FIN449Valuation

Michael Dimond

Are you using your references?

• What helpful parts of the book have you found so far?• Where are you looking? (Table of Contents? Index?)

– Part of Ch 2 (DCF)– Ch 10 (From Earnings to Cash Flows)– Ch 14 (FCFE Discount Models)– ...and other places. This is a reference book, not a textbook.

You need to dig into it.

• 96 Common Errors in Company Valuations by Pablo Fernandez & Jose Maria Carabias

• http://papers.ssrn.com/sol3/papers.cfm?abstract_id=895151

Damodaran has resources online

http://pages.stern.nyu.edu/~adamodar/ His spreadsheets are not always as helpful as

you might want… An example of a valuation summary he did in

2008

What Damodaran’s valuation summary looks like: September 2008

What Damodaran’s valuation summary looks like: October 2008

Bear in mind, these were a summary. We will ultimately want something more detailed for a working document.

Nautilus

• Dynamic, working spreadsheet for Nautilus' financials• This should do the arithmetic for you so you can

concentrate on the thought process• Build your own. Do not use someone else's work.• Capture the previous 5 years

– SEC has some data available as Excel document, NLS website seems to have more

– http://investors.nautilusinc.com/sec.cfm?DocType=Annual&Year=

– Use amended figures if offered• Compute historic FCF & FCFE for the past 5 years

– FCF = OCF - ΔFA - ΔNWC– FCFE = FCF - ΔDebt - Interest - PfdDiv

Be careful of your methodsAssume the following:EBIT = 1,671 Depreciation = 633 Interest = 123 Tax Expense = 599 t = 0.3869509 Net Income = 949 ΔFA = 896 ΔNWC = 385 ΔDebt = 286 Preferred Div = 3

OCF = NI + Int + Depr OCF = EBIT(1-t) + Depr949+123+633 = 1,705.0000 1671(1-0.3869509)+633 = 1,657.4050

FCF = OCF - ΔFA - ΔNWC FCF = OCF - ΔFA - ΔNWC1705 - 896-385 = 424.0000 1657.3230 - 896-385 = 376.4050

FCFE = FCF - ΔDebt - Interest - PfdDiv FCFE = FCF - ΔDebt - Interest - PfdDiv424 - 286 - 123 - 3 = 12.0000 376.3230 - 286 - 123 - 3 = (35.5950)

We need to adjust for the tax shield used earlierFCFE = FCF - ΔDebt - Interest(1-t) - PfdDiv

376.3230 - 286 - 123(1-0.3870) - 3 = 12.0000

What else is useful in the 10-k?

Financial Analysis Financial analysis will answer questions regarding a firm’s

past, present and future situation, including How profitable is the company? Did earnings meet analyst forecasts? How strong is the company’s financial position? What are the firm’s sources of profitability? Does the company have the resources to succeed and

grow? What limitations to growth exist? Is the firm making good use of assets? Does the company have resources to invest in new

projects? What is the company’s future earning power? How does capital structure affect return?

Horizontal & Vertical Analysis

Each line item can be represented as•% of Sales & % of Assets•Growth over time

Try to pick the most relevant line items

What other ratios are helpful to understanding the company?

Calculating Free Cash Flow to Equity

FCFE = Net income – Net investment + Net debt issued

Net Investment

Net investment = (Capital expenditures – Depreciation) + Increase in noncash working capital

CapEx

Line item on Statement of Cash Flows?

Calculate the changes (from year to year) of ALL long-term assets shown on the balance sheet.

Find the total amount (for a given year) shown in the “Investing” section of the Statement of Cash Flows. Issues?

Depreciation

“Basic definition” of net cash flow = net income + depreciation

Non-cash expense

In the “balance sheet” approach to define capital expenditures, depreciation is usually not incorporated explicitly. Why not?

If the “Statement of Cash Flows” approach is used, one must explicitly subtract depreciation from capital expenditures (shown in the “Operating” section of the Statement of Cash Flows)

Non-cash Working Capital

Noncash working capital = (current assets – cash) – current liabilities… what else?

Noncash working capital = (current assets – cash) – (current liabilities – interest bearing debt included in current liabilities) Why?

Why not include cash?

Net Debt Issued

“Net” debt issued implies that one must take both debt issuances AND repayments into account

Discussion: Constant Debt Ratio Suppose a firm always finances new investment with a fixed debt

ratio (say, 30% debt and 70% equity, for example). The general equation for FCFE then may be expressed as follows:

FCFE = Net income – (1 – debt ratio)(Net investment)

OR FCFE = Net income – (equity ratio)(Net investment)

Free Cash Flow to Equity

FCFE = Net income – Net investment + Net debt issued

Next Time

Exam (Tuesday) Valuation #1 (Thursday)