Discounted Cash Flow Analysis - Auburn...

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Discounted Cash Flow Analysis FINC 5670/6670/6676 Yost Discounted Cash Flow Analysis Chapter 3 DCF: The Big Picture Intrinsic value = Intrinsic value versus market value Especially useful if: Caution:

Transcript of Discounted Cash Flow Analysis - Auburn...

Page 1: Discounted Cash Flow Analysis - Auburn Universitywebhome.auburn.edu/.../finc56706670/notes/DCFAnalysis.pdfDiscounted Cash Flow Analysis FINC 5670/6670/6676 ‐Yost DCF: The Big Picture

Discounted Cash Flow Analysis

FINC 5670/6670/6676 ‐ Yost

Discounted Cash Flow AnalysisChapter 3

DCF: The Big Picture

• Intrinsic value =

• Intrinsic value versus market value

•Especially useful if:

•Caution:

Page 2: Discounted Cash Flow Analysis - Auburn Universitywebhome.auburn.edu/.../finc56706670/notes/DCFAnalysis.pdfDiscounted Cash Flow Analysis FINC 5670/6670/6676 ‐Yost DCF: The Big Picture

Discounted Cash Flow Analysis

FINC 5670/6670/6676 ‐ Yost

DCF: The Big Picture

DCF: The Big Picture

•You have forecasted free cash flows over the next five years (in millions) of $100, $125, $150, $160, and $165, respectively, with a perpetual growth rate thereafter of 3%. You have also estimated a 9% WACC. What is your estimate of firm value?

Page 3: Discounted Cash Flow Analysis - Auburn Universitywebhome.auburn.edu/.../finc56706670/notes/DCFAnalysis.pdfDiscounted Cash Flow Analysis FINC 5670/6670/6676 ‐Yost DCF: The Big Picture

Discounted Cash Flow Analysis

FINC 5670/6670/6676 ‐ Yost

Page 4: Discounted Cash Flow Analysis - Auburn Universitywebhome.auburn.edu/.../finc56706670/notes/DCFAnalysis.pdfDiscounted Cash Flow Analysis FINC 5670/6670/6676 ‐Yost DCF: The Big Picture

Discounted Cash Flow Analysis

FINC 5670/6670/6676 ‐ Yost

The Process

•Step 1: Study the Target and Determine Key Performance Drivers

•Step 2: Project Free Cash Flow

•Step 3: Calculate Weighted Average Cost of Capital

•Step 4: Determine Terminal Value

•Step 5: Calculate Present Value and Determine Valuation

Study the Target and Determine Key Performance Drivers

•Know the target

•Key drivers

Page 5: Discounted Cash Flow Analysis - Auburn Universitywebhome.auburn.edu/.../finc56706670/notes/DCFAnalysis.pdfDiscounted Cash Flow Analysis FINC 5670/6670/6676 ‐Yost DCF: The Big Picture

Discounted Cash Flow Analysis

FINC 5670/6670/6676 ‐ Yost

Calculating Free Cash Flow

•What is FCF?

•Time Horizon

•Scenario Analysis

Projections

•Sales

•COGS

•SG&A Expenses

•EBITDA or EBIT

Page 6: Discounted Cash Flow Analysis - Auburn Universitywebhome.auburn.edu/.../finc56706670/notes/DCFAnalysis.pdfDiscounted Cash Flow Analysis FINC 5670/6670/6676 ‐Yost DCF: The Big Picture

Discounted Cash Flow Analysis

FINC 5670/6670/6676 ‐ Yost

Projections

•Taxes

•Depreciation and Amortization• Can differ between GAAP and tax statements

• Can build detailed PPE schedule or use a percent of sales or capex

• Where do we find it?

•Capital Expenditures• Where do we find it?

Changes in Net Working Capital

•What?

•Why?

Page 7: Discounted Cash Flow Analysis - Auburn Universitywebhome.auburn.edu/.../finc56706670/notes/DCFAnalysis.pdfDiscounted Cash Flow Analysis FINC 5670/6670/6676 ‐Yost DCF: The Big Picture

Discounted Cash Flow Analysis

FINC 5670/6670/6676 ‐ Yost

Net Working Capital

•Accounts Receivable• Days Sales Outstanding (DSO) =

• Inventory• Days Inventory Held (DIH) = • Inventory Turnover =

•Other Current Assets

Net Working Capital

•Accounts Payable• Days Payable Outstanding (DPO) =

•Other Current Liabilities

Page 8: Discounted Cash Flow Analysis - Auburn Universitywebhome.auburn.edu/.../finc56706670/notes/DCFAnalysis.pdfDiscounted Cash Flow Analysis FINC 5670/6670/6676 ‐Yost DCF: The Big Picture

Discounted Cash Flow Analysis

FINC 5670/6670/6676 ‐ Yost

Calculating WACC

•What is it?•How do we calculate it?

