USING FINANCIAL ANLYSIS FOR COMPANY le_analyse_naar... · PDF fileNET LONG – TERM...
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USING FINANCIAL ANLYSIS
FOR COMPANY VALUATION
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CONTACTPARMENTIER GUY – MGI BVBAValkenlaan 31 – 2900 Schoten
Tel: 03/685.40.07Mail: [email protected]
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Guy ParmentierBedrijfsrevisor
Executive professor ‐ University of Antwerp Management School 2008 (Real Estate Accounting)
Professor ‐ Karel De Grote Hogeschool Antwerp(Audit/Valuation)
Docent postgraduaat Antwerp ‐ AccountancyGuest professor ‐ University Maastricht (Valuation)Guest professor – University of Economics Nicosia
(Cyprus)Author of the book – Business Valuation ( Intersentia)
ISBN 978-1-78068-016-3
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OVERVIEW OF THE
MAIN VALUATION METHODS Equity Valuation models
Equity Cash Flow value =
Economic Profit Equity value = ABV – BV EXCEEDING ASSETS + + EXCEEDING ASSETS (MINUS TAXES)
Entity Valuation models
Entity DCF Value = + EXCEEDING ASSETS (minus taxes) –INTRESTBEARING DEBTS
Entity Economic Profit value = IC MINUS BV EXCEEDING ASSETS + + EX ASSETS (MINUS TAXES) – INTRESTBEARING DEBTS
Entity APV = + ( FINANCIAL DEBT X TAX RATE ) – INTRESTBEARING DEBTS
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Equity Cash Flow = Incoming Cash Flow ‐ Outgoing Cash Flow= Available cash for company shareholders
ECF = Earnings after Taxes + Depreciations + Amortizations –Δ Working Capital Requirements ‐ Δ Investments (in fixed assets) + Δ Financial debtECF = EAT – Net Investments + Δ Financial debt – Net Investments = New Investments in fixed assets – Depreciations
‐ Amortizations + Δ Working Capital Requirements
1. EQUITY CASH FLOW (ECF)
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N N+1 N+2
° OPENING BALANCE WCR° CLOSINGBALANCE WCR
€ 1,400
€ 2,700
€ 2,700
€ 2,200
€ 2,200
MUTATION IN WCR € 1,300 € ‐500
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“Anything can be priced by considering theamount of money a fool is willing to payfor it.”
Quote from an American stock broker
PART I: Financial Analysis
Liquidity
Solvability
1. Balance sheet structures
FINANCIAL ANALYSIS
& COMPANY VALUATION
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Step 1: calculating net long‐term financing= ‘buffers’ for financing working capital requirements
Step 2: calculating working capital requirements‐> investments = all required financial resources
Step 3: support long term financing ‐> funding working capital requirements
Need to improve financial situation before new strategic investment decisions?
BALANCE SHEET INFORMATION
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PART I: Financial Analysis
Liquidity
Solvability
1. Balance sheet structures
2. Profit – Loss statements in detail
3. Additional steps
FINANCIAL ANALYSIS
& COMPANY VALUATION
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Step 4: Tool: depreciations and amortizations to improve short
–term earning?
Step 5: Calculating net operating cash flow
Step 6: Cash flow sufficient for all maturating debt
obligations?
Step 7: validity of balance sheet forecasts in line with future expectations
ADDITIONAL STEPS
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PART I: FINANCIAL ANALYSIS
CHAPTER ONE: THE BALANCE SHEET
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INTRODUCTION TO
BALANCE SHEET
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BALANCE SHEET
ASSET EQUITY‐LIABILITIES
Ownership Financial Arrangements
Business valuation – Using financial analysis to measure a company’s valueP 13 and following
DE YIN-YANG OF ACCOUNTANCY
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How are assets paid?Assets = Equity + Liabilities– ‘Box of blocks’
Activa
NON‐CURRENT ASSETSProperty, plant & equipment
Financial assets & intangibles
CURRENT ASSETSPrepaid expensesInventoryAccounts Receivable
Eigen+ Vreemd vermogen
Shareholders’ EquityCapitalReservesAccumulated results
Non‐Current liabilitieslong term financial debt
Current LiabilitiesAccrued expensesAccounts payableShort term financial debts
ASSETS
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Assets
Non currentAssets
Net fixedassets
Currentassets
Inventories AccountReceivable
PrepaidExpenses Cash
Business valuation – Using financial analysis to measure a company’s value P 16
Companies only exist as investors have supplied them with capital”
Substantial risk
‐ Fixed return => debt holders‐ Profits => company owners
Shareholders’ equity= Asset ‐ Liabilities
SHAREHOLDERS:
SUPPLIERS OF CAPITAL
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SHAREHOLDERS’S EQUITY:
A RESIDUAL VALUE
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ASSETS
OWNERS EQUITY
LIABILITIES
Non‐currentassets
Current Assets
Owner’s Equity
Long‐term financial debts
Short‐term financial debts
Accounts payable
Accued expenses
Business valuation – Using financial analysis to measure a company’s valueP 22
LIABILITIES AND
SHAREHOLDERS’ EQUITY
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Business valuation – Using financial analysis to measure a company’s valueP 22
NET LONG-TERM FINANCING
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NLF = Equity+ Long‐term debt ‐ Net fixed assets
net fixed assets are funded with long‐term financing
!! financed with resources of a similar duration !!Business valuation – Using financial analysis to measure a company’s value P 27 and following
NET LONG – TERM FINANCING
‐ Positive NLF: not all long‐term financing used‐ Negative NLF: short‐term debt is used to finance fixed assets
• Equity increase to invest in fixed assets NLF will not change• Capital for investments in current assest NLF will increase
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In essence, net long‐term financing indicates to what extent net fixedassets are funded with long‐term financing
NET LONG – TERM FINANCING REVISITED
Net short‐term financing = Short‐term (financial) debt – Cash
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=amount of interest‐bearing debt that is not available in cash
PRACTICAL EXAMPLE
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DEEL 1 : De financiele gezondheid van de onderneming – Financial Health
Periode 8 Periode 9
Stap 1 : Berekening van het NBK – Step 1: Calculation Net working capital 2008 - 2009 2009 - 2010
Totaal eigen vermogen - Total capital and reserves 1.077.853,00 1.206.195,00
Schulden op lange termijn - Payables > 1 year 1.007.154,00 769.145,00
Totaal permanent vermogen- total permanent equity : 2.085.007,00 1.975.340,00
Immateriele vaste activa - Intangible fixes assets 0,00 0,00
Materiële vaste activa - Tangible fixed assets 2.015.869,00 1.755.425,00
Financiële vaste activa - Financial fixed assets 0,00 0,00
Vorderingen op lange termijn - Amounts receivable > 1 year 0,00 0,00
Totale vaste activa en vorderingen LT - Total fixed assets & amounts receivable <1 year: 2.015.869,00 1.755.425,00
Netto-bedrijfskapitaal : 69.138,00 219.915,00
NLF
PART I: FINANCIAL ANALYSIS
CHAPTER TWO:WORKING CAPITAL
REQUIREMENTS, MANAGERIAL BALANCE SHEET AND MATCHING
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WORKING CAPITAL REQUIREMENT
Working capital requirements (WCR) = all necessary investments for keeping business operations going
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CASH
PROCUREMENT
PRODUCTION
SALESImpact on the balance sheet:
∆ Accounts payable∆ Rawmaterials inventory
Impact on the balance sheet:
∆ Raw materials inventory∆ Work in progress inventory∆ Finished goods inventory
Impact on the balance sheet:
∆ Accounts receivable∆ Finished goods inventory
Payments for nonoperating activities
OPERATIONAL CYCLE
WORKING CAPITAL REQUIREMENT
WCR (before cash) = Operating assets – Non interest‐bearing debt
WCR( before cash) = Inventory + (Accounts Receivable ‐ Accounts payable)+ (Prepaid Expenses ‐ Accrued expenses)
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WORKING CAPITAL REQUIREMENT
Positive WCR– Operating company assets > Operating company liabilities
Negative WCR– Operating company assets < Operating company liabilities – Increased cash reserve – Finances a part of a companies operations
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(POSITIVE) WORKING CAPITAL REQUIREMENT
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Assets Equity + LiabilitiesNon‐current assets € 6,000 Shareholders' equity € 4,000Property, plant & equipment € 4,000 Capital € 2,000Financial assets & intangibles € 2,000 Reserves € 1,000
Accumulated results € 1,000Non‐current liabilities € 2,500Long‐term financial debt € 2,500
Current assets € 4,000Prepaid expenses € 500 Current liabilities € 3,500Inventory € 1,500 Accrued expenses € 500Accounts receivable € 1,000 Accounts payable € 1,500
Cash € 1,000 Short‐term financial debt € 1,500
(NEGATIVE) WORKING CAPITAL REQUIREMENT
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Assets Equity + LiabilitiesNon‐current assets € 4,000 Shareholders' equity € 2,000
Long‐term (fin.) debt € 1,000Current assets € 2,500Prepaid expenses € 500 Short‐term financing € 3,500Inventory € 500 Accrued expenses € 500Accounts receivable € 500 Accounts payable € 1,500Cash € 1,000 Short‐term financial debt € 1,500
WORKING CAPITAL REQUIREMENT
ALWAYS WORK WITH WCR BEFORE CASH
CASH DOES NOT NEED TO BE FINANCED BY COMPANIES!
