6 - 1

Investment VI

Company valuation

6 - 2

Company Valuationhistorical financial statementsforecast period

opportunity costs of capital

market value weight

make assumptions for continuation valueuse formula to get value

check different scenarios

6 - 3

Statements

Balance sheetIncome statementStatement of cash flows

Historical Financial

6 - 4

Income Statement

2010 2011Sales 3,432,000 5,834,400 COGS 2,864,000 4,980,000 Other expenses 340,000 720,000 Deprec. 18,900 116,960 Tot. op. costs 3,222,900 5,816,960 EBIT 209,100 17,440 Int. expense 62,500 176,000 EBT 146,600 (158,560)Taxes (40%) 58,640 (63,424)Net income 87,960 (95,136)

6 - 5

Balance Sheet: Assets

2010 2011Cash 9,000 7,282 S-T invest. 48,600 20,000 AR 351,200 632,160 Inventories 715,200 1,287,360 Total CA 1,124,000 1,946,802 Gross FA 491,000 1,202,950 Less: Depr. 146,200 263,160 Net FA 344,800 939,790 Total assets 1,468,800 2,886,592

6 - 6

Statement of Retained Earnings: 2011

Balance of ret. earnings,

12/31/2002 203,768

Add: Net income, 2003 (95,136)

Less: Dividends paid, 2003 (11,000)

Balance of ret. earnings,

12/31/2003 97,632

6 - 7

Balance Sheet: Liabilities & Equity

2010 2011Accts. payable 145,600 324,000 Notes payable 200,000 720,000 Accruals 136,000 284,960 Total CL 481,600 1,328,960 Long-term debt 323,432 1,000,000 Common stock 460,000 460,000 Ret. earnings 203,768 97,632 Total equity 663,768 557,632 Total L&E 1,468,800 2,886,592

6 - 8

Statement of Cash Flows: 2011

Operating ActivitiesNet Income (95,136)Adjustments: Depreciation 116,960 Change in AR (280,960) Change in inventories (572,160) Change in AP 178,400 Change in accruals 148,960 Net cash provided by ops. (503,936)

6 - 9

Long-Term Investing Activities

Cash used to acquire FA (711,950)

Financing Activities

Change in S-T invest. 28,600

Change in notes payable 520,000

Change in long-term debt 676,568

Payment of cash dividends (11,000)

Net cash provided by fin. act. 1,214,168

6 - 10

Summary of Statement of CF

Net cash provided by ops. (503,936)

Net cash to acquire FA (711,950)

Net cash provided by fin. act. 1,214,168

Net change in cash (1,718)

Cash at beginning of year 9,000

Cash at end of year 7,282

6 - 11

What are operating current assets?

Operating current assets are the CA needed to support operations.Op CA include: cash, inventory,

receivables.Op CA exclude: short-term

investments, because these are not a part of operations.

6 - 12

What are operating current liabilities?

Operating current liabilities are the CL resulting as a normal part of operations.Op CL include: accounts payable

and accruals.Op CA exclude: notes payable,

because this is a source of financing, not a part of operations.

6 - 13

What effect did the expansion have on net operating working capital (NOWC)?

NOWC11 = ($7,282 + $632,160 + $1,287,360)

- ($324,000 + $284,960)

= $1,317,842.

NOWC10 = $793,800.

= -Operating

CAOperating

CLNOWC

6 - 14

What effect did the expansion have on total net operating capital (also just called

operating capital)?

= NOWC + Net fixed assets.

= $1,317,842 + $939,790

= $2,257,632.

= $1,138,600.

Operatingcapital11

Operatingcapital10

Operatingcapital

6 - 15

Did the expansion create additional net operating profit after taxes (NOPAT)?

NOPAT = EBIT(1 - Tax rate)

NOPAT11 = $17,440(1 - 0.4)

= $10,464.

NOPAT10 = $125,460.

6 - 16

What was the free cash flow (FCF)for 2011?

FCF = NOPAT - Net investment in

operating capital

= $10,464 - ($2,257,632 - $1,138,600)

= $10,464 - $1,119,032

= -$1,108,568.

