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Strategic Financial Modeling

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12 views10 pages

Strategic Financial Modeling

Uploaded by

MF AA
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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The Essentials of

Strategic Financial
Modeling
Using Excel

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Strategic Financial Modeling

Uncertainty is a part of making Financial models do not make the


business plans. But this should not future more predictable, but it does
stop you from creating strategic help you choose between various
plans. This is where financial options and prepare your business to
modeling comes in. navigate twists and turns as you
implement your strategic plan.

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NET PRESENT VALUE (NPV)
Net Present Value (NPV) is the value of a specific stream of future cash flows
presented in today’s dollar. NPV help you to decide whether the project to
be accepted or rejected.

It’s used in capital budgeting to determine if a project should be undertaken.

=NPV(rate,value1,[value2],…)
Return the NPV of the annual flows

Hint: if a project has a positive


NPV, the project should be
taken as it will add value to the
business.

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XNPV
Question: How much to pay for an asset with irregular cash flows and un-
equal time period?
if you try to calculate an NPV of a project that generates cash flows at different
moments in time, you should use the XNPV function, which includes three
parameters: the discount rate, the series of cash flows and the range of dates
when the cash flows are received in time.

=XNPV(Rate, Cash Flows, Dates of Cash Flow)


Returns the net present value for a schedule of cash flows that is not necessarily
periodic.

NPV XNPV

Assume cash flows Cash flows are not


accur on a regular made on a regular
basis with equal basis.
time interval Cash flows are at
the beginning at
the period
365 year
calculation.

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INTERNAL RATE OF RETURN (IRR)
IRR is one of the most popular method of evaluating potential projects.

IRR is the discount rate needed to make the NPV equal 0. The higher the IRR,
the more valuable the project is. It is useful when comparing between two
projects, or when comparing a project against a company WACC (Weighted
Average Cost of Capital).

=IRR(values, [guess])
Returns the internal rate of return for a series of cash flows represented by
the numbers in values.

The values must include at


least 1 positive and 1 negative
number. The guess rate is a
rate that you can input. If
guess is taken, Excel will begin
its calculations with the rate of
10%

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INTERNAL RATE OF RETURN (IRR)

Problems with IRR in Excel

Many organizations rely on the IRR as a measure of the success


of a project. There are, however, some technical issues with
using the IRR function in Excel, as well as some general issues
that the user should be aware of.

1. The IRR assumes that cash flows are reinvested at the IRR level;

2. Another major issue with IRR occurs when a project has different
periods of positive and negative cash flows. In these cases, the IRR
produces more than one number, causing uncertainty and confusion.

3. Cash flows are often reinvested at the cost of capital, not at the same
rate at which they were generated in the first place. IRR assumes that
the growth rate remains constant from project to project.

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INTERNAL RATE OF RETURN (IRR)

The McKinsey consultants offer the best


advice about the IRR: Avoid it.

However, the idea of an IRR is so widely


accepted that this is difficult to do in many
companies.

Therefore, Excel offers a different solution,


the MIRR (Modified IRR) function.

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MODIFIED IRR (MIRR)
The modified internal rate of return (MIRR) assumes that positive cash flows
are reinvested at the firm's cost of capital and that the initial outlays are
financed at the firm's financing cost.

=MIRR(values, finance_rate, reinvest_rate)


Returns the IRR for a series of cash flows, while taking into account both
the cost of investment, and the interest on reinvestment of cash.
Values will be the cash flows. The Finance Rate is the interest rate you pay on the
money used in the cash flows. Reinvest Rate is the interest rate you receive on the
cash flows as you reinvest them.

In the example, you


can get finance at a
rate of 8%, but you can
only earn interest at a
rate of 6%

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XIRR (EXTENDED INTERNAL RATE OF RETURN)
=XIRR(values, dates, [guess])
Returns the internal rate of return for a schedule of cash flows that is not
necessarily periodic.

With regular IRR, it assumes all cash flows occur on Dec 31, but with XIRR, we
can tell Excel that the first cash flow is in the middle of the year. This has a
substantial impact on the internal rate of return calculation.
If you use the =XIRR() formula in Excel, then you have complete flexibility
over the time periods of the cash flows. In order to do this, enter two series
in your formula:

Hint: Date Format is highly


important. Wrong date
format will give you wrong
result.

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