More on Valuating
Transcript of More on Valuating
-
8/10/2019 More on Valuating
1/21
FIN
2001 M. P. Narayanan University of Michigan
Valuation methods
An overview
-
8/10/2019 More on Valuating
2/21
FIN
2001 M. P. Narayanan University of Michigan 2
Methodologies
Comparable multiplesP/E multiple
Market to Book multiple
Price to Revenue multiple
Enterprise value to EBIT multiple
Discounted Cash Flow (DCF)NPV, IRR, or EVA based Methods
WACC method
APV method
CF to Equity method
-
8/10/2019 More on Valuating
3/21
FIN
2001 M. P. Narayanan University of Michigan 3
Valuation: P/E multiple
If valuation is being done for an IPO or a takeover,Value of firm = Average Transaction P/E multiple EPS offirm
Average Transaction multiple is the average multiple of recent
transactions (IPO or takeover as the case may be)
If valuation is being done to estimate firm valueValue of firm = Average P/E multiple in industry EPS of firm
This method can be used when
firms in the industry are profitable (have positive earnings)
firms in the industry have similar growth (more likely formatureindustries)
firms in the industry have similar capital structure
-
8/10/2019 More on Valuating
4/21
FIN
2001 M. P. Narayanan University of Michigan 4
Valuation: Price to book multiple
The application of this method is similar to that of theP/E multiple method.
Since the book value of equity is essentially the
amount of equity capital invested in the firm, thismethod measures the market value of each dollar ofequity invested.
This method can be used forcompanies in the manufacturing sector which have significantcapital requirements.
companies which are not in technical default (negative bookvalue of equity)
-
8/10/2019 More on Valuating
5/21
FIN
2001 M. P. Narayanan University of Michigan 5
Valuation: Value to EBITDA
multiple
This multiple measures the enterpr is e value, that isthe value of the business operations (as opposed tothe value of the equity).
In calculating enterprise value, only the operationalvalue of the business is included.
Value from investment activities, such as investment intreasury bills or bonds, or investment in stocks of othercompanies, is excluded.
The following economic value balance sheet clarifiesthe notion of enterprise value.
-
8/10/2019 More on Valuating
6/21
FIN
2001 M. P. Narayanan University of Michigan 6
Enterprise Value
Economic Value Balance Sheet
PV of future cash from business
operations$1500
Cash $200 Debt $650
Marketable securities $150 Equity $1200
$1850 $1850
Enterprise Value
-
8/10/2019 More on Valuating
7/21
FIN
2001 M. P. Narayanan University of Michigan 7
Value to EBITDA multiple: Example
Suppose you wish to value a target company using thefollowing data:
Enterprise Value to EBITDA (business operations only)multiple of 5 recent transactions in this industry: 10.1, 9.8, 9.2,
10.5, 10.3.
Recent EBITDA of target company = $20 million
Cash in hand of target company = $5 million
Marketable securities held by target company = $45 million
Interest rate received on marketable securities = 6%.Sum of long-term and short-term debt held by target = $75million
-
8/10/2019 More on Valuating
8/21
FIN
2001 M. P. Narayanan University of Michigan 8
Value to EBITDA multiple: Example
Average (Value/ EBITDA) of recent transactions(10.1+9.8+9.2+10.5+10.3)/5 = 9.98
Interest income from marketable securities
0.06
45 = $2.7 millionEBITDA Interest income from marketable securities
20 2.7 = $17.3 million
Estimated enterprise value of the target
9.98
17.3 = $172.65 millionAdd cash plus marketable securities
172.65 + 5 + 45 = $222.65 million
Subtract debt to find equity value: 222.6575 = $147.65million.
-
8/10/2019 More on Valuating
9/21
FIN
2001 M. P. Narayanan University of Michigan 9
Valuation: Value to EBITDA
multiple
Since this method measures enterprise value itaccounts for different
capital structures
cash and security holdings
By evaluating cash flows prior to discretionary capitalinvestments, this method provides a better estimate ofvalue.
Appropriate for valuing companies with large debtburden: while earnings might be negative, EBIT islikely to be positive.
Gives a measure of cash flows that can be used tosupport debt payments in leveraged companies.
