Lecture_20 Firm Valuation Using DCF
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Transcript of Lecture_20 Firm Valuation Using DCF
8/17/2019 Lecture_20 Firm Valuation Using DCF
http://slidepdf.com/reader/full/lecture20-firm-valuation-using-dcf 1/22
Professor Sang Byung [email protected]
Firm valuation using DCF
8/17/2019 Lecture_20 Firm Valuation Using DCF
http://slidepdf.com/reader/full/lecture20-firm-valuation-using-dcf 2/22
FCF and DCF
•If we compute the FCF, and I give you the discountrate, you can value the operations of the firm.
•
This is called a “discounted cash flow” model (inshort, DCF).
• Two extreme cases
1. One period
2. Constant FCF growth
• A typical case (important!)
• During the forecast period, estimate each year’s FCF based on
financial statements.
• After the period, assume that FCF grows at a constant rate.
8/17/2019 Lecture_20 Firm Valuation Using DCF
http://slidepdf.com/reader/full/lecture20-firm-valuation-using-dcf 3/22
Extreme case 1: one period
•Using DCF is as easy as doing present values.
• For example, if your firm will have cash flows
of $50,000 next year, then cease to exist, and
the discount rate is 12% then
=
1
=$50,000
1.12 = $44,642.86
8/17/2019 Lecture_20 Firm Valuation Using DCF
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Extreme case 2: constant growth
•Unlike the previous examples, companies donot generally plan to cease existing.
• If we believe a firm is stable, and will remain
stable for the foreseeable future, we can use a
growth perpetuity to find enterprise value
=
<
• is the rate at which FCF will grow forever.
8/17/2019 Lecture_20 Firm Valuation Using DCF
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Example
•Company C is established, and has a stablefuture outlook. We expect next year’s FCF to be
$50 million. The discount rate is 8%, and we
expect C’s FCF to grow at a rate of 3% forever.
Use a growth perpetuity to find C’s enterprise value.
=
=$50
0.08 0.03
= $1,000
8/17/2019 Lecture_20 Firm Valuation Using DCF
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A typical case – four steps
• Few companies really qualify as “stable”
• How do we value a firm when we can’t forecast allthe future cash flows?
1. Choose a forecast period , (10 years is typical, but may
vary based on the context).
2. Forecast FCFs for all years based on projected financialstatements.
3. After the forecast period, typically assume that FCF grows
at a constant rate g.• Of course, you can assume differently if you have some reasons.
4. Calculate the present value of the FCF stream to find theenterprise value at time 0 ().
8/17/2019 Lecture_20 Firm Valuation Using DCF
http://slidepdf.com/reader/full/lecture20-firm-valuation-using-dcf 7/22
=
1
1 ⋯
1
1
1 +
1
1 + ⋯
PV of FCFs during theforecast period
PV of FCFs after the
forecast period
10(=H) 11 12
…
…13
0 1 2
…
…
0
3
11 12
…
…13
× ( 1 )
× 1
0 1 2
…
…3
× 1
Timeline
After the forecast period
During the forecast period
10(=H)
8/17/2019 Lecture_20 Firm Valuation Using DCF
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Terminal value
• Terminal value (aka continuing value)
• the present value (as of year ) for all cash flows after year
11 12
…
…13
× ( 1 )
× 1
…
…
× 1
After the forecast period
H=10
×
( )
×
×
…
=
+
=
× (1 )
Since FCF grows at the
constant rate (g) forever
Terminal value =
Year-10 value ofFCFs after year 10
8/17/2019 Lecture_20 Firm Valuation Using DCF
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Timeline revisited
•
This is equivalent to
10(=H) 11 12
…
…13
0 1 2
…
…
0
3
11 12
…
…13
× ( 1 )
× 1
0 1 2
…
…3
× 1
After the forecast period
During the forecast period
10(=H)
H=10 11 12
…
…13
0 1 2
…
…
0
3
8/17/2019 Lecture_20 Firm Valuation Using DCF
http://slidepdf.com/reader/full/lecture20-firm-valuation-using-dcf 10/22
Four steps revisited
• Four steps
1. Choose a forecast period , (10 years is typical, but
may vary based on the context).
2. Forecast FCFs for all years based on projected
financial statements.3. Compute a terminal value , : the present value (as
of year ) for all cash flows after year .
4. Discount the years of FCFs and the terminal
value to the present.