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PRACTICAL EXAMPLEStep 2 : WCR berekening – Step 2 WCR calculation
Voorraden - Stocks 303.533,00 341.621,00
Vorderingen op korte termijn - Amounts receivable < 1 year 617.481,00 753.295,00
Overlopende rekeningen - Deferred charges, accrued income 4.564,00 2.072,00
925.578,00 1.096.988,00
MIN
C. Handelsschulden - Trade payables 313.888,00 484.362,00
D. Ontvangen vooruitbetalingen - Prepayments 0,00 0,00
E. Schulden m.b.t. belastingen en bezoldingen - Staff and taxes 244.985,00 169.989,00
F. Overige schulden - Other debts 196.784,00 201.392,00
Overlopende rekeningen - Accrued charges, deferred income 4.339,00 56.544,00
759.996,00 912.287,00
Werkkapitaal - WCR : 165.582,00 184.701,00
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PRACTICAL EXAMPLE
Stap 3 : Vergelijking tussen NBK en WCR –Matching Step 3: Net working Capital and WCR
Netto-bedrijfskapitaal : 69.138,00 219.915,00
Working capital requirements - Werkkapitaal : 165.582,00 184.701,00
-96.444,00 35.214,00
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PRACTICAL EXAMPLEPeriode 8 Periode 9
2008 - 2009 2009 - 2010
Stap 4 : Bereken de toename van het WCR in het laatste jaar :Step 4: Calculate the increase of WCR in the last year 19.119,00Dit is het bedrag dat het bedrijf minder/meer heeft aan werkkapitaal.Amount more / less WCR
Stap 5: Bereken de cashflow uit gewone bedrijfsactiviteit na belastingStap 5: Calculate the ordinary cash flow after taxResultaat uit normale activiteit - Ordinary profit 319.346,98 191.614,68min taxes 34 % -108.577,97 -65.148,99
winst door gewoon werken na fin lasten na belasting - Ordinary Profit after Taxes 210.769,01 126.465,69Afschrijvingen - Depreciations 465.259,00 437.163,27Waardeverminderingen - Amounts written off 0,00 0,00
Cashflow uit gewone activiteit na belasting : 676.028,01 563.628,96Ordinary Cashflow
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PRACTICAL EXAMPLE
Stap 6: vergelijk met de schulden op > 1 jaar die < 1 jaar vervallenStep 6: Matching with Loans > and < 1 year
Cashflow uit gewone activiteit na belasting – Ordinary Cash Flow: 676.028,01 563.628,96A. Schulden > 1 jr < 1 jr - Loan < 1 year 316.316,00 323.104,00
Verschil : 359.712,01 240.524,96
Stap 7: Controleer of wat er overblijft na betaling aan de banken voldoende is om de toename WCR te financierenStep 7: Check if what’s left after Payments to the bank is enough to finance the increase in WCR
Bedrag dat overblijft aan betaling lening bank > 1 jr < 1 jr - Amount that’s left 240.524,96Toename WCR - Increase WCR 19.119,00
Tekort / overschot in het laatste jaar – deficit / surplus in the last year: 221.405,96
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PRACTICAL EXAMPLE
Step 8: Historische cashflow – Step 8 Historical Cash flow
Operationeel resultaat (EBIT) - EBIT 488.852,98 297.841,68
- Belastingen (34 %) - Taxes (34%) -166.210,01 -101.266,17
+ Afschrijvingen - depreciations 465.259,00 437.163,27
BESCHIKBARE CASHFLOW VOOR INVESTERINGEN ( A ) 787.901,97 633.738,78
Available Cash flow before investments
INVESTERINGEN IN VASTE ACTIVA op X-MAANDEN ( B ) -100.000,00 -100.000,00
Investments ( Fixed assets)
MUTATIE BENODIGD WERKKAPITAAL ( C ) 0,00 -19.119,00
mutation WCR
JAARLIJKSE VRIJE CASHFLOW = A + B - C 687.901,97 514.619,78
annual free cash flow
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MANAGERIAL BALANCE SHEET
Managerial Balance Sheet ( MBS) = modified standard balance sheet for improved decision making on business operations MBS facilitate an overall view on operational management by subtracting accounts payable from operating assets:
Business valuation – Using financial analysis to measurea company’s value P 49 and following
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MANAGERIAL BALANCE SHEET
Business valuation – Using financial analysis to measurea company’s value P 49 and following
Assets Invested Capital/Capital EmployedNet fixed assets € 6,000 Shareholders' equity € 4,000
Property, plant & equipment € 4,000 Capital € 2,000Financial assets & intangibles € 2,000 Reserves € 1,000
Accumulated results € 1,000Long –term financial debt € 2,500
Working Capital Requirement € 1,000CASH € 1,000 Short‐financial debt € 1,500NET ASSETS € 8,000 INVESTED CAPITAL € 8,000
Net fixed assets + WCR + Cash = Equity + financial debt
Capital Employed = Equity + Long‐term debt + Short‐term debt
Capital Employed = Invested Capital
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NET SHORT-TERM FINANCING REVISITED
Net short‐term financing = Short‐term (financial) debt – Cash
= amount of interest‐bearing debt that is not available in cash
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NET LONG-TERM FINANCING & NET
SHORT-TERM FINANCING
Net short‐term financing = WCR – Net long term financing
Cash should serve as backup to finance unexpected changes in working capital requirements
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MATCHING STRATEGIES
Net long‐term financing = Equity + Long‐term debt ‐ Net fixed assets
THE MATCHING PRINCIPLE PRESCRIBES ALIGNING ECONOMIC ASSET LIFE SPANS TO MATURITY DATES OF ALL FINANCIAL ARRANGEMENTS THAT ARE USED TO
FINANCE THESE ASSETS
Finance long term WCR with long‐term financing Finance seasonal capital requirements with short‐ term financing
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PROVISIONS AND WCR
Example : – Tax provision has been booked year X‐1: 100 000,00 EUR
– The moment this provision needs to be paid Year X : Booking from 16‐account to 45‐account
– At this time this amount can NOT be taken into account forthe WCR calculation!
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ABNORMAL ACCRUALS
ABNORMAL WORKING CAPITAL
ACCRUALS (AWCA)WCR represents: net investment the company needs to finance to keep its operating cycle goingAWCA: two different approaches– for a shareholder – for external parties that are analyzing a company
Compare the estimated WCR with the actual WCR to spot for potential abnormal accruals
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ABNORMAL WORKING CAPITAL
ACCRUALS (AWCA)
ABNORMAL WORKING CAPITAL ACCRUALSAWCAt = WCt ‐ [ ( WCt‐1 / St‐1) x St ]
Versus salesWCt = Working capital requirements 207.880 154.564 438.707 411.814 245.504 380.808 299.532WCt‐1 = Working capital requirements 207.880 154.564 438.707 411.814 245.504 380.808
S = Sales 8.556.235 7.533.578 8.105.117 6.254.853 8.359.771 7.615.665 7.016.922St‐1 = Sales 8.556.235 7.533.578 8.105.117 6.254.853 8.359.771 7.615.665
Abnormal working capital accruals ‐28.470 272.417 73.257 ‐304.896 157.156 ‐51.337
Arithmetic mean: 19.688
Median : 22.393
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AWCA VS SALES
AWCAt = WCt ‐ [ ( WCt‐1 / St‐1) x St ]N‐2 N‐1 N
St = Net sales year t € 8,110 € 8,700 € 9,200St‐1 = " year t‐1 € 7,100 € 8,110 € 8,700
WCRt = Working Capital Requirement year t € 1,000 € 1,400 € 2,700
WCRt‐1 = Working Capital Requirement year t‐1 € 600 € 1,000 € 1,400
WCRt‐1 / St‐1 0.08 0.12 0.16(WCRt‐1 / St‐1) x St € 685 € 1,073 € 1,480
AWCA vs. Sales € 315 € 327 € 1,220
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AWCA VS SALES
R² = 0,0744
‐600.000
‐400.000
‐200.000
0
200.000
400.000
600.000
2007 2008 2009‐2010 2010‐2011 2012
AWCA VERSUS SALES
Tegenover omzet Lineair (Tegenover omzet)
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AWCA VS PURCHASES
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AWCA VS PURCHASES
R² = 0,0509
‐400.000
‐300.000
‐200.000
‐100.000
0
100.000
200.000
300.000
400.000
2008 2009 2010 2011 2012
AWCA VERSUS PURCHASES
Reeks1 Lineair (Reeks1)
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AWCA VS INVESTED CAPITAL
AWCAt = WCt ‐ [ ( WCt‐1 / ICt‐1) x ICt ]N‐2 N‐1 N
ICt = Working Capital Requirement year t € 8,000 € 9,000 € 10,800
ICt‐1 = Working Capital Requirement year t‐1 € 6,900 € 8,000 € 9,000
WCRt = Working Capital Requirement year t € 1,000 € 1,400 € 2,700
WCRt‐1 = Working Capital Requirement year t‐1 € 600 € 1,000 € 1,400
WCRt‐1 / ICt‐1 0.09 0.13 0.16
(WCRt‐1 / ICt‐1 ) x ICt € 696 € 1,125 € 1,680
AWCA vs. IC € 304 € 275 € 1,020
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AWCA VS INVESTED CAPITAL
R² = 0,1808
‐900.000
‐800.000
‐700.000
‐600.000
‐500.000
‐400.000
‐300.000
‐200.000
‐100.000
0
100.000
200.000
2007 2008 2009‐2010 2010‐2011 2012
AWCA VERSUS INVESTED CAPITAL
Tegenover geïnvesteerd vermogen Lineair (Tegenover geïnvesteerd vermogen)
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PART I: FINANCIAL ANALYSIS
CHAPTER THREE: BALANCE SHEETS AND
STRATEGIC DECISION MAKING
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BALANCE SHEETS AND
STRATEGIC DECISION MAKING1. Calculating net long‐term financing ‐> financing buffer?2. Converting conventional balance sheet into managerial
balance sheets ‐> WCR?3. Relating WRC to net long‐term financing ‐> structural
liquidity levels over time?
