Download pdf - Corporate Finance DCF Valuation - IESE• Absolute valuation v. Relative valuation 2. DCF Models • The general DCF model • Steps • Versions: WACC, APV, and FTE • Complementary

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Page 1: Corporate Finance DCF Valuation - IESE• Absolute valuation v. Relative valuation 2. DCF Models • The general DCF model • Steps • Versions: WACC, APV, and FTE • Complementary

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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

Page 2: Corporate Finance DCF Valuation - IESE• Absolute valuation v. Relative valuation 2. DCF Models • The general DCF model • Steps • Versions: WACC, APV, and FTE • Complementary

2

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

Page 3: Corporate Finance DCF Valuation - IESE• Absolute valuation v. Relative valuation 2. DCF Models • The general DCF model • Steps • Versions: WACC, APV, and FTE • Complementary

3

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)

Page 4: Corporate Finance DCF Valuation - IESE• Absolute valuation v. Relative valuation 2. DCF Models • The general DCF model • Steps • Versions: WACC, APV, and FTE • Complementary

4

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

Page 5: Corporate Finance DCF Valuation - IESE• Absolute valuation v. Relative valuation 2. DCF Models • The general DCF model • Steps • Versions: WACC, APV, and FTE • Complementary

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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…

Page 6: Corporate Finance DCF Valuation - IESE• Absolute valuation v. Relative valuation 2. DCF Models • The general DCF model • Steps • Versions: WACC, APV, and FTE • Complementary

6

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)

Page 7: Corporate Finance DCF Valuation - IESE• Absolute valuation v. Relative valuation 2. DCF Models • The general DCF model • Steps • Versions: WACC, APV, and FTE • Complementary

7

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

Page 8: Corporate Finance DCF Valuation - IESE• Absolute valuation v. Relative valuation 2. DCF Models • The general DCF model • Steps • Versions: WACC, APV, and FTE • Complementary

8

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

WhyCashFlow?

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

WhyCashFlow?

Back

Page 9: Corporate Finance DCF Valuation - IESE• Absolute valuation v. Relative valuation 2. DCF Models • The general DCF model • Steps • Versions: WACC, APV, and FTE • Complementary

9

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

ReasonableDisagreements

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

ReasonableDisagreements

Back

Page 10: Corporate Finance DCF Valuation - IESE• Absolute valuation v. Relative valuation 2. DCF Models • The general DCF model • Steps • Versions: WACC, APV, and FTE • Complementary

10

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

Back

Page 11: Corporate Finance DCF Valuation - IESE• Absolute valuation v. Relative valuation 2. DCF Models • The general DCF model • Steps • Versions: WACC, APV, and FTE • Complementary

11

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

TerminalValue

JavierEstrada

IESEBusinessSchool

BarcelonaSpain

MBACorpFinSpring,2014

TerminalValue

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