inc. Projected Income Statement (In millions) 2020 Revenue $ Growth Other income (expense) Interest income (expense) Other Percentage of revenue 0.0% $ - - - 5.0% 5.0% - 0.0% $ 7.0% - - - 0.0% $ - 2.5% - 5.0% - $ 7.0% - 5.0% - 2023 2.5% 7.0% - Percentage of revenue $ - 7.0% Operating expenses - 2022 2.5% - Percentage of revenue *Key Assumptions: $ 2.5% Gross profit Net income - 2021 0.0% $ - 2024 $ - Terminal $ 2.5% - - 7.0% 7.0% - - 5.0% 5.0% - - 0.0% $ - 2.5% 0.0% $ - Company ABC Inc. Development of Discount Rate and Capitalization Rate Risk-free long term U.S. Government bond rate Equity risk premium Industry premium estimate Specific company risk Rate 2.6 % 6.0 1.5 3.0 Cost of equity (Discount rate) Less: Long-term sustainable growth rate 13.1 (2.5) Capitalization rate 10.6 % Note (A) (B) (C) (D) Sum of (A) - (D) (E) (A) Yield on the twenty-year U.S. Treasury bond as of December 31, 20XX, per the U.S. Treasury (B) Long-horizon expected return of large stocks over risk free securities, U.S. Equity Risk Premium (6.0%) (C) SIC code XX, 1.5% (D) Appraiser's judgement concerning company-specific risk (E) Estimated long-term growth rate based on inflation, Federal Reserve Bank of Philadelphia Sources: United States Treasury ***You may use other sources to update any of these values; list the applicable source if used. Existing values are actual figures obtained from sources used in prior years. You may use these as default values since a detailed development of the discount rate is beyond the scope of this class. Company ABC Inc. Discounted Cash Flow Method (In millions) Projected for Years Ending 2020 2021 Forecasted Net Income Plus: Depreciation Less: Capital expenditures Debt reduction $ Net Cash Flow $ - $ - Present value of cash flows $ - $ - Discount rate: 13.1% Terminal period cash flows Capitalization rate: 10.6% - $ - - - - - Capitalized terminal cash flow Net present value of terminal cash flow, discounted into perpetuity Net present value - five years ending YE: 2024 Net present value of terminal cash flow Total indication of value (rounded) 1 2 Projected for Years Ending December 31, 2022 $ 2023 - $ Terminal Value 2024 - $ - $ - - - - - - - - - $ - $ - $ - $ - $ - $ - $ - $ 10.6% $ - $ - ÷ 3 $ - $ - 4 5 Company ABC Inc. Final Computation of Value As of December 31, 2019 Income Approach: Discounted Cash Flow Method Indicated Value of Equity Weight $ 100 Weighted Value (rounded) $ - Indicated value with voting rights Less: DLOC (Discount for Lack of Control) $ Marketable, minority value Less: DLOM (Discount for Lack of Marketability) - 15.0% - 25.0% - Nonmarketable, minority value $ - Value of a one-percent interest (in millions) $ - *if valuing an interest greater than 50% then the DLOC will not apply %