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*Valuation AnalysisJudson W. Russell, Ph.D., CFAUniversity of North Carolina-Charlotte

*AgendaEquity Valuation Fundamentals: Intrinsic Value

Enterprise Valuation Fundamentals: Free Cash Flow

Equity Valuation Fundamentals: Relative Value

*IntroductionValuation is both art and scienceArt through reasonable, defensible:Assumptions Judgment and interpretation of dataScience through application of analytical formulaeValuation is based on future performance

*IntroductionTwo main valuation questions:

What is a company worth by valuation metrics?

2) What can or will a potential buyer pay?

*IntroductionThree main valuation methodologiesIntrinsic Value Approach: A stocks price equals the net present value of its dividends.Relative Value Approach: A stocks value is determined by comparing similar stock values.Acquisition Value Approach: Calculate a companys stock price by determining its worth to a third party acquirer.

Golden Rule: Footnote your assumptions

*IntroductionEQUITY VALUE: Value of shareholders interestAfter interest expense, preferred dividends and minority interest expenseMultiples of net income, book value, EPSOther common terms:Market Value, Market Capitalization, Offer Value (in an acquisition context)

*IntroductionENTERPRISE VALUE:Includes all forms of capitalMarket value of equity, debt, preferred stock, minority interestBefore interest expense, preferred dividends and minority interest expenseMultiples of sales, EBITDA, EBIT or any other applicable metric (per subscriber, per bed, etc.)Other common terms:Aggregate Value, Firm Value, Total Capitalization, Adjusted Market Value, Transaction Value

*IntroductionEnterprise Value=Equity Market Cap.Net DebtPreferred StockMinority InterestEquity Market Cap.

*IntroductionCOMPARABLE (or similar) in terms of:

Operations

Financial Aspects

Industry

Size

Products

Leverage

Markets

Margins & Profitability

Distribution channels

Growth prospects

Customers

Shareholder base

Seasonality

Market conditions (acquisitions)

Cyclicality

Consideration paid (acquisitions)

Circumstances surrounding the transaction

*Equity Valuation ProcessThe Graham and Dodd Approach to Security Selection

Study the available factsPrepare an organized reportProject earnings and related dataDraw valuation conclusions based on established principles and sound logicMake a decision

*Valuation ProcessThe top-down approach starts with an analysis of alternative economies and security markets.The initial objective is to decide how to allocate investment funds among countries and within countries to bonds, stocks, and cash.The second phase is the analysis of alternative industries. The objective at this stage is to determine which industries will prosper based on your analysis of the economy.The final, third, phase focuses on security selection. The objective is to determine which companies within the selected industries will prosper and which stocks are undervalued.

Analysis of Alternative Economies and Security MarketsAnalysis of Alternative IndustriesAnalysis of Individual Companies and Stocks

*Valuation Process ExampleThe top-down analysis for a U.S. homebuilder:EconomyGDP will increase 3%Capital MarketsInterest rates will remain lowIndustryHousing starts to stay strongHomebuilding CompanyHomebuilder to gain market share.

Sales will increase by 15% versus the industry average of 10%. Steady profit margins signify a 15% earnings increase.

*Economic Cycles

*Industry AnalysisForecast SalesAn insightful analysis when predicting industry sales is to view the industry over time and divide its development into stages.Pioneering development - ARapid accelerating growth - BMature growth - CStabilization and market maturity - DDeceleration of growth and decline - E

TimeRate of Sales GrowthBADCE

*Porters Five Forces

Valuation Approach Intrinsic Value

*Valuation Approaches Intrinsic ValueThe value of an asset is the present value of its expected returns.

The process of valuation requires estimates of (1) the stream of expected returns and (2) the required rate of return on the investment.

The value of a preferred stock (perpetuity) is simply the stated annual dividend divided by the required rate of return on preferred stock (kp). A preferred stock with an $8 per year dividend and required return of 9% is valued as:

V = $8 / 0.09 = $88.89

*The valuation of common stock is more difficult than bonds or preferred stock because an investor is uncertain about the size of the returns, the time pattern of returns, and the required rate of return (ke).