-
8/10/2019 More on Valuating
10/21
-
8/10/2019 More on Valuating
11/21
FIN
2001 M. P. Narayanan University of Michigan 11
Valuation: DCF method
Here we follow the discounted cash flow (DCF)technique we used in capital budgeting:
Estimate expected cash flows considering the synergy in atakeover
Discount it at the appropriate cost of capital
-
8/10/2019 More on Valuating
12/21
-
8/10/2019 More on Valuating
13/21
FIN
2001 M. P. Narayanan University of Michigan 13
Template for Free Cash Flow
IncomeSta
tement
Working capital
Year 0 1 2
Revenue
Costs
Depreciation of equipment Noncash itemProfit/Loss from asset sales Noncash item
Taxable income
Tax
Net oper proft after tax (NOPAT)
Depreciation Adjustment for
Profit/Loss from asset sales for non-cash
Operating cash flowChange in working capital
Capital Expenditure Capital items
Salvage of assets
Free cash flow
-
8/10/2019 More on Valuating
14/21
FIN
2001 M. P. Narayanan University of Michigan 14
Template for Free Cash Flow
The goal of the template is to estimate cash flows, not profits.
Template is made up of three parts.An Income Statement
Adjustments for non-cash items included in the Incomestatementto calculate taxes
Adjustments for Capital items, such as capital expenditures,working capital, salvage, etc.
The Income Statementportion differs from the usual incomestatement because it ignores interest. This is because, interest,the cost of debt, is included in the cost of capital and including itin the cash flow would be double counting.
Sign convention: Inflows are positive, outflows are negative.Items are entered with the appropriate sign to avoid confusion.
-
8/10/2019 More on Valuating
15/21
FIN
2001 M. P. Narayanan University of Michigan 15
Template for Free Cash Flow
There are four categories of items in our Income Statement.While the first three items occur most of the time, the last one islikely to be less frequent.
Revenue items
Cost itemsDepreciation items
Profit from asset sales
Adjustments for non-cash items is to simply add all non-cashitems subtracted earlier (e.g. depreciation) and subtract all non-
cash items added earlier (e.g. gain from salvage).There are two type of capital items
Fixed capital (also called Capital Expenditure (Cap-Ex), or Property,Plant, and Equipment (PP&E))
Working capital
-
8/10/2019 More on Valuating
16/21
FIN
2001 M. P. Narayanan University of Michigan 16
Template for Free Cash Flow
It is important to recover both at the end of a finite-lived project.
Salvage the market value property plant and equipment
Recover the working capital left in the project (assume full recovery)
-
8/10/2019 More on Valuating
17/21
FIN
2001 M. P. Narayanan University of Michigan 17
Template for Free Cash Flow
Taxable income = Revenue - Costs - Depreciation + Profit from asset sales
NOPAT = Taxable income - Tax
Operating cash flow = NOPAT + Depreciation - Profit from asset sales
Free cash flow = Operating cash flow - Change in working capital - Capital Expenditure +
Salvage of equipment - Opportunity cost of land + Salvage of land
Adjustment of noncash items:
Add the noncash items you subtracted earlier and subtract the noncash items you added earlier.
-
8/10/2019 More on Valuating
18/21
FIN
2001 M. P. Narayanan University of Michigan 18
Estimating Horizon
For a finite stream, it is usually either the life of theproduct or the life of the equipment used tomanufacture it.
Since a company is assumed to have infinite life:Estimate FCF on a yearly basis for about 5 10 years.After that, calculate a Terminal Value, which is the ongoingvalue of the firm.
Terminal value is calculated one of two ways:
Estimate a long-term growth and use the constant growthperpetuity model.
Use a Enterprise value to EBIT multiple, or some suchmultiple
-
8/10/2019 More on Valuating
19/21
FIN
2001 M. P. Narayanan University of Michigan 19
Costs of debt and equity
Cost of debt can be approximated by the yield tomaturity of the debt.
If it is not directly available, check the bond rating of
the company and find the YTM of similar rated bonds.Cost of equityCAPM
Findbeand calculate required r
e.
Use Gordon-growth model and find expected re. Under the
assumption that market is efficient, this is the required re.
-
8/10/2019 More on Valuating
20/21
FIN
2001 M. P. Narayanan University of Michigan 20
Model of a Firm
Value fromOperations
FIRM
DEBT andother
liabilitiesEQUITY
Value generated
Value to Equity
Equal if debtis fairly priced
Value frominvestments
Enterprise value
-
8/10/2019 More on Valuating
21/21
FIN
2001 M P Narayanan University of Michigan 21
Value of equity
Value of equity
= Enterprise value
+ Value of cash and investments
- Value of debt and other liabilities