Valuation

ValuationFIN 449

Michael Dimond

Michael DimondSchool of Business Administration

Calculating Free Cash Flow to Equity• FCFE = Net income – Net investment + Net debt issued


Net Investment• Net investment = (Capital expenditures – Depreciation) +

Increase in noncash working capital


CapEx• Line item on Statement of Cash Flows?

• Calculate the changes (from year to year) of ALL long-term assets shown on the balance sheet.

• Find the total amount (for a given year) shown in the “Investing” section of the Statement of Cash Flows. Issues?


Depreciation• “Basic definition” of net cash flow = net income + depreciation

• Non-cash expense

• In the “balance sheet” approach to define capital expenditures, depreciation is usually not incorporated explicitly. Why not?

• If the “Statement of Cash Flows” approach is used, one must explicitly subtract depreciation from capital expenditures (shown in the “Operating” section of the Statement of Cash Flows)


Non-cash Working Capital• Noncash working capital = (current assets – cash) – current

liabilities… what else?

• Noncash working capital = (current assets – cash) – (current liabilities – interest bearing debt included in current liabilities) Why?

• Why not include cash?


Net Debt Issued• “Net” debt issued implies that one must take both debt

issuances AND repayments into account

• Discussion: Constant Debt Ratio– Suppose a firm always finances new investment with a fixed debt ratio

(say, 30% debt and 70% equity, for example). The general equation for FCFE could be expressed as follows:

– FCFE = Net income – (1 – debt ratio)(Net investment) OR– FCFE = Net income – (equity ratio)(Net investment)


Free Cash Flow to Equity• FCFE = Net income – Net investment + Net debt issued


Damodaran has resources online• http://pages.stern.nyu.edu/~adamodar/• His spreadsheets are not always as helpful as you might

want…• An example of a valuation summary he did in 2008

http://pages.stern.nyu.edu/~adamodar/


What Damodaran’s valuation summary looks like: September 2008


What Damodaran’s valuation summary looks like: October 2008


• Bear in mind, these were a summary. We will ultimately want something more detailed for a working document.


What does the DCF Model look like?

• What drives the figures?• How sensitive are they to basic inputs?

FC Year -> 1 2 3 4 5 Terminal ValueFCFE -> 7,941 9,291 10,236 11,262 12,376 102,804

PV of FCFE 6782.5928 6777.6741 6377.782 5993.5825 5625.4721 46729.87595SUM of PV 78,287

Cash 23,207 Terminal Growth Rate 4.5%Total Value 101,494 Rf 2.95%

Shares Outstanding 30,851 β 3.14 Value per Share 3.29$ MRP 4.50%

Adj. Close Price at 12/31/12 3.51$


• To start, compute historic FCFF & FCFE for the past 5 yearsFCFF = NI + Int(1-t) + Depr - ΔFA - ΔNWC

FCFE = NI + Depr - ΔFA - ΔNWC + ΔDebt - PfdDivFCFF = FCFE + Int(1-t) - ΔDebt + PfdDivFCFE = FCFF - Int(1-t) + ΔDebt - PfdDiv

• How accurate would it be to extrapolate the future cash flows from the past FCFE figures?• In other words, can we simply assume FCFE will grow X% forever?• Here are the historic FCFE for a company:

• Instead, we project the drivers of these figures for the future.• Compute FCFF & FCFE based on the forecast figures

2008 2009 2010 2011 2012110,737 53,050 (1,118) 5,024 25,071


Relationships in financials drives FCFF & FCFE

2012

Revenue 6,900.0$ COGS 4,700.0 Gross marginSG&A 930.0 Operating incomeOther revenues & gainsGain on sale of investments 80.0 Earnings before interest and taxesInterest expense, netEarnings before taxesIncome tax expense 40% tax rateNet income

Strawman CorporationIncome Statement

For year ended 12/31/2012

2011 2012Cash 1,150.0$ Receivables 1,300.0 1,750.0 Inventory 2,050.0 1,750.0 Total current assets 4,500.0 3,500.0 PP&E, gross 1,700.0 1,900.0 Accumulated depreciation (1,170.0) (1,200.0) Long-term investments (held-to-maturity) 1,420.0 1,300.0 Total Assets

Accounts payable 900.0 1,200.0 Short-term note @ 10% 200.0 250.0 10% interestAccrued liabilities 250.0 200.0 Total current liabilities 1,350.0 1,650.0 Long-term debt @ 5% 1,500.0 1,400.0 5% interestCapital stock 1,700.0 1,900.0 Retained earnings 1,900.0 Total Liabilities + Shareholders' Equity

