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Now, let's take a look at Value Drivers,

how we can extract them from the financial information.

I would put like VD "extraction."

Well, first, we start with total assets at time, t. Well,

normally we have the data for the companies for a long period of time before.

Now one observation that they can make here is that in corporate finance,

when we dealt with valuation we said that,

for a company the stock which is traded there is an objective benchmark for evaluation,

this is, you take just this stock

quote then multiply by the number of shares outstanding.

And we concentrated on valuing

private companies for which this information is not available.

Here in an Amadei transaction,

we in most cases deal with the valuation of companies that are

traded that specifically so in large transactions because they all have history.

So strictly speaking, we can always refer to

the market value of this company but this market value is known for now,

and there is no assurance whatsoever that it will

grow in accordance with certain trend if you will.

So, what we are doing here,

we take some numbers well-known

for some previous whatever 10 years or maybe 20 years. It depends.

And then, we make the assumptions that the major trends in development of

all the important components that

result in the calculation of cash flows and later the valuation of the company,

they keep following the same trend on average.

This is a strong assumption but most often people make that.

So, we start with total assets and this is,

shareholders equity at time T plus interest

bearing debt at time t. In some of your assignments,

you'll be given the examples of this information over

some years and you will have to calculate the value of the company.

That just helps you to take proper numbers from proper columns.

Now, the next thing is investment.

So, investment I at time t is equal to

the difference between total assets at point T plus one,

less total assets at point T. So,

we take certain columns and use a length of one year.

Now the next thing which is obviously also the key driver is this net operating income

or X_t which is most often given in the income statement of the company.

Now, here, I would like to make one observation,

that sometimes, people start

working from income statement of the company for the very top from revenues,

and then in this case, I'll put the three in.

We can say that net operating income which is X_sub_zero,

becomes a revenue point zero times margin.

And clearly, that happens not only for zero but for all Ts.

So, you can say that X_sub_t is equal to revenue of time

t times margin at time t. Strictly speaking,

the margin may change but what follows we made this observation,

we will proceed dealing with net operating income.

Now, the most important value driver is the growth rate.

And we know that the growth rate is the product of investment and profitability.

Now, we have to deal openly with these components.

Let's start with profitability.

Well, first of all, before taxes,

it's r_t which is just X_t plus one,

less X_t divided by I_t.

This is how much we invested.

And this is what we got because that was

operating before and now it has grown to t plus one.

Now after taxes, before the tax, that is denoted.

I will use r_t which is R-cap_t times one minus T where T is the tax rate.

Well, strictly speaking, it's not the tax rate,

it's still at time t but not to make it more difficult,

I will use the uniform tax rate and in what follows It will say how people find that.

And that is, if we rewrite X_t plus

one minus X_t over I_t and then times one minus T here.

Now we move on to Investment Ratio.

Investment Ratio for after tax cashflow.

And that will be B_t,

which is just investment at time t divided by X_sub_t over one minus T. See what happens.

I will use the red marker and we're all set to find growth,

because what is growth?

Well, this is G at time t. Which is by definition,

this is X_t plus one less X_t divided by X_t.

Now, you can take a look at this formula and this one.

So, if you multiply this then one minus T cancels out,

then I_t cancels out.

And you'll see that this is nothing else but B_t times r_t.

Now, strictly speaking, at all stages,

these Bs, Rs, Gs,

they are all different.

And you know that the period of supernormal growth,

you can either take the components one by

one but then these summations they don't shortcut.

But it's more realistic if changes are not gross and

if the volatility of income is not like this which,

is most likely for some companies who've stable cash flows.

Then people prefer to deal with some averages.

And therefore, if we can find some constant Bs and Rs.

And then, we get the important formula,

the G in this case is just B times R,

where B and R are taken to be constant.

Now, I mention these averages.

So, how do people calculate averages.

I will give you some examples.

I would say like Getting Averages.

The example that I am offering here.

Well, this is not an example it's better to say it just the way that people do that.

This deals with arithmetic averages,

so you just take sums and divide that by

some other parameters that happened over the same period of time.

Well, when it comes to growth we can use also geometric averages.

So, you can start from some base,

then get to the final point and expect that this is the same growth,

and then it's like one plus G to the nth power.

And then you can find this by dividing

the final number by the base and then getting the corresponding root.

But here, I will give you an example only for arithmetic averages.

So for example, tax rate.

So, we take the sum of all actual tax payments and then divide

that by the sum of actual earnings before taxes or B,

well, what is this B?

We take total assets at the time A minus total assets at time zero,

and then we divide that by the sum of X_t over one minus T. Because this is

nothing else than the sum of all investments

divided by the sum of operating incomes after tax.

And well, by the same token you can deal with Rs or so but this is just the example.

The important thing is that after you calculated all that,

you have to run Sensitivity Analysis.

Well, the good news that we do not have to run Sensitivity Analysis with respect to

net operating income because it goes with this formula as the linear term,

so if it's higher or if it's low we know exactly by how much a total value will change.

And the same happens with the tax rate because it's one minus T it's a linear term.

But so our parameters will be B,

way to the average cost of capital.

This is K, then R and that also the number of years of supernormal grow

because that is an important value driver and all these are non-linear.

So, that wraps up the general idea of working with these numbers and in your assignments,

you will see the specific example of some of this data given like,

SAG, IBD, and so on, and so forth.

You will have to extract these numbers and then arrive at the value of the company.

In the next episode,

we will talk about how we have to treat cost of capital as very

important and non-linearly entering into this formula value driver.

And after that, we will specify

all these approaches with respect to creating value in everyday transactions.