However, the value of common stock is still the present value of its future cash flows. The only cash flows an equity investor ever gets are dividends (cash or liquidating).

A model to value common stock is the dividend discount model (DDM).Valuation Approaches Intrinsic Value

*The DDM assumes that the value of a share of common stock is the present value of all future dividends as;

V = [D1/(1+ke)1 + D2/(1+ke)2 + + D/(1+ke)]

Since estimating D is impossible, other methods have evolved based upon a terminal stock value, or a constant rate of growth.

Valuation Approaches Intrinsic Value

*Assume an investor wants to buy a stock, hold it for one year, and then sell it. We must evaluate the dividend cash flows as well as the terminal value in one year. These cash flows are then discounted at the investors required rate of return.A company earned $2.50 a share last year and paid a $1 dividend (40% dividend payout). The firm has a consistent record regarding payout and we expect it to earn $2.75 per share during the coming year. We expect the stock to trade at $22 at the end of the coming year. Further, the risk-free rate is 5%, the market return is 10%, and the stocks beta is 1.2.

ke = rf + b(E(rm) rf ) = 5 + 1.2 (10-5) = 11%, D1 = E1(dividend payout) = $2.75(.4) = $1.10

V = [D1/(1+ke)1 + Stock Value1/(1+ke)1]V = [$1.10/(1+.11)1 + $22/(1+.11)1]V = 0.99 + 19.82 = $20.81


*When valuing a firm with an infinite holding period we assume that dividends, at some point, exhibit a constant rate of growth. Assume that a firm is in a state of constant growth, we can value the infinite stream of cash flows using the following abbreviated formula:

V = D1/(ke - g)

For instance, in our previous example lets assume that the holding period is infinite and the firms dividends are growing at 6% per year perpetually. The dividend in one year was $1.10 and the required rate of return was 11%.

V = $1.10/(.11- .06) = $22.00


*We can employ the same technique for firms that have varying rates of growth by assuming that the growth rate becomes constant, at some point.For instance, suppose we have a firm experiencing rapid growth due to its position in the product cycle. At some point the growth rate has to slow or the firm will become the market!We can accommodate this scenario with a multistage model by discounting the rapid growth phase dividends individually and then determining the terminal value using the constant growth methodology.

V = [D1/(1+ke)1 + D2/(1+ke)2 + + (Dn+1/(ke-g)) /(1+ke)n]


*Suppose that ABC Company has a current dividend of $1.00 per share with growth expectations of 20% for each of the next two years. After that point, the firm expects dividends to grow at 4% each year indefinitely. Given a cost of equity of 11%, calculate the value of the firms shares.

V = [D1/(1+ke)1 + D2/(1+ke)2 + V2/(1+ke)2]where V2= D3/(ke g)

V = [$1.20/(1+.11)1 + $1.44/(1+.11)2 + ($1.50/(.11-.04)) /(1+.11)2]

V = $1.08 + $1.17 + $17.39 = $19.64


*Valuation Approach Intrinsic ValueDISCOUNTED CASH FLOW ANALYSISIntrinsic value of the companyUnlevered free cash flowsIndependent of capital structureFree cash flows generated by the assets that are available to all capital holdersPresent value of: (1) free cash flows and (2) projected terminal valueTerminal value is used to estimate value beyond the forecast periodExit Multiple Method (assumes the sale of the business)Perpetuity Growth Rate Method(3) Discount rate = Weighted average cost of capital (WACC)WACC = ka = wdkd(1-t) + weke

*FCF1FCF2FCF3FCF4FCF5How do we account for the remaining cash flows of the firm?

Terminal Value ApproachConstant Growth MethodFree Cash Flow AnalysisFCFn

*Terminal Value CalculationA. The Exit Multiple Method

*The Present Value of the Terminal ValueDiscounted Cash Flow Analysis

12010 EBITDA (Terminal Value) $113.10 2x Exit multiple6.5x3= Pretax Sales Proceeds (future value)$735.15 4/ discount factor (back 5 years at 12%)0.56745Present value of terminal value$417.14

*Terminal Value as % of Enterprise ValueProvides a reality check of the DCF valueHigher the %, more of the Enterprise Value is being realized with the assumed sale of the business at the end of the forecast periodConfidence level in the 70-85% range, depending on the company and situationDiscounted Cash Flow Analysis

*Terminal Value as % of Enterprise ValueHow much of the Enterprise Value for the Company is being generated by the Terminal Value?What is your comfort level with this percentage?