How do you suppose investors reacted?

6 - 17

Stock Price and Other Data

2010 2010

Stock price $8.50 $2.25

# of shares 100,000 100,000

EPS $0.88 -$0.95

DPS $0.22 $0.11

6 - 18

Forecasting FCF

Method:Sales forecastsPercent of sales method

6 - 19

Steps in Financial Forecasting

Forecast salesProject the assets needed to support

salesProject internally generated fundsProject outside funds neededDecide how to raise fundsSee effects of plan on ratios and stock

price

6 - 20

2011 Balance Sheet(Millions of $)

Cash. $ 20 Accts. pay. &accruals $ 100

Accounts rec. 240 Notes payable 100Inventories 240 Total CL $ 200 Total CA $ 500 L-T debt 100

Common stk 500Net fixedassets

Retainedearnings 200

Total assets $1,000 Total claims $1,000 500

6 - 21

2003 Income Statement(Millions of $)

Sales $2,000.00Less: COGS (60%) 1,200.00 Other costs 700.00 EBIT $ 100.00Interest 10.00 EBT $ 90.00Taxes (40%) 36.00Net income $ 54.00

Dividends (40%) $21.60Add’n to RE $32.40

6 - 22

AFN (Additional Funds Needed):Key Assumptions

Operating at full capacity in 2011.Each type of asset grows proportionally with

sales.Payables and accruals grow proportionally

with sales.2011 profit margin ($54/$2,000 = 2.70%) and

payout (40%) will be maintained.Sales are expected to increase by $500

million.

6 - 23

Projecting Pro Forma Statements with the Percent of Sales Method

Project sales based on forecasted growth rate in sales

Forecast some items as a percent of the forecasted salesCostsCashAccounts receivable

(More...)

6 - 24

Items as percent of sales (Continued...)

InventoriesNet fixed assetsAccounts payable and accruals

Choose other itemsDebtDividend policy (which determines

retained earnings)Common stock

6 - 25

Implications of AFN

If AFN is positive, then you must secure additional financing.

If AFN is negative, then you have more financing than is needed.Pay off debt.Buy back stock.Buy short-term investments.

6 - 26

Percent of Sales: Inputs

COGS/Sales 60% 60%SGA/Sales 35% 35%Cash/Sales 1% 1%Acct. rec./Sales 12% 12%Inv./Sales 12% 12%Net FA/Sales 25% 25%AP & accr./Sales 5% 5%

2011 2012Actual Proj.

6 - 27

Other Inputs

Percent growth in sales 25%

Growth factor in sales (g) 1.25

Interest rate on debt 10%

Tax rate 40%

Dividend payout rate 40%

6 - 28

2004 Forecasted Income Statement

2011 Factor2012

1st PassSales $2,000 g=1.25 $2,500.0

Less: COGS Pct=60% 1,500.0 SGA Pct=35% 875.0 EBIT $125.0Interest 0.1(Debt03) 20.0 EBT $105.0Taxes (40%) 42.0Net. income $63.0

Div. (40%) $25.2Add. to RE $37.8

6 - 29

2004 Balance Sheet (Assets)

Forecasted assets are a percent of forecasted sales.

Factor 2004

Cash

Pct= 1% $25.0Accts. rec. Pct=12% 300.0

Pct=12% 300.0

Total CA

$625.0Net FA Pct=25% 625.0Total assets $1,250.0

2004 Sales = $2,500

Inventories

6 - 30

2004 Preliminary Balance Sheet (Claims)

*From forecasted income statement.

2011 Factor Without AFN

AP/accruals Pct=5% $125.0Notes payable 100 100.0

Total CL $225.0L-T debt 100 100.0Common stk. 500 500.0Ret. earnings 200 +37.8* 237.8Total claims $1,062.8

20122012 Sales = $2,500

6 - 31

Required assets = $1,250.0Specified sources of fin. = $1,062.8Forecast AFN = $ 187.2

What are the additional funds needed (AFN)?

