ValuationFIN 449
Michael Dimond
Michael DimondSchool of Business Administration
Calculating Free Cash Flow to Equity• FCFE = Net income – Net investment + Net debt issued
Michael DimondSchool of Business Administration
Net Investment• Net investment = (Capital expenditures – Depreciation) +
Increase in noncash working capital
Michael DimondSchool of Business Administration
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?
Michael DimondSchool of Business Administration
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)
Michael DimondSchool of Business Administration
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?
Michael DimondSchool of Business Administration
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)
Michael DimondSchool of Business Administration
Free Cash Flow to Equity• FCFE = Net income – Net investment + Net debt issued
Michael DimondSchool of Business Administration
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
Michael DimondSchool of Business Administration
What Damodaran’s valuation summary looks like: September 2008
Michael DimondSchool of Business Administration
What Damodaran’s valuation summary looks like: October 2008
Michael DimondSchool of Business Administration
• Bear in mind, these were a summary. We will ultimately want something more detailed for a working document.
Michael DimondSchool of Business Administration
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$
Michael DimondSchool of Business Administration
• 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
Michael DimondSchool of Business Administration
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
Michael DimondSchool of Business Administration
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
Michael DimondSchool of Business Administration
We need to assess sensitivity to assumptions
• 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$
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
Michael DimondSchool of Business Administration
We need to assess sensitivity to assumptions
• 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$
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
Michael DimondSchool of Business Administration
Building the sensitivity table
Michael DimondSchool of Business Administration
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
Michael DimondSchool of Business Administration
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