Discounted Cash Flow AnalysisPresent Value of Exit Multiple = $417Enterprise Value = $589.7Percentage = $417/$589.7 = 70.7%

*Terminal Value CalculationB. The Perpetuity Growth Method

*Discounted Cash Flow AnalysisNow well look at the perpetuity growth technique to capture the terminal value of Company.The terminal value captures all future cash flows of the firm assuming a constant growth factor.The operating cash flow of the firm in 2010 is $55.5. Assuming a growth rate of 4% the operating cash flow in 2011 would be $57.72.We have a discount factor of 12% and a growth factor of 4% with a cash flow of $57.72.

*Perpetuity Growth FormulaTerminal Value = FCFN+1 (ka - g)where:FCFN+1 = steady-state free cash flow in period N+1g = nominal perpetual growth rateka = discount rate

Terminal Value = $55.5(1.04)=$57.72= $721.5 .12-.04 0.08

Present Value of Perpetuity Growth Terminal Value = $721.5/(1.12^5) = $409.40Discounted Cash Flow Analysis

*Relative Value Analysis

*How do we use relative value?The hardest part of relative value is finding comparable firms. Once you have a decent list of comparables you need to determine which scaling variable to?Next, you want to compare your target firms multiple to the average of the comparable set.Finally, make sure that you account for differences, e.g. leverage, market position, patents, etc.

*Comparing PE Ratios across a Sector

*Investors prefer to estimate the value of common stock using an earnings multiplier model.

P0 = D1/(ke - g)

Divide both sides by next years projected earnings:

P0/E1 = (D1/E1)(1/(ke - g))

The P/E ratio (forward) is determined by:The expected dividend payout ratio (D1/E1) The required rate of return on the stock (ke)The expected growth rate of dividends (g)

Relative Value

*Assume that a firm has an expected dividend payout of 40%, a required rate of return of 11%, and a growth rate of dividends of 6%. Next years earnings (E1) are expected to be $2.75.

P0/E1 = (.40)(1/(.11-.06)) = 8.0x

The value of the stock today is based on the P/E1 and estimate of E1.

P0 = P0/E1 x E1 = 8.0 x $2.75 = $22.00

Relative Value

*The best known measure of relative value for common stock is the P/E ratio or the earnings multiplier. Analysts have also turned their attention to other measures of relative value:Price/book value (P/BV) : market value of the company divided by its book value. This metric is used a great deal with financial stocks since many of their assets are carried at values very close to market value. This metric can be used for firms with negative earnings or cash flows. Several studies have indicated that P/BV is a good indicator of future performance.Price/cash flow (P/CF) : market value of the company divided by its cash flow. Price/sales (P/S) : market value of the company divided by its sales.

Relative Value

*Expected Growth RateWhen a firm retains earnings and acquires assets, if it earns some positive rate of return on these additional assets, the total earnings of the firm will increase.The rate of earnings growth depends on the proportion of earnings retained and the rate of return it earns on the new assets acquired.Specifically, the growth rate (g) of equity earnings without external financing is equal to the percentage of net earnings retained (retention rate, b) times the rate of return on equity capital (ROE).

g = (retention rate)(return on equity)g = (b)(ROE)

This growth rate is called the internal or sustainable growth rate.The firm can increase its rate of growth by 1) retaining a larger portion of its earnings for reinvestment in the firm or 2) increasing its ROE (recall, ROE = profit margin x total asset turnover x financial leverage).

*Pulling it all togetherFirm XYZ is trading at $18 currently. Last years earnings were $2.00 per share. The firms ROE is 10% and you expect it to stay that way for the foreseeable future. The firm has a stable dividend payout policy of 40%. The current nominal risk-free rate is 7%, the expected market return is 12% and XYZs beta is 1.2. Value XYZ and indicate what you should do based on your estimate.

