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The trading of weather derivatives has changed how the world views managing cash flow and earnings fluctuations associated with weather volatility.
In 1996, energy trading firm Aquila Energy and utility company Consolidated Edison transacted the first weather trade. A broad range of weather derivative futures, options and swap products is available – including those based on temperature, rain, snowfall, wind and frost.
Indeed, energy companies are the main users of weather derivatives, as demand for their products can vary drastically due to extreme weather conditions. CME Group launched the first weather derivative contracts in 1999 to help businesses manage their exposure to temperature-based risk. Utilities and energy companies were the main users of weather futures and options when CME Group first introduced weather derivatives, but the expanded product slate has captured the interest of a diverse set of market participants across several sectors, including construction, hedge funds, retailing, manufacturing, agriculture, insurance and reinsurance. Trading these products on an exchange offers these participants price transparency, financial safeguards and capital efficiencies. On the other hand, while OTC trades in the weather market allow firms to tailor contracts to their individual needs, these transactions can be illiquid, are subject to credit risk exposures and have high transaction costs. Nicholas Ernst, director of weather markets for Choice Natural Gas, says that temperature-based derivatives have been a game changer for utilities that don’t pass through their weather risk to their rate base: “Our customers have been able to effectively transfer their weather risk,” he says. Users of the market say main areas of growth for this product outside of the United States are Europe, specifically London, Amsterdam and Paris. The use of weather derivatives leads to higher market valuations, investments and leverage, according to a scholarly paper distributed in 2010 by Francisco Perez-Gonzalez, an assistant professor of Finance from Stanford University and faculty research fellow of the National Bureau of Economic Research (NBER), and Hayong Yun, an assistant professor of Finance at the Eli Broad College of Business at Michigan State University.
Both company decision makers and shareholders of companies are more educated about available instruments. Market participants have also become more sophisticated and the use of weather derivatives has become more international in scope.
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When interviewing for a junior private equity position, a candidate must prepare for in-office modeling tests on potential private equity investment opportunitiesa€”especially LBO scenarios.
Below we provide the given information from a real-life LBO test that was given to a pre-MBA associate candidate at a large PE firm. ABC Company incurs a 15% bad debt allowance on total revenues (consider this as part of cost of sales, wherein ABC Company is unable to collect from customersa€™ credit card companies). Due to the depressed macroeconomic and investing environment, the PE fund is able to acquire ABC Company for the inexpensive purchase price of 5.0x 2011 EBITDA (assuming a cash-free debt-free deal), which will be paid in cash.
Assume that existing management expects to roll-over 50% of its pre-tax exit proceeds from the transaction. Assume that all cash beyond the minimum cash balance of $5 million and the required amortization of each tranche is swept by creditors in order of priority (i.e. As part of the in-person LBO test, pre-MBA and post-MBA candidates are expected to complete the following exercises in their entirety.
Build an integrated three-statement LBO model including all necessary schedules (see below). Build an annual operating forecast for ABC Company with the following scenarios (using 2010 as the first year for the revenue forecast; note that 2010 EBITDA should be approximately $25 million).
Build a Working Capital schedule using Accounts Receivable Days, Accounts Payable Days, Inventory Days, and other assets and liabilities as a percentage of Revenue.
Note that the above description incorporates all of the information, assumptions and assignments that were given in this LBO in-person test example. As part of the first step, build out the core operating Income Statement line items for years 2010 through 2016.
Based on the provided assumptions, the Upside Case estimates an annual increase of 5.0% for Revenue from 2012-2016. Note that the highlighted a€?1a€? is the input to the operating model, and the a€?5.0%a€? in grey background represents the formula that is built to pick up the appropriate case. OFFSET is a simple Excel formula that is used commonly to interchange scenarios, especially if the model becomes very complex.
As part of the second step, build out the transaction summary section which will consist of the Purchase Price Calculation, Sources and Uses, and the Goodwill calculation.
The management rollover is simply half of the management teama€™s proceeds from selling the company.
