Valuing CompaniesValuing companiesDCF AnalysisValue Assets or Equity?Terminal ValuesTerminal Value in LiquidationRemarksTerminal Value as PerpetuityTerminal Value as Growing PerpetuityTerminal Value as Perpetuity (Summary)RemarksExampleExample (cont.)Example (cont.)Example – Liquidation Value (LV)Example (cont.)Example (cont.)When is Growth Valuable?Economic Value Added (EVA)RemarksEVA: Bottom LineDCF Analysis: Pros and ConsMultiplesProcedureMotivation for Multiples?Motivation for Multiples?RemarksExample: Valuing ADIExample (cont.)Example (cont.)Comparables: Pros and ConsComps & the Conglomerate DiscountPossible InterpretationsDistribution of Price / Sales ratios for Internet stocks (March 2000)Distribution of Price / Sales ratios for all stocks (March 2000)Internet stocks and selected high-tech stocks (March 2000, in $billions)What growth and margin assumptions would have justified Internet valuation in March 2000?Valuing CompaniesKatharina LewellenFinance Theory IIMay 5, 2003Valuing companies Familiar valuation methods¾ Discounted Cash Flow Analysis¾ Comparables¾ Real Options Some new issues¾ Do we value assets or equity?¾ Terminal values (liquidation, going concern)¾ Minority interests, controlling interests2DCF Analysis WACC method:¾ Forecast expected FCF¾ Estimate WACC¾ Compute PV APV method:¾ Forecast expected FCF¾ Estimate kA¾ Compute PV¾ Add PV(Tax Shield)3Value Assets or Equity? DCF methods give you the value of the whole firm (D + E) or Enterprise Value.¾ E.g., you are founding a new firm: you will receive D from creditors and E from shareholders. Often, you need to value the Equity Value in an existing firm ¾ E.g., M&A, IPOs¾ You need to subtract the value of its existing debt D Also, need to add the value of control when valuing a controlling equity position (more on this later).4Terminal Values In valuing long-lived projects or ongoing businesses, we don’t typically forecast every year of cash flow forever. Forecast FCF until it is reasonable (or best guess) to think that the project or company is in “steady state.” Typically, assume:¾ either the company is liquidated;¾ or FCF is a growing, flat, or declining, perpetuity; Note: The forecast horizon will depend on firm and industry.5Terminal Value in Liquidation1) Salvage value (SV): CF that the firm receives from liquidating its assetsSV = Liquidation price - Liquidation costs The firm is taxed on (SV – PPE) so that overall it getsSV*(1- t) + t*PPE2) Net Working Capital Recouped NWC at project end (i.e., last ∆NWC = last WC)6Remarks In principle, you would like NWC’s actual value, not book value. These might differ for instance:¾ cannot recoup full A/R,¾ Inventory sells over or below book value¾ etc. Liquidation value tends to underestimate TV unless liquidation is likely. Useful as a lower bound.7Terminal Value as Perpetuity No-growth perpetuityTV = FCFT+1/ k For a no-growth firm, we can assume (for simplicity)FCF = EBIT(1-t) + Depreciation – CAPX – ∆NWC00TV = EBIT(1-t)T+1/ k8Terminal Value as Growing Perpetuity PV in year t of a perpetuity growing at a rate gTV = FCFT+1/ (k – g) For a growing perpetuity, we