Determine required rate of return: ke = 7% + 1.2(12%-7%) = 13%Determine growth rate: g = (.60)(10%) = 6%Determine last years dividend: $2.00(.40) = $0.80.Determine next years dividend: D1 = D0(1+g) = $0.80(1.06) = $0.85Calculate the value projection: V = D1/(ke - g) = $0.85/(.13-.06) = $12.14Compare the stock value to its current market price: $12.14 vs. $18.00Sell recommendation.

2.Overview of Conrail Inc.Valuation Analysis

*Conrail, through its wholly-owned subsidiary Consolidated Rail Corporation, provides freight transportation services within the northeast and midwest United States. Conrail interchanges freight with other United States and Canadian railroads for transport to destinations within and outside Conrail's service region. Conrail operates no significant line of business other than the freight railroad business and does not provide common carrier passenger or commuter train service.

Consolidated Rail Corporation is a Pennsylvania corporation incorporated on February 10, 1976 to acquire, pursuant to the Regional Rail Reorganization Act of 1973, the rail properties of many of the railroads in the northeast and midwest region of the United States which had gone bankrupt during the early 1970's, the largest of which was the Penn Central Transportation Company ("Penn Central"). The US government sold its 85% stake to the public in 1987.

Conrail Inc.Company Description

*CSX and Norfolk SouthernConrail is the ideal extension for both into the NortheastNortheast corridor is a must for a transcontinental railroadStrategic positioning with 2 major Western railsAnalysis of Potential Acquirers

*Financial Overview of ConrailDate: October 14, 1996 (pre-CSX merger announcement)The Conrail Case Study

CRR Financial Information as of 6/30/96 Dollar amounts and shares in millions

Multiple based on10/14/96 price of $71.00

LTM Revenues

$3,712

2.19x

LTM EBITDA

$993

8.2x

LTM EBIT

$705

11.5x

Diluted Shares Outstanding (a) (b)

81.718

Market Capitalization of Equity

$5,802

ESOP Preferred Stock

$281

Total Debt (at book values)

$2,078

Cash and equivalents

$28

Enterprise Value

$8,133

(a) 81.067 million common shares outstanding and 1.556 million options with an average strike of $41.28. Option proceeds assumed to repurchase shares at current share price under the treasury stock method.

(b) Excludes ESOP junior preferred stock convertible into 9.75 million common shares.

3.Comparable Public Company AnalysisAnalysis of Selected Publicly Traded CompaniesPublic ComparablesTrading ComparablesComp CosCommon Stock Comparisons

*Comparable Public Company AnalysisPrevious analyses of other bankersIndustry specialistsM&AProxy Statement - Peer group index10-K / IPO Prospectus - Competition sectionResearch (respect the Chinese Wall)S&P Tearsheets, Value Line, BloombergSIC code screen from FactSet Companys viewsDetermining the Appropriate Universe

*1)Most recent 10-K and/or annual report2)10-Q from latest quarter3) News announcements (before required filing)4)Research reports and EPS estimatesUse SEC-filed documents whenever possibleComparable Public Company AnalysisPublic Information Checklist

What comparables should be used to value Conrail?Valuation Analysis

*Summary of the Railroad Industry

1995 Financial Information

Name (ticker)

Total Rev

Rail Rev - $

Rail Rev - %

Non-Rail (%-Rev)

Comments

Burlington Northern Santa Fe (BNI)

$8,170

$8,170

100%

BNI operates in 35 states, mostly in the western US. In September, 1995 BNI took control of Santa Fe Pacific, making it the second largest railroad in the US.

Canadian National (CNI)

C$4,100

C$4,100

100%

Canadian National was owned by the government until late 1995 when it was privatized. As a result of this transaction, as well as previous governmental ownership, its financial statements are rather messyeg., there are significant NOLS, and the capital structure is strange. Although no longer owned by the Canadian government, CNI, as all Canadian railroads, operates under government regulation. CNI has some lines that overlap with Conrail in the northeastern US.