The total equity (including management rollover) represents about 30-35% of the funding for the deal, which is about right for a typical LBO transaction. Goodwill is simply the excess paid for the original equity (offer price a€“ book value of equity). Since this is a cash-free and debt-free deal to start, there are no Pro Forma adjustments for the cancelling or refinancing of debt. Cash increases by $5 million upon close because the sponsor is funding the minimum cash balance (minimum cash that is assumed to be needed to run the business). The New Goodwill is simply the purchase value of the equity (not including fees) less the original book value of the equity. The adjustment for Debt Financing Fees reflects the cost of issuing the new debt instruments to buy the company. The Debt-related adjustments reflect the new debt instruments for the new capital structure. The Equity adjustment reflects the fact that the original equity is effectively wiped out in the transactiona€”the a€?adjustmenta€? amount shown here is simply the difference between the new equity value and the old one. VERY IMPORTANT: This stage of the LBO model development (once Pro Forma adjustments have been made to reflect the impact of the transaction on the balance sheet) is a very good time to check to make sure that everything in the model so far balances and reflects the given assumptions. You can link the Revenue, COGS and SG&A calculations to the operating model (built in Step 1) to get to EBITDA. To get from EBITDA to Net Income, set up the framework first (include line items to subtract D&A, and to subtract Interest and fees, to get to EBT.
Interest Expense and Interest Income will be linked to the Debt Schedule that you will need to build.
The amortization of Deferred Financing Fees is fairly straightforward: it uses a straight-line, 5 year amortization of the fees described in the case write-up and computed in Step 2. Laying out the Balance Sheet is similar to laying out the Income Statementa€”youa€™ll have to set up the framework for some line items and leave the formulas blank at first, as they will be calculated in the other schedules you will create. Cash remains at $5 million throughout the life of the model, as wea€™re assuming a 100% cash flow sweep and that the minimum cash balance is $5 million. Youa€™ll need to build out the Operating Working Capital line items (Accounts Receivable, Inventory, Other Current Assets, Accounts Payable, Other Current Liabilities) according to the assumptions stated in the case write-up. Accounts Receivable (AR): Calculate AR days (AR A· Total Revenue A— 365) for 2011 and keep it constant throughout the projection period.
Inventory: Calculate Inventory days (Inventory A· COGS A— 365) for 2011 and keep it constant throughout the projection period.
Other Current Assets: Keep this line item as a constant percentage of revenue throughout the projection period. Accounts Payable (AP): Calculate AP days (AP A· COGS A— 365) for 2011 and keep it constant throughout the projection period. Other Current Liabilities: Keep this line item as a constant percentage of revenue throughout the projection period.
Total Deferred Financing Fees are computed based upon the Debt balances and percentage assumptions given in the model. Equity (specifically Retained Earnings) will increase each year by the same amount as Net Income, because there are no dividends being declared. As discussed earlier, the balance sheet has the pleasing feature that if it balances, the model is probably operating correctly! The primary purpose of the Cash Flow Statement in the integrated financial model is to calculate the Levered Free Cash Flow (LFCF) being generated by the business. Start with Net Income and add back non-cash expenses from the Income Statement, such as D&A, Non-Cash Interest (PIK), and Deferred Financing Fees. Even though the amount is not changing, the Cash line item should link back to the Balance Sheet.
New Depreciation is calculated based on the annual investment in Capital Expenditures over the projection period.
Next, forecast the Debt Paydown and Interest Expenses for each year via the Debt Schedule, as requested in the Exercises section. WARNING: Be very careful about changing formulas once you have built the iterative calculation. To compute the changes in Debt balances, calculate LFCF (the framework for this started already on the Statement of Cash Flows).
The non-discretionary portion is the required amortization payments made on debt (in this case, there is only required pay-down for subordinated debt).


The discretionary portion is the sweep portion of the remaining LFCF less required amortization. Also note that we need to include a fee for the availability of the unused portion of the RCF, even if the business never uses ita€”this is a typical, annual commitment fee arrangement for revolving credit facilities.
The interest rate on the debt is a floating rate (this means an interest rate that is dependent on LIBOR, according to the assumptions provided). However, the 4% PIK (non-cash) interest will accrue based upon the beginning debt balance, not the average.
Because of this difference (and the fact that one source of interest uses cash and the other does not), we need to make sure wea€™re using separate line items for the two types of Interest Expense. We also need to be aware of the mandatory amortization payment of $1 million per year, provided in the assumptions. Interest Income on Cash is fairly easy to calculatea€”it is the Cash interest rate (1%) times the average balance throughout the year. When wea€™ve finished with these calculations, we need to link these line items to various line items in the integrated financial statement.
Non-Cash Interest needs to be added back to Net Income in the Statement of Cash Flows to assist in deriving LFCF (ita€™s a non-cash expense).
