Since valuation models are quantitative, valuation is objective. A well-researched and well-done valuation is timeless
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1 Sessio #6 Valuatio Damodara - Chapter 23: 4,8,1,15,2 Refereces: Damodara: Damodara o Valuatio (1994: Joh Wiley) Copelad, Koller & Murri: Valuatio (199: Joh Wiley) Geeralities (myths) about valuatio: Sice valuatio models are quatitative, valuatio is objective A well-researched ad well-doe valuatio is timeless A good valuatio provides a precise estimate of value The more quatitative a model, the better the valuatio The market is geerally wrog The product of valuatio (i.e. the value) is what matters; the process of valuatio is ot importat I. Relative valuatio methods Comparable firm Comparable trasactio II. DCF methods Equity valuatio: Divided discout model, FCFE Firm valuatio: FCFF, APV Valuatio - 1
2 I. Relative valuatio A. Tradig market valuatios (comparable firm approach) Fid a uiverse of compaies that is valued for you by the market Fid how your compay fits i that uiverse Take clues from the market about valuig your compay The ART here is the word comparable Example: Target Compay Comparables: Village Super Markets Appletree Markets Delchamps Foodarama Sales EBIT EBITDA Gross margi 25.9% 25.7% 26.7% 24.1% MV Equity Net Debt Total value Ave as a multiple of: Reveue.2x.1x.1x.13x EBIT 8.3x 7.8x 4.x 6.7x EBITDA 5.4x 4.x 2.5x 3.97x Appletree Markets valuatio: Total value: Multiple of sales.13*696= 92.8 Multiple of EBIT 6.7*12= 8.4 Multiple of EBITDA 3.97*3= 119 Ave: 97.4 Valuatio - 2
3 Estimatig multiples from fudametals: GordoGrowthModel P : DPS = r 1 g P EPS = PE = PayoutRatio *( 1+ g ) r g P BV = PVB = ROE * PayoutRatio *( 1+ g ) r g P Sales Pr ofitm arg i * PayoutRatio *( 1+ g ) = PS = r g Valuatio - 3
4 B. Comparable trasactios approach Date Acquiror/ Target 3/8/89 Mgmt/ SuperRite 3/1/88 Citicorp/ FarmFresh Purchase price (for equity) Net Debt Total Value Sales EBIT EBITDA Total Value as a Multiple of: Sales EBIT EBITDA Mgmt/ SuperRite Citicorp/ FarmFresh average Appletree Markets valuatio: Total value: Multiple of sales =.22 x 696 = Multiple of EBIT = x 12 = Multiple of EBITDA = 6.55 x 3 = Average Valuatio - 4
5 II. DCF Models Equity value vs. Eterprise Value Divided discout model (DDM) vs. FCFE FCFF vs. Adjusted Preset Value (APV) A. Divided discout model A commo assumptio is that the divided will have a period of extraordiary growth, followed by stable growth forever. The model eeds four iputs: 1. the legth of the high growth period 2. DPS durig the high growth period 3. termial price at the ed of the high growth period 4. discout rate 1. Estimate earigs from : Historical growth aalysts projectios firm fudametals 2. Estimate divided payout ratios 3. Estimate termial price P DPSt P = + ( t t 1 1+ r ) ( = 1+ r ) ; P DPS = r g +1 Earigs growth = CF growth = divided growth Expected divideds = expected earigs*payout ratio Expected growth rate = retetio ratio*roe Fudametal growth model: g = b[roa + D/E(ROA - i(1-t)], where b = retetio ratio = 1 - payout ratio ROA = [NI + iterest exp*(1-t) ] / total assets i = iterest expese/bv debt payout ratio = 1-b = 1 - [g/(roa + D/E(ROA - i(1-t))] Valuatio - 5
6 B. FCFE (flows to equity) model FCFE = cash left over after meetig all fiacial obligatios icludig debt paymets, ad after providig for capex, et workig capital (NWC). Relatioship of FCFE to total firm FCFF: FCFF = EBIT(1-T) + depr - capex - NWC = OCF - capex - NWC FCFE = FCF - Iterest(1-T) - pricipal repaymets + ew debt issues FCFE ca also be derived from et icome: FCFE = NI + depr - capex - NWC - pricipal repaymets + ew debt issues P FCFEt P = + ( t t 1 1+ r ) ( = 1+ r ) ; P FCFE = r g +1 FCFE value will equal divided discout model value whe divideds are equal to FCFE Valuatio - 6
7 C. FCFF Model Discout FCFF at the firm's WACC Cocepts: 1. Eterprise value vs. equity value 2. Termial value Value = PV of FCFF durig forecast period + PV of FCFF after forecast period. Termial value = proxy for all cash flows after the forecast period. Termial value ca be calculated as: 1. A growig perpetuity: Termial value = FFCF fial year (1+g)/(r-g) 2. Based o a multiple (of EBIT, BV, Earigs, FCFF) There should be some cosistecy betwee the two approaches. For example: Idustry with log term growth of 2% A sesible multiple of FCFF is 1x, ot 2x Valuatio - 7