The company must have the assets to make forecasted sales, and so it needs an equal amount of financing. So, we must secure another $187.2 of financing.

6 - 32

Assumptions about How AFN Will Be Raised

No new common stock will be issued.

Any external funds needed will be raised as debt, 50% notes payable, and 50% L-T debt.

6 - 33

How will the AFN be financed?

Additional notes payable = 0.5 ($187.2) = $93.6.

Additional L-T debt = 0.5 ($187.2) = $93.6.

6 - 34

2012 Balance Sheet (Claims)

w/o AFN AFN With AFNAP/accruals $ 125.0 $ 125.0 Notes payable 100.0 +93.6 193.6 Total CL $ 225.0 $ 318.6 L-T debt 100.0 +93.6 193.6 Common stk. 500.0 500.0Ret. earnings 237.8 237.8 Total claims $1,071.0 $1,250.0

6 - 35

What are the forecasted free cash flow and ROIC?

2003 2004(E)Net operating WC $400 $500 (CA - AP & accruals)Total operating capital $900 $1,125 (Net op. WC + net FA)NOPAT (EBITx(1-T)) $60 $75 Less Inv. in op. capital $225

Free cash flow -$150ROIC (NOPAT/Capital) 6.7%

6 - 36

Value of Operations

1tt

tOp )WACC1(

FCFV

6 - 37

Nonoperating Assets

Marketable securitiesOwnership of non-controlling

interest in another companyValue of nonoperating assets usually

is very close to figure that is reported on balance sheets.

6 - 38

Total Corporate Value

Total corporate value is sum of:Value of operationsValue of nonoperating assets

6 - 39

Claims on Corporate Value

Debtholders have first claim.Preferred stockholders have the next

claim.Any remaining value belongs to

stockholders.

6 - 40

Applying the Corporate Valuation Model

Forecast the financial statements, as shown.

Calculate the projected free cash flows.Model can be applied to a company that

does not pay dividends, a privately held company, or a division of a company, since FCF can be calculated for each of these situations.

6 - 41

Data for Valuation

FCF0 = $20 million

WACC = 10%g = 5%Marketable securities = $100 millionDebt = $200 millionPreferred stock = $50 millionBook value of equity = $210 million

6 - 42

Value of Operations: Constant Growth

Suppose FCF grows at constant rate g.

1tt

t0

1tt

tOp

WACC1

)g1(FCF

WACC1

FCFV

6 - 43

Constant Growth Formula

Notice that the term in parentheses is less than one and gets smaller as t gets larger. As t gets very large, term approaches zero.

1t

t

0Op WACC1

g1FCFV

6 - 44

Constant Growth Formula (Cont.)

The summation can be replaced by a single formula:

gWACC

)g1(FCF

gWACC

FCFV

0

1Op

6 - 45

Find Value of Operations

42005.010.0

)05.01(20V

gWACC

)g1(FCFV

Op

0Op

6 - 46

Value of Equity

Sources of Corporate ValueValue of operations = $420Value of non-operating assets = $100

Claims on Corporate ValueValue of Debt = $200Value of Preferred Stock = $50Value of Equity = ?

6 - 47

Value of Equity

Total corporate value = VOp + Mkt. Sec.

= $420 + $100

= $520 million

Value of equity = Total - Debt - Pref.

= $520 - $200 - $50

= $270 million

6 - 48

Expansion Plan: Nonconstant Growth

Finance expansion by borrowing $40 million and halting dividends.

Projected free cash flows (FCF):Year 1 FCF = -$5 million.Year 2 FCF = $10 million.Year 3 FCF = $20 millionFCF grows at constant rate of 6%

after year 3.(More…)

6 - 49

The weighted average cost of capital, rc, is 10%.

The company has 10 million shares of stock.

6 - 50

Horizon Value Formula

Horizon value is also called terminal value, or continuing value.

gWACC

)g1(FCFVHV t

ttimeatOp

6 - 51

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 4rc=10%

416.942 = Vop

g = 6%

FCF= -5.00 10.00 20.00 21.2

$21.2. .

$530.10 0 06

0

6 - 52

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.