strategic valuation issues

8/13/2019 strategic valuation issues

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Prof Dr Catherine Ho12.1


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Review How did we get here?

Simplistic Techniques for Company ValuationValuing Hersheys Hypothetical Strategic Plan(from Chapter 9)

Generalized Valuation ModelsOptions on Assets or Real Options

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Company ValuationFurther discussion about Capital InvestmentAnalysis

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Historical Financial Analysis Chapters 2, 7, and 8Review of General Economic Conditions Cha ters 4 5 and 6

Forecasts of Future Performance Chapter 9Valuation of Projected Cash Flow Chapters 3, 10, and 11

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)(

)1()0(, g r

g CF PVAr

+=

Note: If g=0 then this

model is the same asthe zero growthperpetuity model.

)gk ()g1](IId)T1(m[R V wfg00

++=

)gk (InvestmentOperating NetIncomeOperatingTaxAfter V0

=

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Variables V0 = Value of firm as of today (Year 0) R0 = Revenue (or sales) of firm (Can be last year of actual sales) m = Operating income (EBIT) margin (% of sales) T = Tax Rate d = Depreciation (% of sales) Ifg = Capital expend., gross or fixed capital invested (% of sales) Iw = Working capital incremental investment (% of sales)

g = Growth k = Cost of capital (previously called r)Results

R0 (1+g) = Revenue (or sales) for the next (first) year = R 1 R1 (m) = Operating income (EBIT) in year 1 R1 (m)(1-T) = After-tax operating income in year 1 R1(Ifg d) = Net capital investment R1(Ifg d)+ I w = Investment in operating assets less operating liabilities (or

Net Operating Investment)

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]I)dI[(R )]T1(m[R wfg11 ++=

)gk (

InvestmentOperating NetIncomeOperatingTaxAfter V0

=

)gk (

)025.0082.0()]0074.0()039.0041.0[(957,4$)]37.01(213.0[957,4$

V0 +

=

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= ($665 - $10 + $37) / 0.057 = $692 / 0.057 = $12,140


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V0 = PV (Growth Period CF) + PV (Perpetual Period CF)

Valuation Equations:Multiple Stage

[ ] [ ] nnccccnson

1ttts

sssoo)k 1(

1)gk (

)g1(I)T1(m)g1(R )k 1()g1(I)T1(mR V

c +

+++

++=

=

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Simplistic Equations are appropriate for firstestimates, butSpreadsheet models allow: Appropriate levels of annual detail Communication to all levels of management Expansion to lines of business Detailed cost and investment analysis Additional sensitivity analysis

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The following models are presented: Table 12.1: Valuation of the Strategic Financial

Plan from Chapter 9 Table 12.2: Cash flow conversion to percent of

sales from Table 12.1

Table 12.3: Partial valuation model Table 12.4: Comprehensive valuation model

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The following page (Table 12.1) uses thetechniques discussed in chapter 11 to value

the operating cash flows detailed in theStrategic Financial Plan (chapter 9)The operating assumptions come directly

Table 12.1 only contains operating cash flows NO interest income or expense, no debtrepayment, no dividends, etc.Taxes are recalculated due to the removal ofinterest

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The following page (Table 12.2) illustratesthe conversion of the Strategic Plan CashFlows to a percent of sales basis.This will develop the assumptions to

.The notation also aligns with the valuationequations presented earlier.

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Strategic Financial Management: Applications of Corporate FinanceThe Hershey Company Hypothetical Strategic Plan

Table 12.2

Valuation as a % of Sales($ Millions)Projected

2006 2007 2008 2009 2010 2011 2012 2013 Additional Assumptions

Net Sales 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00% 100.00%

Cost of Sales 57.00% 56.60% 56.30% 56.00% 55.70% 55.50% 55.20% 55.20%Depreciation 4.03% 4.09% 4.17% 4.27% 4.37% 4.50% 4.65% 4.79%Selling, General, & Administrative 18.70% 18.50% 18.30% 18.10% 17.90% 17.70% 17.50% 17.50%

Total Costs 79.72% 79.19% 78.77% 78.37% 77.96% 77.70% 77.35% 77.49%

Operating Income (or Earnings Before Interest and Taxes) 20.28% 20.81% 21.23% 21.63% 22.04% 22.30% 22.65% 22.51% Operating Margin (M)

Tax Expense 7.50% 7.70% 7.85% 8.00% 8.15% 8.25% 8.38% 8.33%

After Tax Operating Income 12.77% 13.11% 13.37% 13.62% 13.88% 14.05% 14.27% 14.18%

Depreciation 4.03% 4.09% 4.17% 4.27% 4.37% 4.50% 4.65% 4.79% Depreciation (D) - Workin Ca ital Investment I

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. . . . . . . .