Any LFCF that is not used to pay down Debt needs to link to the Cash line item of the Balance Sheet. All Debt balances paid down by LFCF need to link to the Debt line items on the Balance Sheet. In the final step of the LBO test, build out the Returns calculation required in the Exercises section. For each year, we simply take EBITDA multiplied by a range of purchase multiples to get to a total Exit Value for the company (Transaction Enterprise Value, or TEV). Next, we subtract out Net Debt (which is dependent on the 3-statement model you just created) to get to Equity Value. Next, we calculate the portion of the Equity Value that belongs to the management and the sponsor by using the initial equity breakdown for each party. From there ita€™s important to calculate both the internal rate of return (IRR) and the cash-on-cash returns (also known as the Multiple of Money or Multiple of Invested Capital).
Put simply, the IRR is equal to the cash-on-cash returns compounded by the number of years, minus 1. We hope that this case study provides some insight into all of the considerations that need to be made in building a realistic LBO model based on a case study in a Private Equity interview, and that the 9-step breakdown helps you simplify the task into easy-to-replicate and easy-to-execute steps. No one becomes an expert LBO modeler overnight, so the key to doing well in this portion of the process is practice, practice, and more practice. A professor of cognitive science argues that the world is nothing like the one we experience through our senses.
Every week, for the sixth season of Game of Thrones, Christopher Orr, Spencer Kornhaber, and Lenika Cruz will be discussing new episodes of the HBO drama.
In January of 1944, in the midst of the terrifying days of World War II, President Franklin Delano Roosevelt unveiled a huge idea in his State of the Union address. Why a high school senior feels alienated from activist groups that share causes in which he believes. A new report demonstrates a stubborn chasm between rich and poor students earning bachelor’s degrees. The nation’s colleges continue to graduate far fewer students who grew up in poor households. How globalization exacerbated the wildly different problems of Zika, ISIS, and Donald Trump.
Epidemics, terrorism, and demagoguery have afflicted the world for centuries, even as they’ve consistently taken on new forms. Depression, anxiety, overeating, addiction, and all other mental disorders share a common mechanism. An adjusted trial balance is a listing of all company accounts that will appear on the financial statements after year-end adjusting journal entries have been made. Preparing an adjusted trial balance is the fifth step in the accounting cycle and is the last step before financial statements can be produced.
Like the unadjusted trial balance, the adjusted trial balance accounts are usually listed in order of their account number or in balance sheet order starting with the assets, liabilities, and equity accounts and ending with income and expense accounts. You could post accounts to the adjusted trial balance using the same method used in creating the unadjusted trial balance.
You could also take the unadjusted trial balance and simply add the adjustments to the accounts that have been changed. Note that only active accounts that will appear on the financial statements must to be listed on the trial balance.
Using Paul's unadjusted trial balance and his adjusted journal entries, we can prepare the adjusted trial balance. Now that the trial balance is made, it can be posted to the accounting worksheet and the financial statements can be prepared. In the past, circumstances such as extreme temperature swings or a lack or overabundance of precipitation could have significant effects on vast sectors of the global economy.  Now there is a way to manage and hedge against weather uncertainty. These products enable market participants to manage global weather-related risk such as catastrophic hurricanes, heat waves and coldbreaks, while also offering opportunities to speculate – absorbing that risk in exchange for possible profit on weather variations. In fact, within the last decade, the Weather Risk Management Association has reported that nearly 70 percent of the end users of weather derivatives were from the energy sector. To help manage that impact on consumers and corporations, CME Group’s product slate has grown to meet customer needs by offering multiple risk management opportunities related to temperature, snowfall, frost, rainfall and hurricanes in more than 50 cities in the United States, Europe, Asia, Australia and Canada.
Users of the market say energy firms, retail and other entities often impacted by weather conditions are simply becoming more adept with taking risk management positions. Some of the newest participants in the market have included end users in the retail, construction and beverage industries. In the course of her career, she's served as a reporter for Dow Jones & Company as well as for Knight-Riudder Financial. The magazine features customer case histories, new product information, technology updates, trend stories, and timely online-only news briefs.
CME Group exchanges offer the widest range of global benchmark products across all major asset classes, including futures and options based on interest rates, equity indexes, foreign exchange, energy, agricultural commodities, metals, weather and real estate. Specific recommendations can only be based on review of clienta€™s individual investment objectives upon request and with clienta€™s review of appropriate offering documents.
The content, to which you link will not have been developed, checked for accuracy, or otherwise reviewed by Newbridge Securities Corporation.
We will use it as an example of how to build an LBO model from scratch during the interview. ABC Company renews approximately 25% of the licenses it sold in the prior year; this renewal fee acts as a source of recurring revenue. RCF is available to help fund operating cash requirements of the business (only as needed).