can assume (for simplicity)FCF = EBIT(1-t) + Depreciation – CAPX – ∆NWC-∆NA = -g*NA prior yearTV = [EBIT(1- t)T+1 –g*NAT] / (k - g)(1+g)EBIT(1-t)T9Terminal Value as Perpetuity (Summary)T T+1 … TV FCFFCFT+1/ kFCFT+1/ (k – g)EBIT(t-1) No growthEBIT(t-1) - ∆NA Growth @ gg*NAT10Remarks Growing perpetuity - assumptions¾ Net assets grow at the same rate as profits¾ ∆NA is a good measure of replacement costs Don’t forget to discount TV further to get PVTV In WACC method, k=WACC IN APV method, k=kA for FCF and appropriate rate for TS11Example You are considering the acquisition of XYZ Enterprises. XYZ’sbalance sheet looks like this as of today (year 0). Projections:Assets LiabilitiesCurrent assets 50 Current liabilities 20Plant 50 Debt 30Net worth 50Total 100 Total 100Year 1Year 2Year 3Year 4Year 5Sales 200 217 239 270 293EBIT 20 22 25 26 30NWC 3337414448Depreciation 55678CAPX 10 10 15 6 2012Example (cont.)What is the value of XYZ’s stock under the following assumptions:1) XYZ is liquidated after year 5 (assuming zero salvage value).2) Sales growth and EBIT/Sales ratios are (past year 5):Sales growth EBIT/Sales5% 10%0% 10%5% 5%0% 5%Tax rate = 34%, and WACC = 13%.13Example (cont.)Start by estimating FCF over 5 years: NWC(year 0) = Current assets - current liabs = 50-20=30FCF = EBIT(1 - t) + Dep - CAPX - ∆NWCYear 0 Year 1 Year 2 Year 3 Year 4 Year 5EBIT 20 22 25 26 30EBIT(1-t) 13.2 14.52 16.5 17.16 19.8NWC 303337414448∆NWC 34434Depreciation 55678CAPX 10 10 15 6 20 FCF 5.2 5.52 3.5 15.16 3.8PV @ 13% 22.714Example – Liquidation Value (LV)1) Liquidation value (LV)t*PPE(year 5) + NWC(year 5)PPE(year 5) = PPE(year 0) + all CAPX - all Dep from year 0 to 5PPE = 80PPE * t = 80 * 34% = 27.2LV = 27.2 + 48 = 75.2 ==> PVLV = 75.2/(1.13)5= 40.8Firm value = 22.7 + 40.8 = 63.5Equity value = Firm value - MV of Debt = 63.5 - 30 = 33.515Example (cont.)For 2) to 5), we need EBIT (year 6) and NA (year 5) to applyTV = [EBIT(year 6)(1 - t) - g*NA(year 5)]/[k - g]EBIT(year 6) = fraction α of Sales(year 6)= α*(1 + g)*Sales(year 5)= α*(1 + g) *293NA(year 5) = NA(year 0) +all CAPX -all Dep +all ∆NWC from 0 to 5= 128PVTV = TV/(1.13)516Example (cont.)αg TV PVTV Firm Equity2) 10% 5% 173.8 94.3 117.0 87.0 3) 10% 0% 148.8 80.7 103.4 73.4 4) 5% 5% 46.9 25.5 48.2 18.2 5) 5% 0% 74.4 40.4 63.1 33.1 17When is Growth Valuable?TV (with growth) > TV (w/o growth)kt)EBIT(1gkNAgt)EBIT(1g)(1−>−⋅−−⋅+[]()kk1kNAt)EBIT(1gkt)EBIT(1kNAgt)EBIT(1g)(1kt)EBIT(1gkNAgt)EBIT(1g)(1≈+>−−×−>×⋅−−⋅+−>−⋅−−⋅+EBIT*(1 - t) - k*NA > 018Economic Value Added (EVA)EVA = EBIT*(1 - t) - k*NAIntuition: Growth is good when the cost of increasing NA is more than compensated by the capitalized increase in EBIT*(1 - t).19Remarks EVA is a particular incarnation of NPV (+ some assumptions) Appeal of EVA coherent measure for Capital budgeting, Performance evaluation and Managerial compensation. Assumes linear relationship between NA and EBIT*(1 - t) EVA has nothing to do with sustainable growth:¾ Sustainable growth rate answers “How fast can I grow without increasing my leverage ratio or issuing equity?”¾ It has nothing to say about whether growing