HOW do companies generate their profits and losses?
Relate balance sheet steps to profit and loss statement (four additional steps)
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WCR-TO-SALES RATIOS
WCR‐to‐sales ratio = WCRSales
High WCR‐to‐sales ratio?N‐3 N‐2 N‐1 N
OPERATING ASSETS € 2,400 € 3,000 € 3,900 € 5,300
PREPAID EXPENSESINVENTORYACCOUNTS RECEIVABLE
€ 500€ 1,100€ 800
€ 500€ 1,500€ 1,000
€ 500€ 2,000€ 1,400
€ 500€ 2,300€ 2,500
OPERATING LIABILITIES € 1,800 € 2,000 € 2,500 € 2,600
ACCRUED EXPENSESACCOUNTS PAYABLE
€ 500€ 1,300
€ 500€ 1,500
€ 500€ 2,000
€ 500€ 2,100
WORKING CAPITAL REQUIREMENTS € 600 € 1,000 € 1,400 € 2,700
WCR‐to‐sales ratios may help to determine if increases in working capital requirements are in line with expectations
Business valuation – Using financial analysis to measure a company’s value P 62 and following
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LIQUIDITY AND CONVENTIONAL
FINANCIAL RATIOSCurrent ratio =
Quick Ratio =
Liquidity Ratio =
Liquidity Ratio = =
Net treasury = Net LT Financing – Working Capital Requirement
We recommend you to use net treasury estimates for assessing liquidity levels
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COMBINING LIQUIDITY
AND NET TREASURY
Companies that use net short-term financing tofinance loans of working capital requirementsrun the risk of becoming increasingly dependenton cash.
Business valuation – Using financial analysis to measurea company’s value p 70 and following
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PART I: FINANCIAL ANALYSIS
CHAPTER FOUR: PROFIT AND LOSS STATEMENTS
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PROFIT AND LOSS STATEMENTS
Profit and loss statements = Summary statements of generated revenues with company assets and associated costs
Earnings after taxes = Revenues ‐ Expenses
Gross Profit = Net sales ‐ Costs of goods sold
Operating Profit =
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Gross profit
‐ Selling, general & administrative expenses
‐ Depreciations
‐ Amortizations
Business valuation – Using financial analysis to measurea company’s value P 77 and following
PROFIT AND LOSS STATEMENTS
The Extraordinary Items account provides a balance between revenues and costs associated with infrequent business activitiesEarnings Before Interest and Taxes ( EBIT) =
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Business valuation – Using financial analysis to measurea company’s value P 80 and following
Gross profits‐Selling, General & Administrative expenses‐Depreciations‐Amortizations
EBIT specifies company profit from regular business operations before paying interests and taxes
Regular profit = Operational profit + Financial result= EBIT + Interest income – Interest expenses
EBIT
Earnings Before taxes = Operational profit + Financial results+ Extraordinary items
Earnings After taxes = Earnings Before taxes ‐ Income taxes
Earnings Before Interest and Taxes (EBIT) will provide different results as extraordinary items are included or excluded.
By excluding extraordinary results EBIT comes to equal operating profits. EBIT figures represent company profit from regular business operations, before paying interests and taxes
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Business valuation – Using financial analysis to measurea company’s value P 83 and following
RETURN ON EQUITY &
SUBSTAINABLE GROWTH RATESReturn On Equity % (ROE%) =
Retention rate: Profit after taxes AFTER dividends = 80 000 EUR = 80%Profit after taxes BEFORE dividends 100 000 EUR
Self‐Sustainable growth rate = Return on Equity x Retention rate– This rate specifies maximum company growth without incurring future cash deficits
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Business valuation – Using financial analysis to measurea company’s value P 83 and following
‐>Financial components = ‐> solvability =‐> liquidity =
PART I: FINANCIAL ANALYSIS
CHAPTER FIVE: PROFIT AND LOSS STATEMENTS
AND STRATEGIC DECISION ‐MAKING
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PROFIT AND LOSS STATEMENTS:
FOUR ADDITIONAL STEPS1. Calculating net long‐term financing 2. Converting conventional balance sheet into managerial balance
sheets3. Relating WRC to net long‐term financing ‐
4. Do companies use annual depreciation and amortizations to adjust company earnings, i.e. EBIT?
5. How to transform earnings into cash flows for more valid indications?
6. Does EBIT or net operational cash flow provide sufficient cash to repay maturing debt obligation
7. How to use analysis of past/ present rate for budget calculations
Make forecast scenarios in line with past performance
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EBIT & EBITDA DEVELOPMENTS
EBITDA = Net sales – Cost of Sold goods (COGS) ‐ Selling, general & administrative expenses (SG&A)
EBITDA = EBIT + Depreciations + Amortizations
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N – 3 N – 2 N – 1 N
DEPRECIATIONSAMORTIZATION
€ 350 € 400 € 250
€ 0 € 0 € 0
NET FIXED ASSETS € 5,500 € 6,000 € 7,000 € 7,500
DEPRECIATION PLUS AMORTIZATION TO NET FIXED ASSETS RATIO
6.36% 6.67% 3.57%
To check if low depreciation / amortization to fixed assets ratios result from deliberate adjustments, we recommend you to compare fixed asset values for
various years. Significantly lower values for fixed assets may indicate asset sale and leaseback policies as major drivers of EBIT and EBITDA convergence
NET OPERATING CASH FLOW
Net operating cash‐flow = Incoming cash from operations ‐ Outgoing Cash from operations
– Note: Use net amounts of incoming or outgoing cash flows associated with company operations
– Comparing two snapshots taken at the end of different fiscal years ‐> total net cash flow
NOCF = Sales ‐ Cost of sold goods ( COGS) ‐ General Expensens and personnel ‐ Tax expenses ‐ Δ WCR
– Note: Cash Flow ≠ profits
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Net operating cash flow represents incoming cash flow from sales after all outgoing cash flow as operating expenses, taxes and working capital requirements have been subtracted
NET OPERATING CASH FLOW
NOCF = EBIT + Depreciations + Amortizations – Tax expenses ‐ Δ WCR
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N‐2 N‐1 N
EBIT € 2.202 € 2.377 € 2.355
+ DEPRECIATIONS
+ AMORTIZATIONS
€ 350 € 400 € 500
0 0 0
‐ TAKS EXPENSES € ‐569 € ‐604 € ‐581
‐MUTATION IN WCR € ‐400 € ‐400 € ‐1.300
NET OPERATING CASH FLOW € 1.583 € 1.773 € 974
Are companies capable of generating sufficient cash for strategic future investments?
DEBT REPAYMENTS AND NET
OPERATING CASH FLOWMaturing debt = short‐term (current) financial debt =interest‐bearing debt that needs to be repaid during the course of the next accounting year
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N‐2 N‐1 N
CURRENT FINANCIAL DEBTCURRENT PORTION OF LONG‐TERM DEBT
OWED TO BANKS
€ 1,500€ 500
€ 1,314€ 600
€ 1,966€ 713
€ 1,000 € 750 € 1,253
NET OPERATING
CASH FLOW COVERAGENOCF coverage = NOCF – Long‐term financial debt due within 1 year
How many investments companies are capable of financing <‐> How much investments may be supported on a sustainable basis.