Assume that the M&A fee cannot be expensed (amortized) by ABC and will be paid out of the sponsor equity contribution upon close. However, you will need to build out the income statement for 2010 and 2011 to forecast the financial statements for years 2012 through 2016. Assume working capital metrics stay constant throughout the projection period and assume 365 days per year.
Use average balances for calculating Interest Expense (except for PIK interesta€”assume that PIK interest is calculated based on the beginning year Subordinated Debt balance and not the average over the year). Next, you should build the following exhibit in Excel in order to be able to change the case scenarios easily (with the selected case driving the revenue growth numbers in the operating model). Be sure to think through each number and how it is calculated, as this is the main summary of the LBO transaction as a whole.
Without debt or cash, the transaction value is simply equal to the offer price for the equity (before fees and minimum casha€”discussed below). Since management owned 10% of the company before the transaction, it constitutes 5% of the offer price for the original equity.
In other words, it is the amount that is solved for once all other amounts are known (offer price + minimum cash + fees a€“ debt instruments a€“ management rollover equity).
To do this, you need to incorporate all the transaction and financing-related adjustments needed to produce the Pro Forma Balance Sheet. The new equity value will equal the amount of the total equity funding for the transaction (sponsor plus managementa€™s rollover) less the M&A fee, which is accounted for as an off balance-sheet cost. This includes old and new assets equaling old and new liabilities plus equity; new sources of capital equaling the transaction value, which equals the offer price for the original equity (adjusting for cash, old debt and fees), etc. Note that a few line items (especially Interest Expense!) will be calculated in later steps. Then subtract taxes to get Net Incomea€”but keep in mind for now that calculating D&A and Interest will come a bit later, from other schedules you have not yet created).
There will be a natural circular reference because of the cash flow sweep feature of the LBO model, combined with the fact that Interest Expense is dependent upon Cash balances.


Note that we start with the 2011 Pro Forma Balance Sheet from Step 3, not the original Balance Sheet. Their balances will decrease over time as a function of the cash available for Debt paydown (since the case write-up specifies a 100% cash sweep function). If dividends were to be added into the model, you would calculate ending Retained Earnings as Beginning Retained Earnings + Net Income a€“ Dividends Declared. This is for obvious reasons: cash generation is very important in the eyes of PE investors, as it is used to pay down debt and thereby increase equity value (and thereby decrease future interest burdens on the business, which helps to decrease risk over time). These include the increase in Operating Working Capital (which you calculated using your balance sheet) and Capital Expenditures (which is calculated here or, alternatively, could be calculated in the Depreciation Schedule to be built shortly). In this case, the model is assuming a 100% cash flow sweep (after mandatory debt amortization payments), so cash should not change after the 2011PF Balance Sheet amount of $5 million. This is because the model could later be used to relax the assumption that 100% of excess cash is swept to pay down Debt. Given that Capital Expenditures do not change each year, and that each new Capital Expenditure is depreciated according to the same simple schedule, the numbers and calculations are fairly straightforward. The Debt Schedule is probably the trickiest part of the LBO model to builda€”especially for anyone who has not built an LBO model before. If you do so and introduce an error, it could bust your entire model if youa€™re not careful. This determines how much debt is going to be paid down (both discretionary and non-discretionary).
Since wea€™re assuming a 100% cash flow sweep, all of the LFCF is used to pay down debta€”first the Senior Credit Facility, then the Subordinated Debt. It should be completely paid off before later tranches receive any discretionary principal repayment in the Debt Schedule. This is essentially a simple calculation based upon the outputs generated by rest of the model.
The only tricky part of this calculation is to make sure that youa€™re calculating IRR correctly, by using the correct Net Present Value or IRR formula and that, very importantly, youa€™re discounting by the right number of years!
With enough sample LBO cases, you should be able to master the steps needed to confidently build a fully functioning, professional LBO model on interview day. There stands the Red Woman, Melisandre, the goddess behind so much of the show’s deus ex machina, in her bedroom. Because no screeners are being made available to critics in advance this year, we'll be posting our thoughts in installments.
The nation had fought its enemies to ensure its residents remained free, he said, but American citizens could not be truly free if they were constantly worrying about where their next meal was coming from or if they could afford a roof over their heads.
With well-paying jobs in manufacturing and the trades largely a relic of the nation’s industrial past, the middle-class pathways for workers with just a high-school education are few and far between.
Three columns are used to display the account names, debits, and credits with the debit balances listed in the left column and the credit balances are listed on the right.
