DCF Valuation of a Firm

8/14/2019 DCF Valuation of a Firm

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Corporate Valuation

DCF valuation methods FCF-WACC method

APV (adjusted present value) method

FTE (flow-to-equity) method

Industry comparables method


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Corporate Valuation:

We introduce the FCF-WACC

method. Of the DCF valuation methods, the

FCF-WACC method is the mostwidely used.

We break up assets into operatingand non-operating assets for thepurpose of firm valuation.


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Operating assets

Operating assets are non-financial assetsincluding buildings, machines andinventory.

They generate operating incomes, whichare expected to grow.

After-tax net operating profit (NOPAT) netof required investment is called free cash

flow (FCF). The PV of the expected future free cash

flows, discounted at the WACC, is thevalue of operations.


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Measurement of FCF

FCF=After-tax net operating profit-required investment

FCF=(EBIT)(1-T)+DEP-(NFA+ NWC+DEP)

FCF=(EBIT)(1-T)-(NFA+ NWC)

FCF=NOPAT-(Operating Asset)


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Nonoperating Assets

Marketable securities

Ownership of non-controllinginterest in another company

Value of nonoperating assets usuallyis very close to figure that is reported

on balance sheets.


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Total Corporate Value

Total corporate value is sum of:

Value of operations

Value of nonoperating assets


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Claims on Corporate Value

Debtholders have first claim.

Preferred stockholders have the nextclaim.

Any remaining value belongs tostockholders.


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Applying the Corporate Valuation

Model Forecast the financial statements.

Calculate the projected free cash flows.

Model can be applied to a company thatdoes not pay dividends, a privately heldcompany, or a division of a company,

since FCF can be calculated for each ofthese situations.


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Data for Valuation

FCF0 = $20 million

WACC = 10%

g = 5% Marketable securities = $100 million

Debt = $200 million

Preferred stock = $50 million

Book value of equity = $210 million


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Value of Operations:

Constant GrowthSuppose FCF grows at constant rate g.

1tt

t0

1tt

tOp

WACC1

)g1(FCF

WACC1FCFV


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Constant Growth Formula

Notice that the term in parentheses isless than one and gets smaller as t

gets larger. As t gets very large,term approaches zero.

1t

t

0OpWACC1

g1FCFV


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Constant Growth Formula (Cont.)

The summation can be replaced by asingle formula:

gWACC)g1(FCF

gWACCFCFV

0

1Op


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Find Value of Operations

42005.010.0)05.01(20

V

gWACC

)g1(FCF

V

Op

0

Op


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Value of Equity

Sources of Corporate Value

Value of operations = $420

Value of non-operating assets = $100

Claims on Corporate Value

Value of Debt = $200

Value of Preferred Stock = $50

Value of Equity = ?


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Value of Equity

Total corporate value = VOp + Mkt. Sec.

= $420 + $100

= $520 million

Value of equity = Total - Debt - Pref.= $520 - $200 - $50

= $270 million


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Market Value Added (MVA)

MVA = Total corporate value of firmminus total book value of firm

Total book value of firm = book valueof equity + book value of debt + bookvalue of preferred stock

MVA = $520 - ($210 + $200 + $50)

= $60 million


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Breakdown of Corporate Value

0

100

200

300

400

500

600

Sources

of Value

Claims

on Value

Market

vs. Book

MVA

Book equity

Equity (Market)

Preferred stock

Debt

Marketablesecurities

Value of operations


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Example of non-constant growth

Debt= $40 million

The company has 10 million sharesof stock.

The weighted average cost ofcapital=10%.

(More)


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Projected free cash flows (FCF):

Year 1 FCF = -$5 million.

Year 2 FCF = $10 million.

Year 3 FCF = $20 million

FCF grows at constant rate of 6%after year 3.


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Horizon Value

Free cash flows are forecast for threeyears in this example, so the forecast

horizon is three years. Growth in free cash flows is not

constant during the forecast,so we

cant use the constant growthformula to find the value ofoperations at time 0.


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Horizon Value (Cont.)

Growth is constant after the horizon(3 years), so we can modify the

constant growth formula to find thevalue of all free cash flows beyondthe horizon, discounted back to thehorizon.


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Horizon Value Formula

Horizon value is also called terminalvalue, going-concern value orcontinuing value.

gWACC)g1(FCF

VHV tttimeatOp


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Vop at 3

Find the value of operations by discounting

the free cash flows at the cost of capital.0

-4.545

8.264

15.026

398.197

1 2 3 4kc=10%

416.942 = Vop

g = 6%

FCF= -5.00 10.00 20.00 21.2

$21.2

. .$530.

10 0 06

0


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Find the price per share of common

stock.Value of equity = Value of operations

- Value of debt

= $416.94 - $40

= $376.94 million.

Price per share = $376.94 /10 = $37.69.


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Practice problem

Marketable securities=$10 million

Debt= $100 million

The company has 10 million sharesof stock.

The weighted average cost ofcapital=13%.

(More)


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Projected free cash flows (FCF):

Year 1 FCF = -$20 million.

Year 2 FCF = $30 million.

Year 3 FCF = $40 million

FCF grows at constant rate of 7%after year 3.


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(a) Estimate the horizon value.

(b) Estimate the value of operation.

(c) Estimate the enterprise value.

(d) Estimate the per share price.

Answers: V=537.89;S=437.89;p=$43.79


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Horizon Value Formula

gWACC)g1(FCF

VHVt

ttimeatOp


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Vop at 3

Find the value of operations by discounting

the free cash flows at the cost of capital.0

-17.70

23.49

27.72

494.37

1 2 3 4kc=13%

527.88 = Vop

g = 7%

FCF= -20 30 40 42.8

$42.8

. .$713.33

13 0 07

0

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DCF Valuation of a Firm