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N‐2 N‐1 N
EBIT € 2,202 € 2,377 € 2,355
+ DEPRECIATIONS
+ AMORTIZATIONS
€ 350 € 400 € 500
0 0 0
‐ TAKS EXPENSES € ‐569 € ‐604 € ‐581
‐MUTATION IN WCR € ‐400 € ‐400 € ‐1,300
NET OERATING CASH FLOW € 1,583 € 1,773 € 974
LT FIN. DEBT DUE <1 YEAR € 500 € 600 € 713
NOFC COVERAGE € 1,083 € 1,173 € 261
Substantial net operating cash flowssignify that companies are capableof financing changes in workingcapital requirements withoperational cash flows
NET CASH FLOW FROM
INVESTING ACTIVITIESNet cash flow from investing activities = Fixed assets acquisitions
– Fixed assets disposalsEstimated net cash flow from investments in year t =
Fixed assets for year t‐1– Fixed assets for year t– Depreciations – Amortizations
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N‐2 N‐1 N
OPENING BALANCE FIXED ASSETS € 5,500 € 6,000 € 7,000
CLOSING BALANCE FIXED ASSETS € 6,000 € 7,000 € 7,500
‐ DEPRECIATIONS (and AMORTIZATIONS) € ‐350 € ‐400 € ‐500
CORRECTIONS FOR REVALUATIONS 0 0 € 500?
€ ‐850 € ‐1,400 ?NOFC COVERAGE
NET CASH FLOW FROM
FINANCING ACTIVITIESNet cash flow from financing activities = mutation in long‐term loans
+ mutation in short‐term loans – Long‐term debt repaid– Interest payments – Dividend payments
Calculation Free Cash Flow (figure 63): we recommend you to use the IAS 7 free cash flow framework for analyzing cash position developments with the help of historical data.
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N‐2 N‐1 N
INCREASE IN LONG‐TERM LOANSINCREASE IN SHORT‐TERM LOANS
€ 600 € 800 € 913
€ 70 € ‐186 € 652
(‐) LONG TERM DEBT REPAID(‐) INTEREST PAYMENTS(‐) DIVIDEND PAYMENTS
€ ‐500 € ‐600 € ‐713
€ ‐305 € ‐365 € ‐420
€ ‐398 € ‐423 € ‐406
NET CASH FLOW FROM FINANCING ACTIVITIES € ‐533 € ‐774 € ‐26
CASH FLOWS
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N‐2 N‐1 N
CASH FLOWS FROM OPERATING ACTIVITIES
SALES 8,110 8,700 9,200
‐ COST OF GOODS SOLD € ‐4,100 € ‐4,500 € ‐4,800
‐ SELLING, GENERAL AND ADMINISTRATIVE EXPENSES € ‐1,458 € ‐1,423 € ‐1,545
‐ TAKS EXPENSES € ‐569 € ‐604 € ‐581
‐WORKING CAPITAL REQUIREMENT CHANGES € ‐400 € ‐400 € ‐1,300
A. NET OPERATING CASH FLOW (NOCF) 1,583 1,773 974
CASH FLOWS FROM OPERATING ACTIVITIES
BEGINNING BALANCE FIXED ASSETS € 5,500 € 6,000 € 7,000
‐ CLOSING BALANCE FIXED ASSETS € 6,000 € 7000 € 7,500
‐ DEPRECIATIONS € ‐350 € ‐400 € ‐500
+/‐ CORRECTIONS FOR REVALUATIONS € 0 € 0 € 0
B. NET CASH FLOW FROM INVESTING ACTIVITIES € ‐850 € ‐1,400 € ‐1,000
CASH FLOWS FROM OPERATING ACTIVITIES
INCREASE IN LING‐TERM LOANS € 600 € 800 € 913
+ INCREASE IN SHORT‐TERM LOANS € 70 € ‐185 € 652
‐ LONG‐TERM FINANCIAL DEBT REPAID € ‐500 € ‐600 € ‐713
‐ INTEREST PAYMENTS € ‐305 € ‐365 € ‐420
‐ DIVIDEND PAYMENTS € ‐398 € ‐422 € ‐406
C. NET CASH FLOW FROM FINANCING ACTIVITIES € ‐533 € ‐773 € 26
TOTAL NET CASH FLOW (A + B + C) € 200 € ‐400 € 0
OPENING CASH € 800 € 1,000 € 600
CLOSING CASH (OPENING CASH + TOTAL NET CASH FLOW) € 1,000 € 600 € 600
ADJUSTED CASH FLOW STATEMENTS FOR
STRATEGIC DECISION-MAKING
69
N‐2 N‐1 N
CASH FLOWS FROM OPERATING ACTIVITIES
SALES 8,110 8,700 9,200
‐ COST OF GOODS SOLD € ‐4,100 € ‐4,500 € ‐4,800
‐ SELLING, GENERAL AND ADMINISTRATIVE EXPENSES € ‐1,458 € ‐1,423 € ‐1,545
‐ TAKS EXPENSES € ‐569 € ‐604 € ‐581
‐WORKING CAPITAL REQUIREMENT CHANGES € ‐400 € ‐400 € ‐1,300
A. NET OPERATING CASH FLOW (NOCF) 1,583 1,773 974
CASH FLOWS FROM OPERATING ACTIVITIES
BEGINNING BALANCE FIXED ASSETS € 5,500 € 6,000 € 7,000
‐ CLOSING BALANCE FIXED ASSETS € 6,000 € 7000 € 7,500
‐ DEPRECIATIONS € ‐350 € ‐400 € ‐500
+/‐ CORRECTIONS FOR REVALUATIONS € 0 € 0 € 0
B. NET CASH FLOW FROM INVESTING ACTIVITIES € ‐850 € ‐1,400 € ‐1,000
CASH FLOWS FROM OPERATING ACTIVITIES
INCREASE IN LING‐TERM LOANS € 600 € 800 € 913
+ INCREASE IN SHORT‐TERM LOANS € 70 € ‐185 € 652
‐ LONG‐TERM FINANCIAL DEBT REPAID € ‐500 € ‐600 € ‐713
‐ INTEREST PAYMENTS € ‐305 € ‐365 € ‐420
‐ DIVIDEND PAYMENTS € ‐398 € ‐422 € ‐406
C. NET CASH FLOW FROM FINANCING ACTIVITIES € ‐533 € ‐773 € 26
TOTAL NET CASH FLOW (A + B + C) € 200 € ‐400 € 0
OPENING CASH € 800 € 1,000 € 600
CLOSING CASH (OPENING CASH + TOTAL NET CASH FLOW) € 1,000 € 600 € 600
Positive available cash flow for strategic decisions indicates if operational company earnings suffice to meet financial obligations resulting from past decisions. Positive figures
signal that new investments may be considered
Nondiscretionary versus discretionary cash flows
= Available for Strategic Decision
PART I: FINANCIAL ANALYSIS
CHAPTER SIX: FORECAST FOR MANAGERIAL
BALANCE SHEET AND PROFIT AND LOSS STATEMENT
70
PROFIT AND LOSS STATEMENTS:
BUDGET FORECASTSAnalysis of past figures to forecast future results
Potential adjustments should future situations differ from current
circumstances
EBIT forecasts for year N+1: influence:
– Expected trends and developments for this industry
– Recent investments
71
PROFIT AND LOSS STATEMENTS:
BUDGET FORECASTS
72
N – 3 N – 2 N – 1 N N+1
EARNINGS BEFORE INTEREST AND TAXES (EBIT) € 1.700 € 2.202 € 2.377 € 2.355
Financial resultExtraordinary items
€ ‐290200
+30%
€ ‐3050
+8%
€ ‐3650
‐1%
€ ‐4200
NET FIXED ASSETS € 1.610 € 1.897 € 2.012 € 1.935
‐ Tax expenses € ‐483 € ‐569 € ‐604 € ‐581
DEPRECIATION PLUS AMORTIZATION TO NET FIXED ASSETS RATIO6.36% 6.67% 3.57%
N+1EARNINGS BEFORE INTEREST AND TAXES (EBIT) € 2.760
Financial resultExtraordinary items
€ ‐300€ 0
EARNINGS BEFORE TAXES (EBT) € 2.460
‐ Tax expenses € ‐738
EARNINGS AFTER TAXES (EAT) € 1.722
Earnings before interest and taxes (year N+1):
€2,760,000 (+17% year N)
MANAGERIAL BALANCE SHEET:
BUDGETS AND FORECASTSForecasting equity
– How much net profits are transferred to equity?– Dividend payments to company shareholders and – The use of internally generated equity capital for reinvestments.