Change in:Accounts Receivable - Trade 1.01% -0.28% -0.23% -0.28% -0.28% -0.19% -0.14% -0.14% Working Capital Investment (Iw)Inventory -0.31% -0.40% -0.24% -0.19% -0.19% -0.11% -0.04% -0.29% Working Capital Investment (Iw)Accounts Payable 0.12% 0.20% 0.18% 0.18% 0.17% 0.16% 0.12% 0.17% Working Capital Investment (Iw) Prepaid Expenses -0.20% -0.19% -0.18% -0.17% -0.20% -0.19% -0.19% -0.18% Working Capital Investment (Iw) Other Assets -0.59% -0.56% -0.54% -0.52% -0.66% -0.64% -0.63% -0.61% Working Capital Investment (Iw) Accrued Liabilities 1.09% 0.99% 1.03% 0.42% 0.42% 0.34% 0.26% 0.32% Working Capital Investment (Iw) Accrued Income Taxes 0.10% 0.09% 0.09% 0.09% 0.17% 0.16% 0.16% 0.15% Working Capital Investment (Iw) Other Long-Term Liabilities 0.37% 0.41% 0.37% 0.33% 0.33% 0.25% 0.21% 0.21% Working Capital Investment (Iw) Cash from Operating Activities 18.94% 18.04% 18.62% 18.39% 18.65% 19.00% 19.36% 19.29%

Working Capital Investment (Iw) - Total 2.14% 0.84% 1.08% 0.49% 0.40% 0.45% 0.44% 0.32% Investment (Iw)

Investment ActivitiesCapital Expenditures -3.64% -3.56% -3.59% -3.45% -3.48% -3.38% -3.46% -3.37% Fixed Capital Investment (Ifg)Business Acquisitions 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00%Other, Net 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Cash (used for) Investing -3.64% -3.56% -3.59% -3.45% -3.48% -3.38% -3.46% -3.37%

Free Cash Flow - % of Sales 15.30% 14.48% 15.03% 14.93% 15.17% 15.61% 15.90% 15.92%


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The following table (table 12.3)presents a valuation of the expliciteight year period.In practice valuation, models often are

, , , , , .This model assumes no value after theterminal year.

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Table 12.3

Valuation Model($ Millions)

Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 82006 2007 2008 2009 2010 2011 2012 2013

Panel A - Projected Free Cash Flow Net Reveneue 5,077.8$ 5,331.7$ 5,571.6$ 5,794.5$ 6,026.3$ 6,207.1$ 6,362.3$ 6,521.4$

Cost of sales (excluding depreciation) 2,894.3 3,017.7 3,136.8 3,244.9 3,356.6 3,444.9 3,512.0 3,599.8 Selling, marketing, and administrative 949.5 986.4 1,019.6 1,048.8 1,078.7 1,098.7 1,113.4 1,141.2 Depreciation 204.4 218.1 232.6 247.6 263.1 279.1 295.6 312.6 Operating Income 1,029.6 1,109.5 1,182.6 1,253.2 1,327.9 1,384.4 1,441.3 1,467.8

% of Sales 20.3% 20.8% 21.2% 21.6% 22.0% 22.3% 22.7% 22.5%

Taxes 381.0 410.5 437.6 463.7 491.3 512.2 533.3 543.1 After Tax Operating Income 648.6 699.0 745.0 789.5 836.6 872.2 908.0 924.7

% of Sales 12.8% 13.1% 13.4% 13.6% 13.9% 14.1% 14.3% 14.2%

Depreciation 204.4 218.1 232.6 247.6 263.1 279.1 295.6 312.6 Working Capital Investment 108.7 44.7 60.0 28.3 24.4 27.8 28.1 20.7 Capital Expenditures (185.0) (190.0) (200.0) (200.0) (210.0) (210.0) (220.0) (220.0)