8 FCFF Example: Hershey Foods Corporatio ($ millios) Free cash flow Forecast 1995 Forecast 1996 Forecast Reveues Operatig Expeses EBIT Taxes Net oper profit less adj tax Depreciatio Gross cash flow Chage i WC Capital expeditures Icrease i et other assets Gross ivestmet FFCF Source of capital Proportio of total capital Opportuity cost Tax Beefit After-tax Cotributio cost to weighted average Debt 25.% 9.9% 3.9% 6.% 1.5% Equity 75.% 13.3% 13.3% 1.% WACC 11.5% Valuatio: Year FCFF Discout Preset value of FCFF 11.5% Cotiuig value (g=.6) Value of operatios 2357 Less: value of debt 254 Equity value 213 Equity value per share 23.5 Valuatio - 8
9 FCFF Example: Lockheed Corporatio Lockheed Corporatio (prior to its merger) reported EBITDA of $129 millio i 1993, prior to iterest expeses of $215 millio ad depreciatio charges of $4 millio. Capital expeditures i 1993 amouted to $45 millio, ad workig capital was 7% of reveues (which were $13,5). The firm had debt outstadig of $3.68 billio (book value), tradig at a market value of $3.2 billio, ad yieldig a pre-tax iterest rate of 8%. There were 62 millio shares outstadig, tradig at $64 per share, ad the most recet beta is 1.1. The tax rate for the firm is 4%; the treasury bod rate is 7%. The firm expects reveues, earigs, capital expeditures ad depreciatio to grow at 9.5% per year from 1994 to 1998, after which the growth rate is expected to drop to 4%. (Capital spedig will offset depreciatio i the steady state period). The compay also plas to lower its debt/equity ratio to 5% for the steady state (which will result i the pretax iterest rate droppig to 7.5%). A. Estimate the value of the firm. Cost of Capital: : From CAPM: Cost of Equity = 13.5 (risk premium = 5.5%) After tax cost of Debt = /(32+64*62) = D/V (64*62)/(32+64*62) = E/V D/V*4.8% + E/V*13.5% = WACC = 9.37 After 1998: Ulevered beta = 1.1/(1+(1-.4)*(32/(62*64))) =.74 Beta at ew leverage =.74*(1+(1-.4)*.5) =.96 From CAPM: Cost of 12.3 Equity = D/E =.5 ; D/V =.5/1.5 = 1/3 ; E/V = 2/3 After tax cost of Debt = 4.5 D/V*4.5% + E/V*12.3% = WACC = 9.7 Cash Flow Projectios: Yr Reveue 13,5 14,783 16,187 17,725 19,48 21,252 Valuatio - 9
10 EBITDA 1,29 1,413 1,547 1,694 1,855 2,31 - Depr EBIT ,67 1,169 1,28 1,41 EBIT(1-t) Depr Capex i NWC FCF Termial Value: = {EBIT(1-t)(1+g) - (Rev 99 -Rev 98 )*(WC as a % of Rev)} / (WACC - g) = {(841*1.4) - (21,252*1.4-21,252)*.7} / ( ) = 14, Value of Firm: = 44/ / / / (633+14,292)/ = $11,149 B. Estimate the value of the equity i the firm ad the value per share. Value of equity = value of firm - market value of debt = $11,149 - $3,2 = $7,95 Value per share = $7,95/62 = $ Valuatio - 1
11 D. Adjusted Preset Value (APV) Approach (read also HBR article) APV = PV of asset flows + PV of side effects associated with the fiacig program. Procedure: 1. Calculate PV of project (or eterprise) assumig it is all equity fiaced (i.e. o iterest expese) Assume: Asset beta =.7 Log Term U.S. Govt Rate = 6% Market Premium = 7.8% From CAPM, Discout rate =.6 +.7*.78 =.1146 Also assume: Termial value = (approx.) 7 x FCF Year: EBIT % Capex Depreciatio Icrease i NWC FCF Termial Value 287 PV@ Total PV 295 Valuatio - 11
12 2. Calculate value of tax shield. Assume: $15 of debt at 8% (pretax) remais outstadig Year: EBIT Iterest (=outstadig debt*.8) Profit before tax Tax Profit after tax Capex Depr Icrease i NWC Net cash flow Edig Debt = (begiig debt - et cash flow) Compare tax paymets with vs. without debt. The differece equals the tax savigs available from the iterest deductio (tax shield). Discout tax savigs at pre-tax rate of retur o debt: Tax paymets with o debt Tax paymets with 8% Tax savigs PV of tax 8% $13 Valuatio - 12
13 Suppose i additio there is a tax loss carryforward of $1 millio. This meas that the first $4 millio of taxes eed ot be paid. Year Tax savigs Taxable Icome Used PV of tax 8% $37 Preset value these savigs at 8%, produces a value of 37 for the tax loss carryforward. Coclusio Total firm value ( ) = 345. = value of all equity firm (295) + side effects of fiacig Valuatio - 13
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