Canadian Pacific (CP)

C$7,946

C$3,757

47%

CP Ships (12%)

Energy (34%)

Real estate (12%)

Obviously another Canadian railroad. Note the rail and non-rail revenue percentages exclude inter-company eliminations.

Conrail (CRR)

$3,686

$3,686

100%

Do you include the company you are trying to value in the list of comparable companies?



Name (ticker)

Total Rev

Rail Rev - $

Rail Rev - %

Non-Rail (%-Rev)

Comments

CSX (CSX)

$10,504

$4,819

46%

Shipping (38%)

Intermodal (9%)

Barge (5%)

Real estate (2%)

Although only 46% of CSXs revenues are from rail operations, the shipping, intermodal, and barge lines are all transportation businesses. Notwithstanding the fact that rail is only 46% of CSXs revenues, rail contributes 77% of operating income.

Florida East Coast (FLA)

$201

$149

74%

Real estate (14%)

Mtr carrier (12%)

FLAs rail operations run the length of Florida, along the Atlantic coast. FLA has a unique ownership structure. It is owned 54% by St. Joe Paper Company, which is in turn 69% owned by the DuPont family. The DuPonts chief interest in FLA is its extensive land holdings.

Illinois Central (IC)

$644

$644

100%

IC is a single track line that runs up and down the Mississippi River. Unlike the other large US railways, IC principally hauls agriculture commodities, rather than freight.

Kansas City Southern (KSU)

$775

$502

65%

Asset mgt (31%)

Other (4%)

The rail operations run through MO, AR, TX, LA, MS, AL. The Asset Management segment is comprised of two prominent investment operations: the Janus and Berger funds.



Name (ticker)

Total Rev

Rail Rev - $

Rail Rev - %

Non-Rail (%-Rev)

Comments

Norfolk Southern (NSC)

$4,668

$4,012

86%

NAVL (14%)

Its rail operations are principally in the SE and MW. North American Van Lines (NAVL) is its other major segment. Rail accounts for 94% of consolidated operating income.

Union Pacific (UNP)

Wisconsin Central (WCLX)

$11,100

$263

$9,874

$263

90%

100%

Trucking (9%)

Logistics (1%)

The countrys largest railroad operating throughout the western US. Recently acquired Southern Pacific.

An extremely profitable railroad operating in the upper Midwest. Also has equity, investments in rail operations in New Zealand and the UK.

Required Analytical AdjustmentsValuation Analysis

*One-Time Non-Recurring ItemsNormalizing the income statement for one-time itemsAdjust for non-recurring items (gains and losses)What was Conrails normalized 1995 income statement?What adjustment needs to be made to operating income?What adjustment needs to be made to net income?What adjustment needs to be made to taxes?Subjectivity of the Analysis

*Conrails 1995 Income Statement

*Note 2: Asset Disposition Charge

2. Asset Disposition Charge

------------------------

Included in 1995 operating expenses is an asset disposition charge of $285 million, which reduced net income by $176 million. The asset disposition charge resulted from a review of the Company's route system and other operating assets to determine those that no longer effectively and economically support current and expected operations. The Company identified and has committed to sell 1,800 miles of rail lines that are expected to provide proceeds substantially less than net book value. In addition, other assets, principally yards and side tracks, identified for disposition have been written down to estimated net realizable value.

Normalizing Conrails Income Statement for 1995

Reported

Adjustment

Normalized

Operating Income Pretax Adjustment

$456

000000000

000000000

Taxes Incremental Tax Adjustment

128

000000000

000000000

Net Income After-tax Adjustment

264

000000000

000000000

4.Comparable Acquisition AnalysisAnalysis of Selected AcquisitionsAcquisition ComparablesAcq CompsDeal Comps

*Comparable Acquisition AnalysisPrevious analyses of other bankersScreen for comparable M&A transactionsSecurities Data Corp. (SDC)Compile list from SIC code screenOther possibilities:Industry newsletters, journalsM&A journals and almanacsNews servicesResearch reportsDetermining the Appropriate Universe