•Capital Structure•Cost of Debt

Estimating the Cost of Equity

•The CAPM

•How do we get rf?•How do we get the market risk premium (MRP)?

Page 9: Discounted Cash Flow Analysis - Auburn Universitywebhome.auburn.edu/.../finc56706670/notes/DCFAnalysis.pdfDiscounted Cash Flow Analysis FINC 5670/6670/6676 ‐Yost DCF: The Big Picture

Discounted Cash Flow Analysis

FINC 5670/6670/6676 ‐ Yost

Estimating Beta

• How do we get Β?

• Raw vs. adjusted

• Private firms

• Unlevering and relevering betas:

• Other factors (e.g., size)

𝐶𝑜𝑣 ,

σ

ΒΒ

1 𝐷𝐸 1 𝑡

Β Β 1𝐷𝐸

1 𝑡

Terminal Value

•Exit Multiple Method (EMM)• Terminal Value = • Assumption:

•Perpetuity Growth Method (PGM)• Terminal Value = • Assumption:

𝐹𝐶𝐹 1 𝑔𝑟 𝑔

𝐸𝐵𝐼𝑇𝐷𝐴 𝐸𝑥𝑖𝑡 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑒

Page 10: Discounted Cash Flow Analysis - Auburn Universitywebhome.auburn.edu/.../finc56706670/notes/DCFAnalysis.pdfDiscounted Cash Flow Analysis FINC 5670/6670/6676 ‐Yost DCF: The Big Picture

Discounted Cash Flow Analysis

FINC 5670/6670/6676 ‐ Yost

Checking the Consistency

•PGM EMM

• If mid-year discounting:

𝐼𝑚𝑝𝑙𝑖𝑒𝑑 𝐸𝑥𝑖𝑡 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑒𝑇𝑉

𝐸𝐵𝐼𝑇𝐷𝐴

𝐼𝑚𝑝𝑙𝑖𝑒𝑑 𝐸𝑥𝑖𝑡 𝑀𝑢𝑙𝑡𝑖𝑝𝑙𝑒𝑇𝑉 1 𝑊𝐴𝐶𝐶 .

𝐸𝐵𝐼𝑇𝐷𝐴

Checking the Consistency

•EMM PGM 𝑇𝑉𝐹𝐶𝐹 1 𝑔

𝑟 𝑔

Page 11: Discounted Cash Flow Analysis - Auburn Universitywebhome.auburn.edu/.../finc56706670/notes/DCFAnalysis.pdfDiscounted Cash Flow Analysis FINC 5670/6670/6676 ‐Yost DCF: The Big Picture

Discounted Cash Flow Analysis

FINC 5670/6670/6676 ‐ Yost

Checking the Consistency

•EMM PGM

• If mid-year discounting:

𝐼𝑚𝑝𝑙𝑖𝑒𝑑 𝑃𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 𝐺𝑟𝑜𝑤𝑡ℎ 𝑅𝑎𝑡𝑒𝑇𝑉 𝑊𝐴𝐶𝐶 𝐹𝐶𝐹

𝑇𝑉 𝐹𝐶𝐹

𝐼𝑚𝑝𝑙𝑖𝑒𝑑 𝑃𝑒𝑟𝑝𝑒𝑡𝑢𝑖𝑡𝑦 𝐺𝑟𝑜𝑤𝑡ℎ 𝑅𝑎𝑡𝑒𝑇𝑉 𝑊𝐴𝐶𝐶 𝐹𝐶𝐹 1 𝑊𝐴𝐶𝐶 .

𝑇𝑉 𝐹𝐶𝐹 1 𝑊𝐴𝐶𝐶 .

Valuation

•Mid-year Convention

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Discounted Cash Flow Analysis

FINC 5670/6670/6676 ‐ Yost

Valuation

•Enterprise Value

• Implied Equity Value

• Implied Share Price

Discounted Cash Flow Analysis

Pros• _____________-based

• Market ____________

• Self-sufficient

• _______________

Cons• Dependence on financial projections

• Sensitivity to ________________

• __________________________

• Assumes constant _________ ________________