Forecast equity : equity retention rate =
– Assuming no other external equity issues
Forecasting Fixed assets– Historical Date – Depreciations– New Strategic Investments
Forecasting Working Capital Requirements & Cash– WCR
• Analysis of historical data • Assess relative new investments in fixed assets
– Cash Block• What cash amounts need to be accommodated to situations?• Specify amounts for other assets
73
Provide indications on required financial resources
MANAGERIAL BALANCE SHEET:
BUDGETS AND FORECASTSBudget WCR & Cash
74
MANAGERIAL BALANCE SHEET:
BUDGETS AND FORECASTSForecast Long‐term and short‐term financial debt
– Financial debt forecasts equal all asset forecasts, which are not financed with increased equity as forecasted for a given accounting year
75
N + 1
Net fixed assetsRecurrent WCR
€ 7,700€ 1,939
Needed long‐term financing € 9,639
Shareholders’ equity € 7,139
Long‐term financial debt € 2,500
NET ASSETS INVESTED CAPITAL/CAPITAL EMPLOYED
Ned fixed assets € 7,700 Shareholders’ equity € 7,139
Property, plant & equipmentFinancial & Intagible assets
€ 5,700€ 2,000
CapitalReservesAccumulated results
€ 2,000€ 1,000€ 4,139
Working Capital Requirement € 2,200 Long‐term financial debt € 2,500
Cash € 800 Short‐term financial debt € 1,061
NET ASSETS € 10,700 INVESTED CAPITAL € 10,700
BUDGETS AND FORECASTS: STEPS
1. Equity block 2. Fixed Assets block3. Long term financial debt4. Working Capital Requirements5. Cash block 6. Saldo = Short‐term financial debt block
76
PART II: COMPANY VALUATION
INTRODUCTION
77
COMPANY VALUATION
Company valuation needs to reflect profits and associated risksDifferent investors expectations will lead to different value estimatesTakeover fee and company value do not necessarily go together– Value reflects stakeholder expectations.– Price represents a compromise between perceptions of different stakeholders
regarding variables that affect company value.Use multiple valuation methodsProvide a business case for any profit increases, if you intend to sell your companyPublic versus Private companies
78
OVERVIEW OF THE MAIN
VALUATION METHODS
79
Equity Valuation models
Equity Cash Flow value = + Exceeding assets (minus taxes)
Economic Profit Equity value = Equity – BV exceeding assets + + Exceeding Assets (minus taxes)
Entity Valuation models
Entity DCF Value = + EXCEEDING ASSETS (minus taxes)
Entity Economic Profit value = IC MINUS BV EXCEEDING ASSETS + + EX ASSETS (MINUS TAXES)
Entity APV = + ( Financial debt x tax rate )
REAL TAX RATE –
MARGINAL TAX RATEIn calculating the value of a company we look at the future
We can not be certain the current tax incentives will be maintained in the future
Thus we take the MARGINAL tax rate into consideration
80
PART II: COMPANY VALUATION
WEIGHTED AVERAGE COST OF CAPITAL
81
WACC
The Weighted Average Cost of Capital (WACC)=a measure of average capital costs for each acquired euro ̸dollar
WACC%=KE% x + Kd% x (1‐t) x
Required return on debt:– = Expected company costs of capital from financial institutions– Few Debt contracts: interest rates as stipulated in debt contracts– Multiple contracts: calculate return rates by having interest charges divided by average
amounts of interest‐bearing debt
Required return on equity: – Calculate with CAPM ( Capital Asset Price Models)– Expected return rates on equity:
• Returns on risk‐free investments• Market risk premiums in addition to risk‐free returns • Individual company risk profiles as compared to average company risk profiles
82
CAMP AND BETA
Equity betas or leveraged betas => estimates on company performance as compared to market performance
Systematic risks: which investors cannot avoid by investment diversificationUnsystematic risk: general economic trends that affect entire markets in negative ways or events that will only hit specific companies
CAPM relies on market risk premium: represents the trade‐off between security and volatility
83
βe of 1 company results fluctuate in line with market rates
βe of 2 company shares fluctuate twice as much relative to market index
βe of 0,5 company results will be half as volatile as compared to market indexes
BETA
We can distinguish two types of risks:1 Diversifiable risk = can be eliminated by diversifying the portfolio
2. Market Risk: cannot be eliminated by diversifying the portfolioBeta only measures the portfolio’s market risk
A share’s volatility measures the TOTAL risk; Beta only measures the incrementalrisk
In mathematics volatility is measured by standard deviation and variance ( of ROE)
A Share’s beta is calculated as the covariance between the stock return andmarker return ( ROE), divided by the variance of the market return (1)
Beta’s levered usually have values between 0,7 and 1,3 in 80% of the casesBron: Valuation Methods and Shareholder value Creation, Pablo Fernandez,Elsevier Science 2002, blz 205
84
BETA
Business risks or operational risksBeta estimates that are based on covariance of company shares relative to market indexes suffer from a number of disadvantages– covariance is not stable over time– betas cannot be estimated for companies that are not listed on the stock‐
exchangeβa reflect business risksβe reflect both business
βe = βa x [ 1 + (1 –t) x ]
Ke% =Rf% + (Rm% – Rf%) x βe
Equity risk premium
85
DETERMING THE RISK PREMIUM
86
IMPORTANT
Always take into consideration which Rm% is used for valuation of the company– High % will mean a lower value– Look at what’s realistic for the company : what risks are involved in you’re investment : High risks you may expect high return
– We consider Rm % = 18%‐ 20 % in order to make a conservative valuation of a company
87
INFLUENCE REQUERED
RETURN ON VALUE
88
GERMAN GOVERNMENT BONDS
89
GERMAN GOVERNMENT BONDS
90
IMPLIED PREMIUMS
91
IMPLIED PREMIUMS
92
Implied premiums versus Risk free rates
IMPLIED PREMIUMS
93
London Business School – Global Evidence on the equity risk premium
WHICH RISK PREMIUM
If we look back : 1928 – 2004 : 4,84 % on US EquityMarketIf we look back 1926‐1996 : 7,1%‐7,5% Equity risk premium on NASDQ,AMEX and NYSEThis shows it is important to take into considerationwhich market has been regarded as a benchmark
94
WHICH RISK PREMIUM
Percentages of between 4,84% ‐ 7,5% (as mentionned on previous page) are not realistic forthe valuation of mid‐sized companies!Diversification of risk is not possible whiles takingover a companyThis increase in risk should be compensated by a higher risk premium.
95
DETERMINANTS OF
EQUITY RISK PREMIUMSRisk aversion : equity risk premiums should increase as saving rates decrease in an economy
Economic risk: when inflation, interest rates and economic growth are volatile : higher risk premiums
96
TAKING INFLATION
INTO ACCOUNTWhen we actualize Cash Flows we need to take into account inflation.In the past banks determined their interest rates as following : save return % (example 2%)+ the % of inflation (for example 4 %) : resulting in an interest rate of 6 %Now banks do not take inflation into account , giving you an interest rate of for example 2 %For valuation we need to take the percentage of inflation into account ourselves.
97
TAKING INFLATION
INTO ACCOUNTVOKS = Cash FlowH = inflation rateKr = Cost of equity / WACC%I = taking initial investment into account (because we are calculating a NET present value)
98
SMALL FIRM PREMIUM
Banz( 1981) looked at return on stocks from 1936‐1977 of small companies (bottom 20 % NYSE)He came to the conclusion that they have generated about 6 % more than larger companies.Small companies are also more volatile, and thus, an investment with more risk involvedOperating risk: degree of operating leverage (Damodaran on valuation p51)
Higher risk premium necessary
99
SMALL FIRM PREMIUM
100
EQUITY RISK PREMIUM
101
COUNTRY RISK PREMIUM –
MOODY’S RATING
102
VOLATILITY ON THE MARKET
103
STANDARD ERRORS
104
IMPORTANCE OF PERIOD TAKEN
INTO CONSIDERATION
105
CONCLUSION REQUIRED RETURN
Risk free : 20 year German bond +/‐ 5%Historical premiums : +/‐ 6%/8%Small company : +6%
Required return : +/‐ 19 %Risk premium : difference between Required return and risk
free : 14 % minimum!
Ps : use three step method and remember RM does know an evolution versus Ke due to competition in the market
106
107
GEOMETRIC MEAN VS
ARITHMETIC MEAN
ARITHMETIC MEAN
In its most basic form, you can just take the sum of the different values and divide that sum by the amount of values you added up.
Example: evolution returns
% % % = 3,33%
108
Year 1 +10%Year 2 ‐10%Year 3 +10%
ARITHMETIC MEAN
Perhaps counter‐intuitively at first, this does not however mean that the company in example will be worth 9.99% (3 times 3.33%) more at the end of year 3.
Although the relative gain and loss are the same in year 1 and 2, +‐10%, the final absolute value in year 2 will not be equal to the starting value. This is a result of ‘compounding’, which entails that your starting point in year 1 is not 100, but 100 + the capital increase realized during year 1 (10).
109
Year Return over year (relative) Final (absolute) value Year 0 €100Year 1 +10% €100 + €10 = €110Year 2 ‐10% €110 – €11 = €99Year 3 +10% €99 + €9,9 = €108,9
GEOMETRIC MEAN
More precise than arithmetic mean.