As of 12/31/2012

Strawman CorporationBalance Sheet

We will start with financial statements and forecast expected reportings, then adjust to find expected future cash flows


Relationships in financials drives FCFF & FCFEWe will start with financial statements and forecast expected reportings, then adjust to find expected future cash flows

Cash flows from operations Cash flows from operationsNet income Cash collections from customersAdjustments to reconcile net income to net cash provided by operating activities LESS:Depreciation Cash paid for merchandiseGain on sale of investments Cash paid for SG&AChange in inventory Cash paid for interestChange in receivables Cash paid for income taxesChange in accounts payable Net cash provided (used) by operating activitiesChange in accrued liabilitiesNet cash provided (used) by operating activities

Cash flows from investing activities Cash flows from investing activitiesSale of held-to-maturity investments Sale of held-to-maturity investmentsPurchase of plant assets Purchase of plant assetsNet cash provided (used) by investing activities Net cash provided (used) by investing activities

Cash flows from financing activities Cash flows from financing activitiesIssuance of capital stock Issuance of capital stockRepayment of long-term debt Repayment of long-term debtProceeds from short-term debt Proceeds from short-term debtPayment of cash dividends (260.0) Payment of cash dividends (260.0) Net cash provided (used) by financing activities Net cash provided (used) by financing activities

Net increase in cash Net increase in cashCash, beginning of year Cash, beginning of yearCash, end of year Cash, end of year

Noncash investing and financing activities Noncash investing and financing activitiesIssuance of common stock for PP&E 70.0$ Issuance of common stock for PP&E 70.0$

Strawman Corporation Strawman CorporationStatement of Cash Flows - Indirect Method Statement of Cash Flows - Direct Method

For year ended 12/31/2012 For year ended 12/31/2012


We need to assess sensitivity to assumptions







SENSITIVITY ANALYSIS:New Terminal Growth Rate

% ∆ in β New β Ke 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%-40% 1.88 11.4% 4.79 4.98 5.21 5.46 5.75 6.09 6.50-35% 2.04 12.1% 4.47 4.63 4.81 5.01 5.24 5.51 5.82-25% 2.36 13.5% 3.95 4.06 4.19 4.33 4.48 4.66 4.86-15% 2.67 15.0% 3.55 3.64 3.73 3.83 3.94 4.06 4.190% 3.14 17.1% 3.11 3.16 3.22 3.29 3.36 3.44 3.52

+15% 3.61 19.2% 2.78 2.82 2.86 2.91 2.96 3.01 3.06+25% 3.93 20.6% 2.61 2.64 2.68 2.71 2.75 2.79 2.83+35% 4.24 22.0% 2.46 2.49 2.52 2.55 2.58 2.61 2.64+40% 4.40 22.7% 2.40 2.42 2.45 2.47 2.50 2.53 2.56


We need to assess sensitivity to assumptions







SENSITIVITY ANALYSIS:New Terminal Growth Rate

% ∆ in β New β Ke 3.0% 3.5% 4.0% 4.5% 5.0% 5.5% 6.0%-40% 1.88 11.4% 4.79 4.98 5.21 5.46 5.75 6.09 6.50-35% 2.04 12.1% 4.47 4.63 4.81 5.01 5.24 5.51 5.82-25% 2.36 13.5% 3.95 4.06 4.19 4.33 4.48 4.66 4.86-15% 2.67 15.0% 3.55 3.64 3.73 3.83 3.94 4.06 4.190% 3.14 17.1% 3.11 3.16 3.22 3.29 3.36 3.44 3.52

+15% 3.61 19.2% 2.78 2.82 2.86 2.91 2.96 3.01 3.06+25% 3.93 20.6% 2.61 2.64 2.68 2.71 2.75 2.79 2.83+35% 4.24 22.0% 2.46 2.49 2.52 2.55 2.58 2.61 2.64+40% 4.40 22.7% 2.40 2.42 2.45 2.47 2.50 2.53 2.56


Building the sensitivity table


Building the sensitivity table

What’s in the yellow cell in the middle of the table?(easier to click cells than type references)

=(NPV($E223,$H$206,$I$206,$J$206,$K$206,$L$206+($L$206*(1+I$218)/($E223-I$218)))+$G$209)/$G$211

You should be able to paste the foumula into the remaining cells in the table and get the correct results.

equalsgroup everything togetherPV of cash flowsKe from the sensitivity tableCF1CF2CF3CF4CF5 plus… terminal value, using %s in tableclose the NPV function add the cashdivide by the number of shares


Coming up• Strawman exercise

– Template on the course webpage– Final version due via email by midnight Sunday 4/20

• Mini-projects 1 & 2• Begin valuation #1

Documents

Valuation