Valuation: Cash Flow

1
Chapter 11

• Valuation Cash Flow

2
Valuation Cash basis better than Accrual?

• Accrual earnings cannot be spent
• Debatable, legitimate accounting
• Earnings management

3
Cash Flows Three Components

• Periodic Cash Flow
• Terminal Value
• Discount Rate

4
Periodic Flows

• Dividend payment irrelevant for valuation
• Use expected free cash flows
• Unleveraged vs. Leveraged
• Free cash flow Cash Flow available for a stated
  purpose

5
Unleveraged Free Cash Flows

• Cash Flow from Operations
• ignoring interest costs (net of tax)
• Adjusted for Investing Activities
• Provides Unleveraged FCF for Creditors and
  Shareholders

6
Leveraged Free Cash Flows

• Cash Flow from Operations
• Adjust for Interest Expense (net)
• Adjust for Investing Activities
• Adjust for Borrowings
• Adjust for Pfd Stock and Pfd Div
• Leveraged FCF for Shareholders

7
Free Cash Flows

• Unleveraged Free Cash Flow
• appropriate for valuation of assets
• appropriate discount rate is weighted avg. cost
  of capital
• Leveraged Free Cash Flow
• appropriate for valuation of equity
• appropriate discount rate is cost of equity
  capital

8
Terminal Period

• Focus Cash Flow Equilibrium
• Text Four to Seven Years
• Typical Five Years
• Occasional Ten Years
• What occurs after forecast horizon?

9
Residual Value

• Post-Terminal Period value
• Value at end of Forecast Period
• Periodic CF(n-1) x (1 g)
• (1 r)
• Last CF grows at a rate g

10
Negative or No-Growth Valuation

• Periodic CF(n-1) x (1 g)
• (1 r)
• Just modify g
• Problem? When g results in r

11
Discount Rate r

• Cost of Capital
• Cost of Debt Capital
• Cost of Pfd Equity Capital
• Cost of Common Equity Capital

12
Cost of Debt

• Debt Vs. Liabilities
• focus on interest-bearing debt
• ignore operating liabilities
• Weighted-average cost of debt
• Yield to Maturity (1-t)
• Adjust for leases to current interest rate on
  collateralized borrowing with equivalent risk.

13
Cost of Preferred Equity

• Read the Pfd Stock contract Depends on
  preference conditions
• Cost of Pfd Equity Capital ?
• Cost dividend rate
• Net of tax?
• Convertible PS cost f(cost of nonconv. PS and
  common equity)

14
Cost of Equity Capital

• CAPM -gt B (systematic risk)
• Betagt1.0 indicates higher than average risk
• CoCE Rf B (Rm - Rf)
• Rf ? Intermediate term US debt
• Historically, 6 Vs. Today?
• B ? Effect on Cost of Equity?
• Rm? Defend your choice. Historically, 9-13