*Financial informationSEC filed documents if possibleSDC M&A summarySummary description of the transaction, key dates, premiums paidNews runMerger documents (if applicable)Form 8-K, Proxy/S-4 for pro forma financial infoResearch & EPS estimates (if applicable)Comparable Acquisition AnalysisInformation Checklist

*Looking for comparability regarding:transaction sizeNature of acquirer:Strategic buyerfinancial buyerRecent timeframeComparable Acquisition Analysis

*Comparable Acquisition AnalysisComparable Acquisition Analysis - Multiples Summary(Dollars in Millions)EffectiveTransactionDateTargetAcquirorEnterprise ValueSales EBITDAJun-96CCP Holdings, Inc.Illinois Central Corp.$1572.06x5.3xSep-96Southern PacificUnion Pacific Corp.$5,5001.74x7.7xMay-95Chicago & North West.Union Pacific Corp.$2,6112.25x8.3xSep-95Santa Fe PacificBurlington Northern$5,1061.90x8.5xCancelledKansas City SouthernIllinois Central Corp.$1,6253.25x9.0x(1) Adjusted average omits the high and low values.Enterprise Value as a Multiple of:Comparable Industry TransactionsComments: CCP was a small railroad owned by three individuals.Comments: This is a large, recent transaction.Comments: Union Pacific had owned 32% of CNW, and completed the purchase of the remaining 68%. The statistics in the chart reflect the transaction as if the entire 100% were purchased.Comments: Another large, recent transaction.Comments: The transaction from mid-1994 was cancelled since the parties could not agree on how to value the asset management businesses.

*Comparable Acquisition AnalysisComparable Acquisition Analysis - Multiples Summary(Dollars in Millions)EffectiveTransactionDateTargetAcquirorEnterprise ValueSales EBITDASep-92Midsouth Corp.Kansas City Southern$3473.39x8.8xApr-90Soo Line Corp.Canadian Pacific Ltd.$5280.98x7.4xOct-89CNW Corp.CNW Acquisition Corp.$1,6511.65x7.1xJul-89Illinois Central Rail.The Prospect Group$6721.22x5.8xEnterprise Value as a Multiple of:Comparable Industry TransactionsComments: The target operates rail lines in La, Miss, Ala.Comments: The target operates principally in the upper Midwest---Minn and Wisc.Comments: A very successful acquisition by the Blackstone group, a major financial buyer in the US.Comments: Another very successful LBO, this time by another prominent financial buyer, the Prospect group.(1) Adjusted average omits the high and low values.

5.Discounted Cash Flow Analysis

*Discounted Cash Flow AnalysisIn this section we will project free cash flow for Conrail and determine the enterprise value by discounting these cash flows at the appropriate discount rate.We will also explore the following:valuation using a terminal exit multiplevaluation using a perpetuity growth formulavaluation incorporating the effects of synergies

*Discounted Cash Flow AnalysisAs the title implies we will need to determine Conrails cash flows.Typically, we will want to look at the past three years of financials to form a basis for our projections.The projection period is usually five years and then either:an assumed sale of the firm takes place to capture the value of all future cash flows (exit multiple approach), orwe value all future cash flows assuming that growth will remain constant at a level approximately equal to the economys GDP growth level (perpetuity growth approach).

*Discounted Cash Flow AnalysisSince we are interested in the firm value, we will look at unlevered after-tax cash flows to the firm.This allows us to view the firm value to all stakeholders, i.e. debt, preferred, and common.The basic approach is to:project salesdetermine EBITDAsubtract the tax deductible depreciation and amortization amountssubtract taxesadjust for non-cash expenses, capital expenditures, and working capital needs.

*Discounted Cash Flow AnalysisLets start with a historical look at Conrails cash flows:

*Discounted Cash Flow AnalysisAdditional assumptions:Taxes are assumed to be 38.5% of operating income.Working capital will be:-$34.0 million1997-$22.1 million1998-$23.1 million1999-$24.3 million2000-$25.6 million2001Cost of capital is 11% for Conrail based on the stability of the firms cash flows.We will use an exit multiple of 8x EBITDA in 2001 to value the sale of Conrail. This multiple compares to an average 8.3x EV/LTM EBITDA multiple using Comparable Acquisition Analysis.