Example: evolution returns
– 1 = 2.88%
110
Year 1 +10%Year 2 ‐10%Year 3 +10%
Result : annual increase of 2,88 %Arithmetic mean : 3,33 %Conclusion: geometric mean results in lower percentage (this is useful for CF calculations, not for risk premium calculations)
Attention:– This formula can not be used for negative figures– For negative figures you need to use percentages
GEOMETRIC MEAN
111
When evaluating past returns (with compounding), use the geometric average– This generally gives a lower, and thus safer result
When calculating the average risk premium, use the arithmetic average– This generally gives a higher, and thus safer result (Higher risk premium = lower company value)
WHEN TO USE GEOMETRIC AVERAGES
AND WHEN ARITHMETIC AVERAGES
112
GEOMETRIC MEAN –
EQUITY RISK PREMIUMS
113
EQUITY RISK PREMIUMS
VERSUS BILLS
114
London Business School –Global Evidence on the equity risk premium
SURVEY ON RISK PREMIUMS
115
London Business School –Global Evidence on the equity risk premium
116
RETURNING TO THE WACC
WACC%
117
WACC% = Ke % x + Kd % x (1‐t) x Figure 107: WACC estimates (euro in ‘000s) N‐2 N‐1 N N+1
Equity (adjusted book value) € 4,000 € 4,986 € 5,934 € 7,139
Invested Capital € 8,000 € 9,000 € 10,800 € 10,700
Equity ratio 0.50 0.55 0.55 0.67
Required on equity 24% 23% 23% 20%Weigted cost of equity 12.1% 12.5% 12.5% 13.3%
Interest‐bearing debt € 4,000 € 4,014 € 4,866 € 3,561Invested Capital € 8,000 € 9,000 € 10,800 € 10,700Interest‐bearing debt ratio 0.50 0.45 0.45 0.33
Required return on debt 7.8% 9.1% 9.5% 7.1%Kd x (1‐t) 5.5% 6.4% 6.6% 5.0%Weighted cost of debt (after‐taks) 2.7% 2.8% 3.0% 1.7%
Weighted Average Cost of Capital 14.9% 15.4% 15.5% 15.0%
PRACTICAL EXAMPLE
118
Periode 8 Periode 92008 - 2009 2009 - 2010
Calculate cost of Invested Capital
Berekening van de WACC – Calculation of WCR2009 - 2010
Stap 1: Beta – Step 1 Beta
Gegevens - Data
Beta asset 0,5risicoloze rente -Risk Free Return 4%verwacht marktrendement - Expected Market Return 20%
Intrest bearing debt 1.160.024,00
Schulden op lange termijn (enkel rentedragende schulden)-Long-term Debts ( inerest bearing) 769.145,00
Schulden op korte termijn (enkel rentedragende schulden)- Short- Term Debts ( intrest bearing) 390.879,00A. Schulden op meer dan één jaar - Loan < 1 year 323.104,00B. Financiële schulden - Financial debts 67.775,00F. Overige schulden - Other debts (Standaard op nul)- Other Debts 0,00
Equity 1.206.195,00
Beta-equity = B asset x [ 1 + ( 1 - tax rate ) x Intrest bearing debt/equity ]
Beta-equity = 0,5 * [ 1 + ( 1 - 0,34 ) * 1160024 / 1206195 ]
Beta equity = 0,82
PRACTICAL EXAMPLE
119
Cost of Equity
Ke = Risicovrije rente + (Beta-coëfficiënt x (de rendementseis -risicovrije rente))Ke= Risk free return + ( Equity Beta x( Required Return - Risk Free return)Ke = 0,04 + 0,82 x ( 0,2 - 0,04 )
Kost eigen vermogen (Ke)- Cost of Equity 17,08%
Cost of Debt
kost VLT - Cost of LT debts 4%min belasting/taxes 2,64%
kost VVKT - Cost of ST debts 10%Min belastingen/taxes 6,60%
PRACTICAL EXAMPLE
120
Calculate total debt – Equity
Totaal eigen vermogen - Total capital and reserves 1.206.195,00 50,98%Schulden op lange termijn - Payables > 1 year 769.145,00 32,51%A. Schulden op meer dan één jaar - Loan < 1 year 323.104,00 13,65%B. Financiële schulden - Financial debts 67.775,00 2,86%
Totaal- Total 2.366.219,00Management Balanstotaal- Management Balance Sheet total 2.556.219,00
PRACTICAL EXAMPLE
121
Percentages X costs
Verhouding Kost TotaalTotaal eigen vermogen - Total capital and reserves 50,98% 17,08% 8,71%Schulden op lange termijn - Payables > 1 year 32,51% 2,64% 0,86%A. Schulden op meer dan één jaar - Loan < 1 year 13,65% 2,64% 0,36%B. Financiële schulden - Financial debts 2,86% 6,60% 0,19%
WACC 10,11%
Calculate cost of invested equity
Invested capital = geinvesteerd vermogen : 2.791.761,00 2.366.219,00Wacc 10,11% 10,11%
Cost invested capital - kost van het geinvesteerd vermogen : 282.337,24 239.301,19
PART II: COMPANY VALUATION
CHAPTER EIGHT: KEY VALUATION CONCEPTS
122
EQUITY VERSUS
ENTITY VALUATION
Equity approaches usually start by considering profits after taxes and interestEntity approaches take both equity AND financial debt holders in account for company valuation
What exactly is company value?
123
Business valuation – Using financial analysis to measurea company’s value P 135 and following
ECONOMIC PROFITS AND
DISCOUNTED CASH FLOW
124
Establishing company value:
Discounted cash flow models:Free cash flows Equity cash flows
Economic profit models
ECONOMIC PROFITS
Profit margin: profit margins per invested euro/dollarMultiply profit margin with all invested resourcesEquity Approaches
– Return on equity %=
– EP = (Return on equity – Required return on equity) x Adjusted Book Value of equity of the previous year
– Ept = (ROE % ‐ Ke % ) x Ebvt‐1– Ept = PATt ‐ (Ebvt‐1 x Ke %)
125
Equity value = Adjusted book value equity + + EX Assets (-Tax)
ECONOMIC PROFITS
Calculation in 6 septs:
1. Calculate adjusted company book values for the previous year
2. Calculate current required return on equity
3. Multiply the outcomes of steps 1 and 2 and subtract this product from company earnings after taxes
4. Step 3 provides you with economic profit for a single year. Calculate average profits with historical
data and use this figure as benchmark
5. Divide the average economic profit (step 4) by required return on equity (step 2) minus specified
growth rates to calculate present values for average economic profits
6. Add all present values of economic profits to adjusted book values
Using various annual economic profits will prevent invalid residual values that result from using a single reference years. Should you prefer direct calculations of company equity, economic profits provide more reliable values as compared to equity cash flow generated values
126
GROWTH RATE
127
N‐1 N N+1NOPLAT € 1,664 € 1,649 € 1,932Invested capital at the start of the fiscal year € 8,000 € 9,000 € 10,800Return on Invested Capital 20.8% 18.3% 17.9%
Net Investment € 1,400 € 1,800 ‐€ 300NOPLAT € 1,664 € 1,649 € 1,932Investment rate 84.1% 109.2% ‐15.5%
Growth rate (ROIC x IR) 17.5% 20.0% ‐2.8%
RETURN ON EQUITY & ECONOMIC PROFITS
Return on equity % = – Adequate? Depends on shareholders’ opinion
Economic profit = (Return on equity – required return on equity) (Equity Based) x equity invested at the start of the fiscal year
– Economic profits represent all company profits that exceed required profits for covering all associated risks and costs with conducting business operations.
Equity value=(Adjusted book value – Exceeding assets) + + ex assets (‐Tax)
128
These calculations include all invested equity as well as present values of expected future economic profits
This value makes use of expected company profits in terms of invested equity as these profits exceed all required profits for compensating equity owners in view of all entrepreneurial risks
RETURN ON INVESTED CAPITAL AND
ECONOMIC PROFITSReturn on invested capital = all company profits from business operations in terms of all used resources for investments in assets
Return on Invested Capital % =
– Note: EBIT minus operating taxes, or EBIT x [1‐t], is often referred to as NOPLAT – High EBIT ≠ high ROIC– Invested capital = Equity + interest bearing debts
129
Company X Company YEBIT € 20 € 100(1‐taks rate) 70% 70%NOPLAT € 14 € 70
Invested Capital € 100 € 700
Return on Invested Capital 14.0% 10.0%
RETURN ON INVESTED CAPITAL AND
ECONOMIC PROFITSTaking cost of capital into account– Weighted Average Cost of Capital (WACC)
Economic Profits = (ROIC % – WACC %) x Invested CapitalROIC % = Operating margin x capital turnover x (1‐ tax rate)
= x x ( 1‐tax rate)
130
ECONOMIC PROFITS
Entity approaches• Net Operating Profit Less Adjusted Taxes = Earnings Before Interest and taxes
‐ Operating taxes• NOPLAT = EBIT x (1 – real tax rate%)
• Invested Capital = Equity + Interest‐bearing debt= Equity + LT financial debt + ST financial debt
• ROIC % =
Operational profit levels irrespective of used financial arrangements.
