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1.Introduction• Pricev.Value• Absolutevaluationv.Relativevaluation
2.DCFModels• ThegeneralDCFmodel• Steps• Versions:WACC,APV,andFTE• Complementaryissues
CorporateFinanceDCFValuation
JavierEstradaSpring,2014
JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
IntroductionTwoimportantdistinctions Pricev.Value
• Priceiswhatyoupay,valueiswhatyouget! Absolutevaluationv.Relativevaluation
• AbsolutevaluationDCFmodels:DDM,WACC,APV,FTE ValueisderivedfromfundamentalsinaPVcalculation(Cashflows,notearnings,andtheirrisk) Go
• RelativevaluationMultiples:P/E,P/B,P/CF,P/D,… Valueisderivedfromalignmenttoabenchmark
RememberacriticalpointWhenvaluingstocks,thereisampleroomforreasonable disagreement Go
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JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
TheGeneralDCFModel
Twokeyvariables Expectedcashflows
• T dependsontheasset• Oftenaterminalvalue playsaroleinE(CFT)
Discountrate• R =Rf +RP Rf:Risk‐freerate
(Compensatestheexpectedlossofpurchasingpower)
RP:Riskpremium(Compensatesriskbearing)
JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
DCFModel– StepsBasicsteps1. Chooseamodel2. Estimatetheappropriatefreecashflows (FCF)forthatmodelovertheforecastingperiod (T)
3. Estimateaterminalvalue (TV)4. Estimatetheappropriatediscountrate (DR)forthatmodel
5. Calculatethepresentvalue ofallFCFsdiscountedattheDR
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JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
Step1– ModelThereareseveralversionsoftheDCFmodelWACCmodel
• Discountsunlevered FCFsatthecostofcapital APVmodel
• Discountsunlevered FCFsattheunleveredcostofequity
• Addsthenetpresentvalueofdebteffects FTEmodel
• Discountslevered FCFsatthecostofequityRecall TheDDMisjustanotherversionoftheDCFmodel
• Discountsdividendsatthecostofequity
JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
Step2– FreeCashFlows
Remarks FCFscanalsobecalculatedbeginningfromEBIT
• UFCF=(1–tc)⋅EBIT+Dep– NetCapEx– IncreaseNWC UFCFsareindependentfromthecapitalstructure Go
IncomeStatement FreeCashFlowsRevenues NetIncome– OperatingCosts +After‐taxInterest– Depreciation +DepreciationEBIT OperatingCashFlow– Interest – NetCapExEarningsBeforeTaxes – IncreaseinNWC– Taxes UnleveredFCF(UFCF)NetIncome – After‐taxInterest
LeveredFCF(LFCF)
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JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
Step3– TerminalValueTheterminalvaluecanbeestimatedinseveralways,andisusuallyestimatedinoneoftwoways Agrowingperpetuity Amultiple(M)ofafundamentalvariable
JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
Step4– DiscountRateThediscountratedependsontheFCFsused,whichinturndependsonthemodelchosenWACCmodel
• Costofcapital(RWACC) APVmodel
• UFCFsattheunleveredcostofequity(RU) CAPMwithanunleveredbeta
• Taxshieldsattherequiredreturnondebt(RD) FTEmodel
• Leveredcostofequity(RL) CAPMwithaleveredbeta
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JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
Step5– PresentValueCalculationWACCmodel Go
Remarks ThePVoftheUFCFsyieldsthevalueofthecompany
• V=D+E Thevalueofthecompany’sequity isobtainedaftersubtractingtheassumedlong‐termdebtfromV• E=V–D
TheimpactofdebtisaccountedforinRWACC
JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
Step5– PresentValueCalculationAPVmodel
Remarks Thevalueofthecompany isgivenbythePVoftheUFCFsplusthenet impactofdebt(V=D+E) Thevalueofthecompany’sequity isobtainedaftersubtractingtheassumedlong‐termdebtfromV(E=V–D) Theimpactofdebtisaccountedforintheusually‐miswritten lastterm‘NPV(D)’
Unfortunately,theAPVisusuallywrittenas…
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JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
Step5– PresentValueCalculationFTEmodel
Remarks ThePVoftheLFCFsyieldsthevalueofthecompany’sequity• Nodebthastobesubtractedfromthisvalue
TheimpactofdebtisaccountedforbothintheLFCFsandinRL
JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
ComplementaryIssues
WACCmodel(Validfortheothermodelsaswell) Forecastingperiod
• Howlong?Whatgrowthrate? Stagesofgrowth
• Howlongeach?Whatgrowthrateforeach? Terminalvalue Go
• Caneasilybe40‐60%oftheestimatedvalue• Alwaysperformsensitivityanalysisonit(ong orM)• Keepinmindlong‐termconstraints(g≤gGDP)
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JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
ComplementaryIssues Intheory,allthreemodels(andtheDDM)shouldyieldexactlythesameresult Inpractice,theyhardlyeverdo
Whentouseeachmodel?WACCorFTE
• Usuallywhentheproportions ofdebtandequityareexpectedtobe(moreorless)constantovertime
APV• Usuallywhenthelevel offuturedebtis(moreorless)knowninadvance
Otherissuesthathavetobedealtwith Circularity,targetcapitalstructures,…
JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
Appendix
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JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
WhyCashFlow?
JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
WhyCashFlow?
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JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
ReasonableDisagreements
JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
ReasonableDisagreements
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JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
UFCFsandCapitalStructureIncomeStatement NoDebt WithDebtRevenues 16,667 16,667– OperatingCosts 15,000 15,000– Depreciation 100 100
=EBIT 1,567 1,567– Interest 0 300
=EBT 1,567 1,267– Taxes(40%) 627 507
=NetIncome 940 760
UFCFsNetIncome 940 760+After‐taxInterest 0 180+Depreciation 100 100
=OperatingCF 1,040 1,040– IncreaseinNWC 100 100– NetCapEx 100 100
=UnleveredFCF 840 840Back
JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
TheWACCModel
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JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
TerminalValue
JavierEstrada
IESEBusinessSchool
BarcelonaSpain
MBACorpFinSpring,2014
TerminalValue
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