Quantitative Models in Finance

Quantitative Models in Finance

Final Project: Valuation

Company: Sky PLC

It is an unusually sunny day in London in March. The Chairman of Diversify plc, Sir Charles

Curmudgeonly

Pricing-Model, is speaking with his investment banker, Professor Cinzano Bianco.

“We urgently need to discuss our strategy going forward. Diversify has shown slower growth in

recent

years. We have a lot of cash on our books. The equity analyst community has noted this and are

starting

to comment. We must find attractive ways to invest this cash and create shareholder value. If we

don’t

our share price will suffer. We might even attract the attention of a corporate raider.”

“Of course”, responded Professor Bianco. “I am sure you know there many ways in which Diversify

could

achieve a financial restructuring. For example, increased dividend payments or a share repurchase.

Or,

you might consider acquiring a company in a business related to Diversify, but at different stage of

maturity. Would you like me to put together some ideas for you?”

“How would you approach the analysis?” responded Sir Charles. “You know we have a competent

staff

here at Diversify... ”

“We would, of course, work together”, replied Professor Bianco. “Suppose that we have spent time

identifying the parameters in which Diversify is interested, and then narrowed down the search to a

single company: let’s call it ‘Target’ plc. We would thoroughly analyse Target’s operating and

financial

results. We would review Target’s financials and identify companies which are comparable in terms

of

business lines, size, products, markets and other relevant parameters. By comparing Target’s

financial

performance and prospects to such comparables will give us a sense of how Target’s value would

compare in an acquisition context.

“In terms of market parameters, we would also look at the price at which other companies—in

Target’s

business—trade in the market, and the price at which other companies have been acquired in

comparison to publicly-quoted prices. We would prepare a financial projection for Target, consisting

of

five years of forecast income statements (P&Ls) and balance sheets. This projection would form the

basis for a discounted cash flow (DCF) analysis. Of course, it would be necessary to examine the

sensitivity of this analysis and the resulting values to changes in various assumptions. For example,

there

are several ways in which we might calculate a company’s WACC; changing this assumption is one

example of such a sensitivity analysis.

“Finally, we would pull together the alternative approaches to valuation and arrive at some

consensus

view as to what Diversify should pay for Target.”

“Well,” said Sir Charles, “that sounds eminently reasonable, and not dissimilar to the approach I

understand major institutional investors and money managers take in evaluating shares. I'd like to

meet

with you for breakfast on Monday .... How does 8:30am sound? If you can e-mail me an eight-page

report by midnight on Sunday that would be helpful. I'd best hang up and let you get started right

away...”

When submitting your project, it must consist of each of the following items:

• An Executive Summary (5%)

• An eight-page report focusing on the valuation analysis, with a fully justified conclusion (45%)

• Appendices containing relevant elements of your spreadsheet model (45%)

• A complete and properly formatted Bibliography (5%)