{"id":29586,"date":"2023-01-04T12:27:49","date_gmt":"2023-01-04T12:27:49","guid":{"rendered":"https:\/\/analystprep.com\/study-notes\/?p=29586"},"modified":"2025-12-31T08:17:07","modified_gmt":"2025-12-31T08:17:07","slug":"modeling-and-valuation","status":"publish","type":"post","link":"https:\/\/analystprep.com\/study-notes\/corporate-finance\/modeling-and-valuation\/","title":{"rendered":"Modeling and Valuation"},"content":{"rendered":"<p><script type=\"application\/ld+json\">\n{\n  \"@context\": \"https:\/\/schema.org\",\n  \"@type\": \"QAPage\",\n  \"mainEntity\": {\n    \"@type\": \"Question\",\n    \"name\": \"Which decisions will an investment grade issuer most likely make to avoid moving to a speculative grade rating following an acquisition?\",\n    \"text\": \"Which decisions will an investment grade issuer most likely make to avoid moving to a speculative grade rating following an acquisition?\\n\\nA. Use a large proportion of stock.\\nB. Borrow from banks instead of issuing bonds.\\nC. Use a large proportion of cash.\",\n    \"answerCount\": 1,\n    \"acceptedAnswer\": {\n      \"@type\": \"Answer\",\n      \"text\": \"Use a large proportion of stock.\\n\\nFinancing an acquisition with a higher proportion of equity reduces the need for additional debt or cash, helping the issuer preserve its credit metrics and avoid a downgrade to speculative grade.\\n\\nBorrowing from banks rather than issuing bonds does not materially change the issuer\u2019s credit profile, as both forms of debt increase leverage. Using cash has a similar effect on net debt as borrowing and therefore does not help prevent a downgrade.\",\n      \"dateCreated\": \"2025-12-31\"\n    }\n  }\n}\n<\/script><\/p>\n<p><iframe loading=\"lazy\" src=\"\/\/www.youtube.com\/embed\/6644l74Og94\" width=\"611\" height=\"343\" allowfullscreen=\"allowfullscreen\"><\/iframe><\/p>\n<p>A pro forma financial statement is an estimated financial statement with restructuring effects. The pro forma financial statement includes the EPS, revenue, and free cash flow measures. The situational specifics and the type of restructuring will determine the process of creating the pro forma financial statement.<\/p>\n<h2><strong>Financial Modeling Steps for Acquisitions<\/strong><\/h2>\n<ol type=\"1\">\n<li>The acquirer\u2019s and target\u2019s financials are combined.<\/li>\n<li>The financing effect of the transaction is included.<\/li>\n<li>The lack of synergies or the effect of synergies and incompatibilities in forecasted costs and revenue is projected.<\/li>\n<li>The divesture effect, either voluntary or involuntary, required by regulators for the approval of the acquisition is incorporated.<\/li>\n<li>Adjustments for goodwill recognition and the book value increase of the target\u2019s assets and liabilities to fair value are made.<\/li>\n<\/ol>\n<h2>Pro forma Weighted Average Cost of Capital<\/h2>\n<p>The weighted average cost of capital is used to estimate the required rate of return used to discount the pro forma free cash flow. The market value weighted average cost of capital of an issuer\u2019s debt-equity and other capital is an issuer\u2019s cost of capital.<\/p>\n<p>Restructuring changes the weights of each type of capital, the cost of each capital type, and the capital structure. An example is an acquirer buying a target entirely with cash financed largely by debt. This will cause the capital structure to shift from equity to debt as debt increases, given that the price change is not material. It is more challenging to estimate the restructuring effect on the cost of equity and debt than to estimate changes in capital structure weights.<\/p>\n<p>Restructuring changes the cost of capital by changing the factors that affect the cost of capital. Thus, it is common for an investment-grade issuer to structure transactions to reduce their weighted average cost of capital and maintain their investment-grade rating. Moving to a speculative grade credit rating will increase WACC.<\/p>\n<blockquote>\n<h2>Question<\/h2>\n<p>Which decisions will an investment grade issuer <em>most likely<\/em> make to avoid moving to a speculative grade rating following an acquisition?<\/p>\n<ol type=\"A\">\n<li>Use a large proportion of stock.<\/li>\n<li>Borrow from banks instead of issuing bonds.<\/li>\n<li>Use a large proportion of cash.<\/li>\n<\/ol>\n<h4>Solution<\/h4>\n<p>The correct answer is<strong> A<\/strong>.<\/p>\n<p>Using more equity in an acquisition will mean that less debt and cash will be used to finance the acquisition.<\/p>\n<p><strong>B is incorrect<\/strong>. Bond debt and bank debt have no material difference from credit.<\/p>\n<p><strong>C is incorrect<\/strong>. Using cash has the same effect on net debt as borrowing.<\/p>\n<\/blockquote>\n<p>Reading 21: Corporate Restructuring<\/p>\n<p><em>LOS 21 (d) Demonstrate how corporate restructurings affect an issuer\u2019s EPS, net debt, EBITDA ratio, and weighted average cost of capital.<\/em><\/p>\n","protected":false},"excerpt":{"rendered":"<p>A pro forma financial statement is an estimated financial statement with restructuring effects. The pro forma financial statement includes the EPS, revenue, and free cash flow measures. The situational specifics and the type of restructuring will determine the process of&#8230;<\/p>\n","protected":false},"author":3,"featured_media":0,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[102,345],"tags":[],"class_list":["post-29586","post","type-post","status-publish","format-standard","hentry","category-cfa-level-2","category-corporate-finance","blog-post","no-post-thumbnail","animate"],"acf":[],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v26.9 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Modeling and Valuation - CFA, FRM, and Actuarial Exams Study Notes<\/title>\n<meta name=\"description\" content=\"Learn financial modeling steps for acquisitions, including pro forma financial statements and the pro forma weighted average cost of capital.\" \/>\n<meta name=\"robots\" content=\"index, follow, max-snippet:-1, max-image-preview:large, max-video-preview:-1\" \/>\n<link rel=\"canonical\" href=\"https:\/\/analystprep.com\/study-notes\/corporate-finance\/modeling-and-valuation\/\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Modeling and Valuation - 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