• WACC% = Ke % x x Kd% x (1‐t) x • Economic Profit (EP) = Invested Capital x (ROIC% – WACC %)• Economic Profit (EP) = NOPLAT ‐ (Invested Capital x WACC %)
131
Entity value= (Invested Capital –Exceeding assets) + + ex assets (- Tax)
EXCEEDING ASSETS
Equity ApproachesExample 1: exceeding asset : 200 000 (book value) 250 000 (actual value) = 50 000 (plusvalue)
tax rate 34% Equity: 1 000 000Economic profit: 150 000
Equity value =
(Adjusted book value equity – Exceeding assets) + + EX assets(-Tax)
Adjusted book value equity = 1 000 000 + 50 000 – 17 000 = 1 033 000
(1 033 000 – 200 000) + 150 000 + (250.000– 17 000) = 1 816 000 €20%
132
Business valuation – Using financial analysis to measurea company’s value P 169 and following
EXCEEDING ASSETS
Equity Approaches
Always take in account debts relating to exceeding assets and calculate withnet exceeding assets
Example 2: exceeding asset : 200 000 (book value) 250 000 (actual value) = 50 000 (plusvalue)exceeding debt: 100 000tax rate 34% Equity: 1 000 000Economic profit: 150 000
Equity value =
(Adjusted book value equity – NET Exceeding assets) + + EX NET assets(-Tax)
Adjusted book value equity = 1 000 000 + 50 000 – 17 000 = 1 033 000
(1 033 000 – (200 000 – 100 000)) + 150 000 + (250 000 – 100 000 – 17 000)= 1 816 000 €
133
EXCEEDING ASSETS
Entity ApproachesExample 1: Exceeding asset : 200 000 (book value) 250 000 (actual value) = 50 000 (plusvalue)
Tax rate 34% Equity: 1 000 000Economic profit: 150 000WACC: 15%
Entity value =
(Invested Capital – Exceeding assets) + + ex assets (- Tax )
Invested capital = 1 000 000 + 50 000 – 17 000 = 1 033 000
(1 033 000 – 200 000) + 150 000 + (250 000 – 17 000) = 2 066 000 €15%
134
EXCEEDING ASSETS
Entity Approaches
Always take in account debts relating to exceeding assets and calculate withnet exceeding assets
Example 2: exceeding asset : 200 000 (book value) 250 000 (actual value) = 50 000 (plusvalue)exceeding debt: 100 000tax rate 34% Equity: 1 000 000Economic profit: 150 000WACC: 15%
Entity value =
(Invested Capital – NET Exceeding assets) + +ex NET assets (- Tax )
Invested capital = 1 000 000 + 50 000 – 17 000 = 1 033 000
((1 033 000) – (200 000 – 100 000) + 150 000 + ((300 000 – 100 000) – 17 000) = 2 116 000 €15%
135
ENTITY APPROACHES TO
ECONOMIC PROFITS, OR EVAEconomic Value Added (EVA): calculation
1. Calculate Net Operating Profit Less Adjusted Taxes
2. Establish Invested Capital for the previous fiscal year
3. Calculate the Weighted Average Cost of Capital
4. Insert all inputs in the following equation:
Economic Profit (EP) = NOPLATt ‐ (Invested Capitalt‐1 x WACCt)
5. Estimate expected growth rates
6. Calculate entity values by inserting data in the following equation
Entity value = Invested Capital0 +
7. Subtract all financial debt to arrive at equity values
136
GROWTH RATE
137
N‐1 N N+1NOPLAT € 1,664 € 1,649 € 1,932Invested capital at the start of the fiscal year € 8,000 € 9,000 € 10,800Return on Invested Capital 20.8% 18.3% 17.9%
Net Investment € 1,400 € 1,800 ‐€ 300NOPLAT € 1,664 € 1,649 € 1,932Investment rate 81.1% 109.2% ‐15.5%
Growth rate (ROIC x IR) 17.5% 20.0% ‐2.8%
EVA
138
Figure 121: Economic profits (euro in ‘000s) N‐2 N‐1 N N+1NOPLATInvested capital
€ 1,664 € 1,649 € 1,932€ 8,000 € 9,000 € 10,800
Return on Invested Capital 20.8% 18.3% 17.9%
Weighted Average Cost of Capital 15,4% 15,5% 15,0%
Spread between ROIC and WACC 5,4% 2,9% 2,9%Invested capital € 8,000 € 9,000 € 10,800
Economic Profits (Entity) € 435,2 € 256,6 € 313,6
Economic ProfitN‐2 N‐1 N N+1
Equity (adjusted book value) € 4,000 € 4,986 € 5,934 € 7,139
Invested Capital € 8,000 € 9,000 € 10,800 € 10,700
Equity ratio 0.50 0.55 0.55 0.67
Required on equity 24% 23% 23% 20%Weigted cost of equity 12.1% 12.5% 12.5% 13.3%
Interest‐bearing debt € 4,000 € 4,014 € 4,866 € 3,561Invested Capital € 8,000 € 9,000 € 10,800 € 10,700Interest‐bearing debt ratio 0.50 0.45 0.45 0.33
Required return on debt 7.8% 9.1% 9.5% 7.1%Kd x (1‐t) 5.5% 6.4% 6.6% 5.0%Weighted cost of debt (after‐taks) 2.7% 2.8% 3.0% 1.7%
Weighted Average Cost of Capital 14.9% 15.4% 15.5% 15.0%
WACC
Figure 121: Economic profits (euro in ‘000s)
N‐2 N‐1 N N+1
Earnngs before Interest and taxex (EBIT) € 2,207 € 2,377 € 2,355 € 2,760‐ Real taks rate x EBIT ‐€ 661 ‐€ 713 ‐€ 707 ‐€ 828
NOPLAT € 1,541 € 1,664 € 1,649 €1,932
NOPLAT
EVA
Management implications of economic profits:– Economic Profit = Invested Capital x NOPLAT/invested capital – WACC%– Be very cautious with equating economic profits or EVA to company value creation for identical fiscal
years– Never ever use economic profits or EVA indices that only relate to single fiscal years for awarding
management bonuses– Economic profits indicate whether companies succeed or fail to create value through business
operations. Economic profits, however, do NOT necessarily express value creation for any specified time interval
Growth rate = (Average) ROIC% x Investment rate %Investment rate =
Entity value = (Invested Capital – exceeding assets) + + ex assets (‐Tax‐Equity value = (IC – exceeding assets) + ‐ financial debt + ex assets (‐Tax)
139
PRACTICAL EXAMPLE
140
Stap 1: bereken de NOPLAT - Calculate NOPLAT
sub 1: berekenen het effectieve bel % versus ordinary profit- Calculate the effective tax% vs EBIT
ORDINARY PROFIT 319.346,98 191.614,68
taxes -118.011,00 -65.127,00
% bel / EBIT 36,95% 33,99%
Bedrijfsresultaat - Operating profit - (EBIT) 488.852,98 297.841,68
36,95% 33,99%
min taxes % -180.649,99 -101.231,99
NOPLAT : 308.202,99 196.609,69
PRACTICAL EXAMPLE
141
Calculate total Invested CapitalTotaal eigen vermogen - Total capital and reserves 1.077.853,00 1.206.195,00Schulden op lange termijn - Payables > 1 year 1.007.154,00 769.145,00A. Schulden op meer dan één jaar - Loan < 1 year 316.316,00 323.104,00B. Financiële schulden - Financial debts 390.438,00 67.775,00
Invested capital = geinvesteerd vermogen : 2.791.761,00 2.366.219,00
PRACTICAL EXAMPLE
142
Stap 1: bereken de NOPLAT - Calculate NOPLATsub 1: berekenen het effectieve bel % versus ordinary profit- Calculate the effective tax% vs EBITORDINARY PROFIT 319.346,98 191.614,68taxes -118.011,00 -65.127,00% bel / EBIT 36,95% 33,99%
Bedrijfsresultaat - Operating profit - (EBIT) 488.852,98 297.841,6836,95% 33,99%
min taxes % -180.649,99 -101.231,99
NOPLAT : 308.202,99 196.609,69
Stap 2: bereken het totaal geinvesteerd vermogen- Calculate total invested CapitalTotaal eigen vermogen - Total capital and reserves 1.077.853,00 1.206.195,00Schulden op lange termijn - Payables > 1 year 1.007.154,00 769.145,00A. Schulden op meer dan één jaar - Loan < 1 year 316.316,00 323.104,00B. Financiële schulden - Financial debts 390.438,00 67.775,00
Invested capital = geinvesteerd vermogen : 2.791.761,00 2.366.219,00
Stap 3: bereken nu het rendement van het totaal geinvesteerd vermogen - Calculate return of total invested capitalNOPLAT : 308.202,99 196.609,69Invested capital = geinvesteerd vermogen : 2.791.761,00 2.366.219,00
Rendement - Return = ROIC : 11,04% 8,31%
PRACTICAL EXAMPLE
143
Stap 5 : bereken nu de waarde van de vennootschap op basis van de economic profit - Economic Profit ValuationEconomic ProfitNOPLAT : 308.202,99 196.609,69min kost van het geinvesteerd vermogen - cost invested capital -282.337,24 -239.301,19
Economic Profit : 25.865,75 -42.691,50
waarde van de onderneming op basis van de EP methode - EP valuationInvested capital = geinvesteerd vermogen : 2.791.761,00 2.366.219,00EP/ WACC 255.761,52 -422.135,12min rentedragende schulden - interest bearing debts -1.713.908,00 -1.160.024,00
waarde - value 1.333.614,52 784.059,88
maar als de waarde lager is dan het EV dan nemen we de waarde van het EV 1.077.853,00 1.206.195,00Use Capital and Reserves if valuation < Capital and Reserves
ENTITY APPROACH
& ADJUSTED BOOK VALUEEntity approach Adjusted book value
144
Entity approaches consider companyvalue to equal amounts of alreadyinvested capital plus potential futureprofits as generated with availablecapital.