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Free Cash Flow 776.7$ 771.8$ 837.6$ 865.4$ 914.1$ 969.1$ 1,011.7$ 1,038.0$

% of Sales 15.3% 14.5% 15.0% 14.9% 15.2% 15.6% 15.9% 15.9%

Present Value 5,025.4$ 8-Year Total 717.8$ 659.3$ 661.2$ 631.4$ 616.4$ 604.0$ 582.7$ 552.6$

Panel B - Valuation Model AssumptionsYear 0 Revenue 4,836.0$Revenue growth 5.00% 5.00% 4.50% 4.00% 4.00% 3.00% 2.50% 2.50%Tax rate 37.00% 37.00% 37.00% 37.00% 37.00% 37.00% 37.00% 37.00%% of Sales

Cost of sales (excluding depreciation) 57.00% 56.60% 56.30% 56.00% 55.70% 55.50% 55.20% 55.20%Selling, marketing, and administrative 18.70% 18.50% 18.30% 18.10% 17.90% 17.70% 17.50% 17.50%

Expenses excluding depreciation 75.70% 75.10% 74.60% 74.10% 73.60% 73.20% 72.70% 72.70%Operating margin before depreciation 24.30% 24.90% 25.40% 25.90% 26.40% 26.80% 27.30% 27.30%

Fixed capital investment 3.64% 3.56% 3.59% 3.45% 3.48% 3.38% 3.46% 3.37%Depreciation (% of Sales) 4.03% 4.09% 4.17% 4.27% 4.37% 4.50% 4.65% 4.79%

Net, fixed investment 0.38% 0.53% 0.59% 0.82% 0.88% 1.11% 1.19% 1.42%

Working capital (dis) investment -2.14% -0.84% -1.08% -0.49% -0.40% -0.45% -0.44% -0.32%Cost of Capital 8.20%


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Table 12.4 presents a comprehensivevaluation model that values the explicit eightyear period as well as provides a terminal orresidual value.

the final years cash flow grown at someresidual period growth rate:

)8()8(, esidualValuRe)(

)1(=

+=

g k

g CF PVAr

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The Comprehensive Valuation Model provides: Value of the operations Intrinsic value of the business Business valuationTo focus on the e uit value: Need to adjust the value of the operations Add excess cash Subtract interest bearing debt

Divide the value of the equity by sharesoutstanding to determine the value per share.

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PresentValue($mms)

Explicit Period $5,025.4Terminal Value 9,936.5

Enterprise Value $14,961.9

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Value of the Operations $14,961.9Add: Cash and equivalents 67.2Less: Interest bearing debt (1,762.0)

Value of the Equity $13,267.1

Shares outstanding 240.5Value per share $55.16


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Review your base case results.Test the impact of your assumptions: Sensitivity analysis Scenario analysis Monte Carlo Sensitivity

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Table 12.5Sensitivity Analysis

1% Change in the Assumption

Year 1 Assumption Value Per

Sensitivity Share ImpactOriginal 1.01 * Orig. $ %

Revenue growth (Explicit period only) 5.000% 5.050% 0.35$ 0.641%

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xpenses exc u ng eprec a on . . . - .Tax rate 37.000% 37.370% (0.32) -0.587%

Fixed capital investment 3.640% 3.676% (0.14) -0.246%Depreciation (% of Sales) 4.030% 4.070% 0.07 0.126%

Working capital (dis) investment -2.140% -2.161% 0.02 0.034%

Residual period growth rate 2.500% 2.525% 0.19 0.348%Cost of capital 8.200% 8.282% (0.65) -1.186%


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A company can use the Strategic FinancialPlan developed in Chapter 9 along with thevaluation concepts developed here tomonitor and manage shareholder value.

an increase in shareholder value.

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Recent development in capital evaluationApplies concepts of financial options to realassetsAcknowledges the flexibility in projects that

standard discounted cash flow analysis.

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Abandonment Option Ability to walk away from an investment.Option to Expand or Grow Phased in approach to development. New shopping

mall example.Option to Shrink

u arger to ta e a vantage o ower per un t cost,but be prepared to downsize. Distribution centerexample.

Option to Defer Development Only take the steps necessary today to be able to

develop fully later. Retailer who buys the land anddefers development.Switching Option Ability to switch between products or for different uses.

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