Valuation Techniques The infamous DCF

1
Valuation TechniquesThe infamous DCF
2
Why Value a company?

• TAKEOVERS, MERGERS, THE SELL-OFF OF DIVISIONS OR
  COMPANIES, IPOS
• THE PURCHASE OF SALE OF A PRIVATE COMPANY

3
Why not use Book Value?

• IT IS BASED ON HISTORIC COSTS OF ASSETS
• IT IGNORES THE VALUE CREATED BY MANAGEMENT WITH
  THESE ASSETS
• IT MAY INCLUDE REDUNDANT ASSETS
• IT MAY GROSSLY UNDERESTIMATE CERTAIN ASSETS E.G.,
  REAL ESTATE.

4
Different Valuation Techniques

• Discounted Cash Flow (DCF)
• FREE CASH FLOWS TO THE FIRM
• FREE CASH FLOWS TO EQUITY
• ECONOMIC VALUE ADDED (EVA)
• Relative Valuation
• Comparable Companies (Comps)
• Precedent Transactions

5
DCF

• THE FIRM VALUE IS THE PRESENT VALUE OF THE FUTURE
  NET CASH FLOWS COMING TO THE COMPANY AND WHICH
  ARE DISCOUNTED AT THE WACC TO REFLECT THE
  RISKINESS OF THESE FLOWS.

6
Free Cash Flows (FIRM)

• FCFF REPRESENTS CASH FLOWS TO WHICH ALL
  STAKEHOLDERS MAKE CLAIM AND NOT ONLY
  SHAREHOLDERS.
• Project the cash flows for X years
• FCFF EBIT x (1-TAX RATE)
• DEPRECIATION AND AMORTIZATION
• - CAPITAL EXPENDITURES
• - INCREASE IN WORKING CAPITAL
• IT BEARS A RELATIONSHIP TO EBITDA.

7
WACC

• DISCOUNT EACH FCFF AT THE FIRMS WEIGHTED AVERAGE
  COST OF CAPITAL (WACC).
• ( of debt cost of debt) ( of equity cost
  of equity)
• Debt govt bond risk premium
• Equity risk free rate (betamarket premium)
• THEN ADD TO GET THE TOTAL SUM OF THE DISCOUNTED
  FCFFS.

8
Terminal Value

• TERMINAL VALUE IS THE ESTIMATED VALUE IN ALL
  UNPROJECTED YEARS
• IN CALCULATING THE TERMINAL VALUE A CONSTANT
  GROWTH RATE IN FCFS IS USUALLY ASSUMED. THE
  TERMINAL VALUE IS USUALLY LARGE RELATIVE TO THE
  EXPLICIT FCFF FORECASTS.

9
Other Additions

• Add REDUNDANT ASSETS TO SELL OFF
• EXCESS CASH THAT IS NOT NEEDED FOR DAY TO DAY
  OPERATIONS
• RESULT TEV (Total Enterprise Value)

10
Value of Equity

• THE VALUE OF THE FIRMS EQUITY (VEQUITY) EQUALS
  THE VALUE OF THE FIRMS ASSETS (VFIRM) MINUS THE
  VALUE OF DEBT OBLIGATIONS (Net Debt)
• VEQUITY VFIRM VDEBT

11
Example
12
(No Transcript)
13
Relative Valuation

• PRICE TO EARNINGS (P/E) MULTIPLES
• ENTERPRISE VALUE/EBITDA
• OTHER MULTIPLES E.G., P/CF, P/B, P/S
• VALUE BASED ON PREMIUM PAID TO ACQUIRE CONTROL IN
  A SIMILAR SITUATION

14
Example

• ASSUME WE ARE VALUING FIRM XYZ AND WE HAVE A
  COMPARABLE FIRM ABC WITH A KNOWN P/E RATIO OF 10.
• IF XYZ HAS EARNINGS OF 12M, THEN WE MIGHT
  ESTIMATE ITS VALUE IN THIS WAY TO BE 10 X 12M
  120M.
• A COMPARABLE FIRM IDEALLY MEANS SIMILAR
  BUSINESS RISK, DIVIDEND PAYOUT RATES, AND GROWTH
  PROSPECTS