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8/14/2019 DCF Valuation of a Firm
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Corporate Valuation
DCF valuation methods FCF-WACC method
APV (adjusted present value) method
FTE (flow-to-equity) method
Industry comparables method
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Corporate Valuation:
We introduce the FCF-WACC
method. Of the DCF valuation methods, the
FCF-WACC method is the mostwidely used.
We break up assets into operatingand non-operating assets for thepurpose of firm valuation.
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Operating assets
Operating assets are non-financial assetsincluding buildings, machines andinventory.
They generate operating incomes, whichare expected to grow.
After-tax net operating profit (NOPAT) netof required investment is called free cash
flow (FCF). The PV of the expected future free cash
flows, discounted at the WACC, is thevalue of operations.
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Measurement of FCF
FCF=After-tax net operating profit-required investment
FCF=(EBIT)(1-T)+DEP-(NFA+ NWC+DEP)
FCF=(EBIT)(1-T)-(NFA+ NWC)
FCF=NOPAT-(Operating Asset)
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Nonoperating Assets
Marketable securities
Ownership of non-controllinginterest in another company
Value of nonoperating assets usuallyis very close to figure that is reported
on balance sheets.
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Total Corporate Value
Total corporate value is sum of:
Value of operations
Value of nonoperating assets
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Claims on Corporate Value
Debtholders have first claim.
Preferred stockholders have the nextclaim.
Any remaining value belongs tostockholders.
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Applying the Corporate Valuation
Model Forecast the financial statements.
Calculate the projected free cash flows.
Model can be applied to a company thatdoes not pay dividends, a privately heldcompany, or a division of a company,
since FCF can be calculated for each ofthese situations.
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Data for Valuation
FCF0 = $20 million
WACC = 10%
g = 5% Marketable securities = $100 million
Debt = $200 million
Preferred stock = $50 million
Book value of equity = $210 million
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Value of Operations:
Constant GrowthSuppose FCF grows at constant rate g.
1tt
t0
1tt
tOp
WACC1
)g1(FCF
WACC1FCFV
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Constant Growth Formula
Notice that the term in parentheses isless than one and gets smaller as t
gets larger. As t gets very large,term approaches zero.
1t
t
0OpWACC1
g1FCFV
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Constant Growth Formula (Cont.)
The summation can be replaced by asingle formula:
gWACC)g1(FCF
gWACCFCFV
0
1Op
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Find Value of Operations
42005.010.0)05.01(20
V
gWACC
)g1(FCF
V
Op
0
Op
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Value of Equity
Sources of Corporate Value
Value of operations = $420
Value of non-operating assets = $100
Claims on Corporate Value
Value of Debt = $200
Value of Preferred Stock = $50
Value of Equity = ?
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Value of Equity
Total corporate value = VOp + Mkt. Sec.
= $420 + $100
= $520 million
Value of equity = Total - Debt - Pref.= $520 - $200 - $50
= $270 million
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Market Value Added (MVA)
MVA = Total corporate value of firmminus total book value of firm
Total book value of firm = book valueof equity + book value of debt + bookvalue of preferred stock
MVA = $520 - ($210 + $200 + $50)
= $60 million
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Breakdown of Corporate Value
0
100
200
300
400
500
600
Sources
of Value
Claims
on Value
Market
vs. Book
MVA
Book equity
Equity (Market)
Preferred stock
Debt
Marketablesecurities
Value of operations
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Example of non-constant growth
Debt= $40 million
The company has 10 million sharesof stock.
The weighted average cost ofcapital=10%.
(More)
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Projected free cash flows (FCF):
Year 1 FCF = -$5 million.
Year 2 FCF = $10 million.
Year 3 FCF = $20 million
FCF grows at constant rate of 6%after year 3.
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Horizon Value
Free cash flows are forecast for threeyears in this example, so the forecast
horizon is three years. Growth in free cash flows is not
constant during the forecast,so we
cant use the constant growthformula to find the value ofoperations at time 0.
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Horizon Value (Cont.)
Growth is constant after the horizon(3 years), so we can modify the
constant growth formula to find thevalue of all free cash flows beyondthe horizon, discounted back to thehorizon.
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Horizon Value Formula
Horizon value is also called terminalvalue, going-concern value orcontinuing value.
gWACC)g1(FCF
VHV tttimeatOp
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Vop at 3
Find the value of operations by discounting
the free cash flows at the cost of capital.0
-4.545
8.264
15.026
398.197
1 2 3 4kc=10%
416.942 = Vop
g = 6%
FCF= -5.00 10.00 20.00 21.2
$21.2
. .$530.
10 0 06
0
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Find the price per share of common
stock.Value of equity = Value of operations
- Value of debt
= $416.94 - $40
= $376.94 million.
Price per share = $376.94 /10 = $37.69.
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Practice problem
Marketable securities=$10 million
Debt= $100 million
The company has 10 million sharesof stock.
The weighted average cost ofcapital=13%.
(More)
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Projected free cash flows (FCF):
Year 1 FCF = -$20 million.
Year 2 FCF = $30 million.
Year 3 FCF = $40 million
FCF grows at constant rate of 7%after year 3.
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(a) Estimate the horizon value.
(b) Estimate the value of operation.
(c) Estimate the enterprise value.
(d) Estimate the per share price.
Answers: V=537.89;S=437.89;p=$43.79
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Horizon Value Formula
gWACC)g1(FCF
VHVt
ttimeatOp
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Vop at 3
Find the value of operations by discounting
the free cash flows at the cost of capital.0
-17.70
23.49
27.72
494.37
1 2 3 4kc=13%
527.88 = Vop
g = 7%
FCF= -20 30 40 42.8
$42.8
. .$713.33
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0