Typically, the heading consists of three lines containing the company name, name of the trial balance, and date of the reporting period. Both ways are useful depending on the site of the company and chart of accounts being used. The account balances are taken from the T-accounts or ledger accounts and listed on the trial balance. In many ways this is faster for smaller companies because very few accounts will need to be altered.
Extrapolate potential figures to the scale of the entire world, and you have a stunning picture. Weather futures and options are available for block trading, which are privately negotiated futures, options, or combination transactions. And no doubt, a heightening intensity in global weather events is likely to draw an even larger focus on these products going forward. She currently runs her own media effort, Geodialog Media LLC, and has a patent pending on technology that aims to improve the news delivery process. CME Group brings buyers and sellers together through the CME Globex electronic trading platform and trading facilities in New York and Chicago. Newbridge Securities Corporations does not warrant or make any representations regarding the use, or the results of the use of the materials in those sites in terms of their correctness, accuracy, or reliability.
In-office case studies and modeling tests can occur at various stages of an interview process, and additional interviews with other members of the private equity team could occur on the same day. Repeated practice, checking for errors and difficulties and learning how to correct them, all the while enhancing your understanding of how an LBO works, is the key to success. Remember that candidates will receive a laptop and a printout with key information regarding the transaction to complete this assignment. To simplify, assume that renewals happen for only one additional year and that the recurring revenue stream is based on the prior yeara€™s new licenses. Thus, for example, =OFFSET(A1, 3, 1) will read the value in cell B4 (3 rows and 1 column after A1). Once the Cash Flow section and other schedules are built, link all the final line items to complete the integrated financials.
If ita€™s less than 100%, Cash would accumulate, and that would need to tie in to the other financial statements. The sum of all of the component Depreciation line items (one row for each year, plus the Depreciation on the original PP&E) gives the total Depreciation Expense for the year. Here, wea€™re simply assuming that new Capital Expenditures are expensed evenly over a 5 year period (using straight-line depreciation), as specified in the case write-up.
The Debt Schedule will create the circular (iterative) reference that is the defining characteristic of a true LBO model.
This is because the error will travel all the way through the iterative calculations and end up everywhere! The cash flow sweep and required payments will help you calculate the beginning and ending balances of both of the debt tranches.
After all the mental energy youa€™ve expended to get to this point, ita€™s easy to make this mistake. The current Zika epidemic started in 2015, but the virus was first identified in a monkey in Uganda’s Zika Forest in 1947.
If they aren't equal, the trial balance was prepared incorrectly or the journal entries weren't transferred to the ledger accounts accurately.
Essentially, you are just repeating this process again except now the ledger accounts include the year-end adjusting entries. Then, in late 1999, CME launched an exchange-traded market.  Each is a multi-billion dollar market in notional value today. Futures contracts are also available to be traded on CME Globex, and options contracts are available via open outcry on the CME trading floor.
She is a member of the TechNexas community, which was named one of the top 10 tech incubators in the U.S. CME Group also operates CME Clearing, one of the largest central counterparty clearing services in the world, which provides clearing and settlement services for exchange-traded contracts, as well as for over-the-counter derivatives transactions through CME ClearPort. Therefore, you should strive to be able to do these studies effectively and efficiently without draining yourself so much that you cana€™t quickly rebound and move on to the next interview.
Before linking the Debt, Cash, and Interest calculations to one another in the Debt schedule, be sure to turn a€?Iterationsa€? on in the Formulas section of Microsoft Excela€™s Options menu. If you run into this problem, break the circular reference entirely (by deleting it), reconstruct the calculations for the first forecast year (2012), and then copy and paste them across the columns, one year at a time (2013, then 2014, etc.). The answer: 47 percent of respondents said that either they would cover the expense by borrowing or selling something, or they would not be able to come up with the $400 at all. ISIS rose to international prominence in 2014, but it traces its ideological lineage and some of its leadership to al-Qaeda, a terrorist group formed in 1988, and even further back to ideas of radical Islam sketched out in Egypt in the 1960s. Beyond utilities seeking weather protection, market participants utilizing the weather markets include dedicated brokers and market makers, investment banks, insurance and re-insurance firms, and hedge funds. DWA is a world leader in supplying technical research services to the financial services industry.A  DWA is not affiliated with Newbridge Securities or COR Clearing.
Make sure to take your time and build every formula correctly, since this process is not a race. Many PE professionals have spent late nights in the office trying to recover from an accidental error introduced into a circular LBO model formula! There are many complex formulas in this test, so make sure you understand every calculation. All that remains is her necklace—a choker made of metal, completed with a red stone.




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