Terminal Value

A. The Exit Multiple Method

*The Present Value of the Terminal ValueDiscounted Cash Flow AnalysisNote: Does not match the $7,177.2 on the previous page due to rounding.

*Terminal Value as % of Enterprise ValueProvides a reality check of the DCF valueHigher the %, more of the Enterprise Value is being realized with the assumed sale of the business at the end of the forecast periodConfidence level in the 70-85% range, depending on the company and situationDiscounted Cash Flow Analysis

*Terminal Value as % of Enterprise ValueHow much of the Enterprise Value for the Conrail Base Case is being generated by the Terminal Value?What is your comfort level with this percentage?

Discounted Cash Flow Analysis

B. The Perpetuity Growth Method

*Discounted Cash Flow AnalysisNow well look at the perpetuity growth technique to capture the terminal value of Conrail.We will combine this technique with an analysis of the synergy benefits from a possible Norfolk Southern or CSX acquisition of Conrail.

*Synergies ValuationAnalyze for the synergy value independentlyDetermine the DCF value with synergiesRealization percentage for additional sensitivities analysisWhat is the timing of the realization?Discounted Cash Flow Analysis

*Synergies ValuationTerminal Value by Perpetuity Growth MethodUse a steady-state FCFMaintenance CapX (Depreciation = CapX)No deferred taxesEstimate steady-state working capital needs Discounted Cash Flow Analysis

*Perpetuity Growth Formula

Terminal Value = FCFN+1 (r - g)

where:FCFN+1 = steady-state free cash flow in period N+1g = nominal perpetual growth rater = discount rateDiscounted Cash Flow Analysis

*Discounted Cash Flow Analysis - SYNERGIESThe Synergies valuation analysis was created to calculate the present value of the expected net sales and operating savings benefits from a possible Norfolk Southern or CSX acquisition of Conrail.

*Terminal Value of the SynergiesDiscounted Cash Flow AnalysisNote: Does not match the $2,702 on the previous page due to rounding.

What is the Total DCF for Conrail?

*What is the Total DCF Valuation?Base Case DCFConrails FCFs+50% of Synergies$8,880 million+$1,400 million= $10,280 million

Discounted Cash Flow Analysis

*2*Brief overview of my background:- M&A for Merrill Lynch from 1995-1997- ML IBK Training for summers of 1997, 1998 and 1999 (instructor and manager of analyst and associate training programs)- teacher for last two years

Resource to help you: not the worlds leading expert on valuation; former banker with practical experiences and teaching experiences

ASK questions. I want to help you understand the world of Wall Street valuation and investment banking.

TODAYS lecture - Overview

Other opportunities: (1) financial modeling workshop and (2) practice exercises with valuation techniques- Pub comps in 40 minutes, 1 day in training programs!*These are the three ingredients you find in almost every equity research report - comparables, a multiple (or standardized price) and a story (which represents the attempt to control for differences).*In this sample, note that some of the firms in the sample are emerging market firms any may be exposed to more risk (political risk, economic risk, inflation risk)*In this sample, note that some of the firms in the sample are emerging market firms any may be exposed to more risk (political risk, economic risk, inflation risk)*Brief overview of my background:- M&A for Merrill Lynch from 1995-1997- ML IBK Training for summers of 1997, 1998 and 1999 (instructor and manager of analyst and associate training programs)- teacher for last two years




Other opportunities: (1) financial modeling workshop and (2) practice exercises with valuation techniques- Pub comps in 40 minutes, 1 day in training programs!*Brief overview of my background:- M&A for Merrill Lynch from 1995-1997- ML IBK Training for summers of 1997, 1998 and 1999 (instructor and manager of analyst and associate training programs)- teacher for last two years




































Other opportunities: (1) financial modeling workshop and (2) practice exercises with valuation techniques- Pub comps in 40 minutes, 1 day in training programs!