Agenda

1
Agenda

• Last session
• This lecture
• Next
• Valuation depends mainly on understanding the
  business, its industry, and the general economic
  environment, and then doing a prudent job of
  forecasting. Correct methodology is only a
  small, but necessary, part of the valuation
  process p.292

2
CMK 8 Framework for valuation

• Models
• DCF enterprice
• Economic Profit (EP)
• APV (changing cap.structure)
• DCF equity (fin.institutions)
• add ons
• options
• nominal vs. real
• pre-post tax
• formulae instead of explicit forecast

3
Framework for valuation

• DCF enterpricemodel
• value of operations based on free cash flow
  forecast
• discounted back with risk adjusted rate
• less value of debt
• regulated for non-operating assets / liabilities
• The discount rate reflects the opportunity cost
  of all capital (WACC, tax shield), eg. exhibit
  8.5.
• Forecast for 100 years OR utilize a formula for
  the last 90 years - giving the continuing value,
  whose
• formula is composed of NOPLAT, growth, ROIC
  - and WACC p.136

4
Framework for valuation

• Growth rate ROnewIC investment rate, p. 138.
• Investment rate
• Net Investments / NOPLAT
• (Gross Investments - depreciation) / NOPLAT
• Key drivers of value are ROIC (relative to WACC)
  and growth, exhibit 8.8.
• ECONOMIC PROFIT MODEL
• V capital invested PV-value created in the
  future - debt /- non-operating
  assets/liabilities
• economic profit invested capital(ROIC-WACC) or
  NOPLAT-(inv.cap.WACC)

5
Framework for valuation

• ADJUSTED PV MODEL (APV)
• values based only on cost of equity and then adds
  value of tax benefit of debt (tax shield)
• DCF-equity MODEL
• values the equity DIRECTLY based on cost of
  equity
• BUT get the leverage right !
• 5 STEP how to do in ch.9-13

6
Step 1 (ch.9) Analyzing Historical Performance

• Reorganize accounting statements to be able to
  calculate NOPLAT, free cash flow operating
  capital
• Focus on key value drivers i.e. ROIC and growth
• Break them down into their component drivers i.e.
  ROIC into cap.turnover and profit margin, cf.
  exhibit 9.8
• Distinguish operating from non-operating
• Ending with consistency between NOPLAT and
  operating invested capital
• How is the liquidity balance, p. 173-176
  (Donaldson)

7
Analyzing Historical Performance

• NOPLAT Convert tax to cash basis as tax expensed
  on operating profit (eg. exhibit 9.4)
• Add quasi-equity (reserves, provisions, deferred
  income tax) to invested capital, adjust NOPLAT if
  necessary to secure consistency (eg. exhibit 9.10
  p. 179)
• Extraordinary items should not be included in
  NOPLAT calculations
• Goodwill amortization is not deducted in NOPLAT
  (operating capital should be calculated both
  inclusive and exclusive goodwill resulting in two
  ROIC-measures)
• ROIC NOPLAT / Invested capital
• FCF NOPLAT - Net investments
• (NOPLAT depreciation) - Gross
  Investments

8
Analyzing Historical Performance

• Do not correct for inflation unless in a high
  inflation environment
• IF lumpy investments - spread it out or utilize
  CFROI Valuation, cf. p. 181-183
• Expensed investments (RD, marketing) could be
  capitalized and depreciated, p. 181.
• Foreign exchange translation effects are treated
  as non-operating cash flow
• Operating leases should be capitalized if
  material, p. 177.
• Minority interest earnings financing cost
  cash flow (dividend) financing flow, p. 180.

9
Analyzing Historical Performance Output

• NOPLAT Free Cash Flow-statements
• Cash flow available to investors Total
  financing flow, Exhibit 9.7
• Operating invested capital (ex. incl. Goodwill)
• Total investor funds (assets) Total investor
  funds (liabilities), Exhibit 9.3
• Debt, equity, non-operating liabilities and
  assets.
• ROIC, ROIC-tree, and growth (in revenues and
  NOPLAT) Economic Profit
• Credit health and liquidity
• Look for trends and compare with industry
• Linking economic measures (ROIC growth) to
  historic development in
• Industry
• Competitors
• Stock markets

10
Step 2 (ch.10) Cost of Capital

• WACC
• Market weights should be used
• Use target capital structure
• Look out for changes in inflation, systematic
  risk, capital structure, and market weights over
  the time horizon
• CAPM for cost of equity
• Market risk premium 4 - 5 in US
• Risk free rate use a 10-year Treasury bond
• Check your beta ! And leverage it correct
  (p.307-311)
• Debt in foreign exchange is valued with foreign
  exchange interest rates and converted at spot rate

11
Step 3 (ch.11) Forecast performance

• How the company may develop
• Length and level of detail
• the explicit forecast should cover a full cycle
• one or two explicit periods terminal period
  (see ch. 12)
• the forecast should be explicit until steady
  state
• Have a strategic perspective considering the
  industry (Ghemawat) and competitive position
  (e.g. 2Porter)

12
Forecast performance

• Historical performance
• ROIC, growth in revenues, EBITA, NOPLAT,
  investments, free cash flow, etc.

• Strategic context
• SWOT, competitive advantages, competitors,
  industry structure (Porter), value chain, PEST
  (politics, economics, social technology), etc.
• Changes

Cause
Continuity, consistency

• Future performance
• ROIC, growth in revenues, EBITA, NOPLAT,
  investments, free cash flow, etc.
• Value

Cause
13
Forecast performance

• Good idea to develop a strategic perspective
  about the companys future performance, eg
• Demand is increasing rapidly because of changing
  demographics, yet prices will remain stable ,
  p. 235. (or Heineken, p. 252)
• Should be formulated with basis in the strategic
  context
• Should be consistent with the historical
  performance
• Future performance should be derivable from the
  strategic perspective
• Follow the advise on p. 241 in establishing exh.
  11.16-11.27 p. 292-293.
• Alternative scenarios, e.g. exhibit 11.7
• Check for consistencies, e.g. exhibit 11,25,
  11.27, 9.19

14
Step 4 (ch.12) Continuing Value

• PV of cash flow after the explicit forecast
  period
• Simplified assumptions make formulas do the
  impossible job
• Different formulas for different approaches
• For DCFenterprise the value-driver formula
  NOPLATt1 (1-g/ROIC)/ WACC-g
• Also non-cash flow based approaches in special
  situations (Price to earnings, Market to book,
  liquidation value, replacement cost)

15
Step 5 (ch.13) Calculating and interpreting the
results

• Discount FCF using WACC
• Discount continuing value using WACC
• Add value of non operating assets
• Subtract value of non operating liabilities
• Mid-year adjustment.
• Subtract value of debt
• Compare with present market value
• Evaluate debt-equity forecast / balance sheet
• Compare the scenarios and assess the likelihood
• Define your margin of error / test sensitivity

16
Aggarwal 16 Justifying strategic investments

• Has the manufacturing setup an impact on value ?
• Different types of man.systems - fig.16-1
• Optimality of manufacturing setup - fig.16-2

17
NEXT - 21. October

• Workshop
• Dialogue and coaching
• Exercise 12.4
• Lectures
• Options (chap. 20, Kasanen, 2 Luehrman)
• Remember mid stage report on 21 October
• One pager (1 A4) per group
• Email to me
• How is things going
• information gathering, work plan, outline of
  report, model building, valuation method, etc.