8/17/2019 Lecture_20 Firm Valuation Using DCF
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Final recap: DCF and enterprise value
0 FCF1
FCF2
FCF3
…
FCF10 +
TV
1 2 3 10…
• Enterprise value
=
1
1 ⋯
−
1 −
1
• To compute TV, assume a constant growth
perpetuity after year (10 in the timeline)
=+
= × (1 )
8/17/2019 Lecture_20 Firm Valuation Using DCF
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FCF example revisited
•Pretend it’s 2012 and you want to value thefollowing company.
• You’re given the income statement and balance
sheet for 2012, and projections for 2013 and
2014.
• Use these to find FCF for years 2013 and 2014.
• Assume a discount rate of 10% and a terminal
growth rate of 2%.
• Find the value of the firm’s operations.
8/17/2019 Lecture_20 Firm Valuation Using DCF
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Income statement
2012 2013 2014
Sales 2440 2800 3000
Cost of goods sold 1780 2020 2143
SG&A expense 467 542 580
Depreciation 61 78 88
Interest expense 38 38 29
Interest income 3 2 0
Income before taxes 97 124 160
Income tax 38.8 43.4 56Net Income/(loss) 58.2 80.6 104
8/17/2019 Lecture_20 Firm Valuation Using DCF
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Balance sheet2012 2013 2014
ASSETS
Cash and equivalents 12 13 31Receivables, net 46 44 58
Merchandise inventories 732 852 950
Other current assets 77 69 55
Total current assets 867 978 1094
Property and equipment at cost 636 726 827
Accumulated depreciation 202 245 312
Net property and equipment 434 481 515
Other non-current assets 70 90 95
Total assets 1371 1549 1704
LIABILITIES
Accounts payable 350 415 424
Accrued liabilities 200 255 275
Total current liabilities 550 670 699
Long-term debt 366 346 325
Total Liabilities 916 1016 1024
Shareholders’ equity
Common stock 445 470 525
Retained earnings 10 63 155
Total shareholder's equity 455 533 680
Total Liabilities and Equity 1371 1549 1704
8/17/2019 Lecture_20 Firm Valuation Using DCF
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FCF
•Previously, we calculated that the firm’s FCF in2013 and 2014 are $67M and $19.85M,
respectively.
• Need to calculate the terminal value given the
assumptions of 10% discount rate and 2%
growth.
8/17/2019 Lecture_20 Firm Valuation Using DCF
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Terminal value
•Terminal value in 2014 is therefore:
=( 1 )
=
19.85(1.02)
0.1 0.02 = $253.09
• What is the value of the firm’s operations then,
from the perspective of 2012?
8/17/2019 Lecture_20 Firm Valuation Using DCF
http://slidepdf.com/reader/full/lecture20-firm-valuation-using-dcf 17/22
8/17/2019 Lecture_20 Firm Valuation Using DCF
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Notes on terminal value
• How do we determine perpetual growth rate ‘g’?
• Make an informed guess based on the nature of the business, and link ‘g’ to
either a industry growth rate or some relevant macroeconomic variable.
• For example, in the long run Walmart can’t probably grow faster in real
terms than US population growth (~1.5%). Combining with inflation of ~3%
gives a long-run estimate of ‘g’ of ~4.5%.
• Unfortunately, valuation is highly sensitive to ‘g’
• A 1% change in ‘g’ can make a big difference to TV, which in turn, will make
a big difference to enterprise value and MV of equity!
• Always do a sensitivity analysis to understand how your answers vary with
key underlying assumptions.
8/17/2019 Lecture_20 Firm Valuation Using DCF
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DCF and MV of equity
•Once we find the enterprise value, we can alsocalculate the market value of equity using the
balance sheet identity:
= "ℎ"
• So using the DCF method, we can estimate the
stock price (per share value)
ℎ =
# ℎ
8/17/2019 Lecture_20 Firm Valuation Using DCF
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Example
•New startup Houston Inc believes it will havestable FCF growth, at a growth rate of 5%, after
5 years. FCFs for year 1 through 5 are expected
to be -$27M, -$11M, $0M, $6M, $33M.
• Houston Inc has $17M in cash, $19M in bank
debt, and a $8M loan from a supplier.
• Find the enterprise value, equity market value,
and share price for Houston Inc with a = 21%and 4M shares outstanding.
8/17/2019 Lecture_20 Firm Valuation Using DCF
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TV and EV
= × 1 = $33 × 1.05 = $34.65
=$34.65
0.21 0.05 = $216.56
= $27
1.21
$11
1.21
$6
1.21
$33 $216.56
1.21
= $.
8/17/2019 Lecture_20 Firm Valuation Using DCF
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MV of equity
= $. $17 $19 $8
= $.
ℎ =$59.19
4 = $.