to the successful crossing of some key critical steps in the project life. This is the case, for instance, of some pharmaceutical businesses, or of the projects subjected to articulated authorization itinera (e.g., wind farms). In such situations, cash flow profiles linked to the business can be analyzed through the techniques of the event trees and of the decision trees. These techniques to deal with uncertainty have the advantage to highlight the key critical aspects in the formation of the value of a project along its life. Typically, during the initial phases idiosyncratic risks are the prevailing ones, and they can determine the survival or abandonment of an initiative. Once the uncertainty surrounding the first phases of the life cycle of an initiative has been solved, systemic (market) risk factors tend to emerge.
Such analyses on the risk profiles have important consequences on the choices regarding the determination of which is the most appropriate discount rate to be applied. Indeed, if the dominant risk is an idiosyncratic one, the risk-free rate can be used assuming a Capital Asset Pricing Model framework (Chapter 8). In the opposite case, some more complex techniques deriving from the valuation models of financial option should be used.
Chapter 2
Business Forecasting for Valuation
2.1 INTRODUCTION
The business plan is the document that represents both the management strategies and the results that management expects from their implementation. As a consequence, analysts carrying out the valuation should always include the business plan in their valuation report. When the business plan is provided by the company itself (or by its advisors), a careful assessment – from both a qualitative and quantitative point of view – is a phase of paramount importance within the valuation process. Bearing this in mind, we devote this chapter to illustrate, by means of several examples, three aspects:
● The key phases of any business plan preparation
● The structure of the business plan as a function of the nature and the features of the activities carried out by the company
● The main practical issues arising when preparing or assessing a business plan.
2.2 KEY PHASES OF THE BUSINESS PLAN ELABORATION
Business plan preparation consists of several interrelated phases:
● Thorough analysis of the company features, of the market(s) it competes in, of its positioning within such market(s), and of the past performance achieved
● Definition of the precise competitive strategies that the management is expected to pursue the future
● Definition of the actions that need to be implemented to pursue those competitive strategies
● Definition of the quantitative assumptions underpinning the forecast income statement, balance sheet, and cash flow statement
● Preparation of the forecast income statement, balance sheet, and cash flow statement
2.2.1 Markets, Competitive Positioning, and Past Results
In order to prepare accurate and reliable forecasts, it is necessary to deeply understand and analyze the markets the company is operating in.
The articulation and the complexity of the analysis to be carried out are a function of several variables, including the number of business segments the company operates. The following cases are indeed possible:
● The company operates in unrelated businesses (e.g., the case of the so called “holding companies”);
● The company operates in different geographical markets. In case such markets differ because of nature and intensity of the competition, it is advisable to carry out in depth analyses for each of them.
● The business unit(s) targets different distribution channels (e.g., the company sells its products through both its proprietary website and a network of retail stores)
● Hybrid situations that mix the cases above.
2.2.2 Definition of the Competitive Strategies
The definition of the competitive strategies expected to implemented by the company over the business plan horizon is certainly a key aspect.
If the company operates in different sectors, the competitive strategies should be prepared both at the overall company level and at any single business unit level.
Competitive Strategies at Company Level
The definition of competitive strategies at the company level should include the following aspects:
● The sectors in which the company is expected to operate in. This element impacts on:
● Shutting down or divesting business units
● Planning the entry in new segments/sectors (if appropriate via extraordinary corporate transactions such as M&A or joint ventures)
● The legal structure to adopt. Some possible choices are:
● Comprehensive unique legal entity embedding all the operations regardless of the nature of the businesses
● Creation of a holding with coordination and headquarters functions; such parent company would own (entirely or partially) subsidiaries running the different business the company operates in
● Mixed structure where the parent company runs some operating activities and runs other activities via legally independent subsidiaries and
● The best way to get and structure financing. Companies may decide, for example, to finance their growth by going public listing their shares on a stock exchange, opening their capital and raising primary proceeds that will be invested to carry out the growth plans. In the case of large corporations, there might be an “internal capital market” that provides financing for new business/projects via cash pooling arrangements with the subsidiaries. In general, companies can choose from these alternatives:
● Render the legal subsidiaries financially autonomous from the parent company, with the consequence that each subsidiary is free to arrange and procure autonomous financing on the private and public markets in the way it prefers.
● Manage the raising of financing at holding level, redistributing it through the group entities by means of intragroup loans.
● Use a mix of the two above.
● The tax strategy at corporate level. For instance:
● Assessment of the opportunity to consolidate the fiscal incomes generated by the different legal subsidiaries.
● Definition of the transfer pricing policies (this is the most common choice of multinational corporations).
● The investment and management strategy of the corporate intangible assets. For instance, the intangible assets could be:
● Controlled by the single legal entities that have developed or bought it.
● Concentrated in a unique legal entity created ad-hoc to develop, maintain, and protect the overall company intangible assets stock in the best possible way. The other legal entities of the group can use the intangible assets