Economic Profit Entity Value =Invested Capital +
=>Equity Value= Entity value‐ financial debt
Adjusted Book Value =Book value equity+ Revaluation surpluses– Latent taxes
Adjusted Book Value method reflects company value in terms of book values along with corrections for differences between book values and market values and adjusted for relevant taxes.
COMPANY VALUATION:CASH FLOW ‐METHODS
145
1. EQUITY CASH FLOW ECF
Equity Cash Flow = Incoming Cash Flow ‐ Outgoing Cash Flow– = Available cash for company shareholders
ECF = Earnings after Taxes + Depreciations + Amortizations – Δ Working Capital Requirements ‐ Δ Investments (in fixed assets) + Δ Financial debt
ECF = EAT – Net Investments + Δ Financial debt – Net Investments = New Investments in fixed assets – Depreciations
‐ Amortizations + Δ Working Capital Requirements
146
N N+1 N+2Opening Balance WCR € 1,400 € 2,700 € 2,200Closing Balance WCR € 2,700 € 2,200
Mutation in WCR € 1,541 € ‐500
1. EQUITY CASH FLOW (ECF)
∆ Financial Debt
147
N N+1 N+2Opening Balance long‐term financial debt € 2,700 € 2,900 € 2,900Closing Balance long‐term financial debt € 2,900 € 2,500
Opening Balance short‐term financial debt € 1,314 € 1,966 € 861Closing Balance short‐term financial debt € 1,966 € 1,061
Changes in LT financial debt € 200 € ‐400Changes in ST financial debt € 652 € ‐905
∆ Financial debt € 852 € ‐1,305
ECF =Earning after tax ( EAT)+ depreciations & amortizations‐ Increase in WCR‐ Principal payment of financial debts+ Increase in financial debts‐ Increase in other assets‐ Gross investment in fixed assets(+ Book value of fixed assets sales)
Equity value = ECF/Ke% + exceedingassets (‐Tax)
Business valuation – Using financial analysis to measurea company’s value P 155 and following
EQUITY CASH FLOW
ECF = EAT + Depreciations – Δ Investments – Δ WCR + Δ Financial debt
148
N‐2 N‐1 N N+1Asset beta 0.74 0.74 0.74 0.74
Interest‐bearing debt € 4,000 € 4,014 € 4,866 € 3,561Adjusted book value (equity) € 4,000 € 4,986 € 5,934 € 7,139Debt‐to‐equity ratio 100% 81% 82% 50%
1 + (1‐tax rate) x debt‐to‐equity ratio 1.70 1.56 1.57 1.35
Equity Beta 1.26 1.16 1.16 1.00
N‐2 N‐1 N N+1Risk‐free retum 3.5% 3.5% 3.5% 3.5%
Required return 20% 20% 20% 20%Risk premium 16.5% 16.5% 16.5% 16.5%Equity beta 1.26 1.16 1.16 1.00
Required return on equity 24.3% 22.6% 22.7% 20.0%
Equity Value = E0 = PV [Ket; ECFt] = +…+
Business valuation – Using financial analysis to measurea company’s value P 155 and following
EQUITY CASH FLOW
Considerations– Equity cash flow may fail to represent company equity, as our company
expects to invest quite substantially after year N‐2. – we used a reference year that is characterized by massive debt repayments to
calculate our residual value
Be very cautious about links between debt creation, equity cash flows and company values, should you decide to select equity cash flow as your method of company valuation. In case you decide to use equity cash flow methods, be sure to use formulas for calculating equity or leveraged betas that increase in line with significant debt‐to‐equity increases
149
Business valuation – Using financial analysis to measurea company’s value P 155 and following
PRACTICAL EXAMPLE
150
Equity Cash flow
Resultaat voor belastingen - earnings before taxes 319.346,98 193.468,68
Correcties- uitzonderlijke opbrengsten - extraordinary income 0,00 -2.500,00+ Uitzonderlijke kosten - extraordinary charges 0,00 646,00
Gecorrigeerd operationeel resultaat – Corrected Operational Result 319.346,98 191.614,68
- Belastingen op belastbare basis:(Tax-rate :Total tax paid/ Ordinary profit) -108.577,97 -65.148,99
Netto operationeel resultaat – Net Operational Result 210.769,01 126.465,69
+ afschrijvingen - Depreciations 465.259,00 437.163,27
Beschikbare cashflow voor investeringen – Available Cash flow forinvestments 676.028,01 563.628,96
- Gemiddelde investeringen - Average investments -100.000,00 -100.000,00
- Mutatie benodigd werkkapitaal - Mutation Work Capital Requirments -19.119,00
- Kapitaalaflossing- Capital Repayment -323.104,00
Equity Cashflow 121.405,96
PRACTICAL EXAMPLE
151
Calculate value based on Equity Cash flow
Equity Cashflow 121.405,96
Ke - Cost of Equity (zie berekening WACC) 17,08%
(when applicable : PLUS exceeding assets )
Waarde op basis van de Equity Cashflow - Equity Cashflow valuation 710.895,50
maar als de waarde lager is dan het EV dan nemen we de waarde van het EV 1.206.195,00
Use Capital and Reserves if valuation < Capital and Reserves
Bijgevolg weerhouden we de waarde volgens de Equity Cashflow op 1.206.195,00
2. FREE CASHFLOW (FCF)
FCF = EBIT‐ Operating Taxes NOPLAT
+ Depreciations and amortizations ‐ Increase in working capital NET INVESTMENT‐ Investments fixed assets
152
N+1
EQUITY CASH FLOW € 717
+ Interest charges x (1‐t)‐ Changes regarding financial debt
+ € 210‐(€ 1,305)
FREE CASH FLOW € 2,232
Business valuation – Using financial analysis to measure a company’s value P 164 and following
FROM NOPLAT TO FCF
FCF = NOPLAT ‐ Net investmentsEntity value =Discounted cash flows identify company earnings and adjust these earnings for cash flow estimatesDiscounted cash flows link company earnings to all outgoing cash flows in order to establish company profitsTo their advantage discounted cash flow incorporate all required company investments for generating profitsHowever, both methods only consider additional investments as opposed to taking all previously invested capital for generating company earnings into account
153
Business valuation – Using financial analysis to measure a company’s value P 166 and following
FREE CASH FLOWDefinitie beschikbare cashflow voor intrest = entity benaderingResultaat VOOR belastingen
+ uitzonderlijke kostenuitzonderlijke opbrengsten
+ ondernemersgebonden kostenondernemersgebonden opbrengsten
_______________________________________Gecorrigeerd operationeel resultaat‐ belastingen op het operationeel resultaat (1)_______________________________________Netto operationeel resultaat+ afschrijvingen+/‐ voorzieningen ( in principe NIET toe te voegen vb discussie belasting, risico: cfr art 50 KB) +/‐ waardeverminderingen ( in principe NIET toe te voegen want is vaak def verlies)________________________________________Beschikbare cashflow voor investeringenMin gebudgetteerde gemiddelde investeringen per jaar (= replacement investments)+/‐mutaties in gebudgetteerd werkkapitaal ( +:/‐)________________________________________Beschikbare cashflow
Opgepast in de praktijk voor de mutaties in de bedrijfskapitaal. ( Working capital ‐WCR)Definitie WCR:Het betreft de voorraden en de vorderingen verminderd met de niet rente dragende schulden. Deze laatste omvatten dus in essentiede leveranciers en de overige schulden.
(1) The tax payable on the ebit must be calculated Directly (Valuation methods and Shareholder value Creation, Academic Press , 2002, blz 40, Pablo Fernadez)
154Business valuation – Using financial analysis to measurea company’s value P 164 and following
FREE CASH FLOW
Discounted Free Cash Flow calculation1. Calculate company NOPLAT2. Estimate expected changes in working capital requirements3. Estimate expected investments in fixed assets and deprecations4. Calculate expected growth rates with data derived from steps
1,2 and 35. Calculate the WACC6. Insert this number in formula
Entity Value = FCF / ( WACC% – g %) (+ exceeding assets)
155
Business valuation – Using financial analysis to measurea company’s value P 164 and following
FREE CASH FLOWFree Cash Flow Growth Rate !
WACC
Investment rate
156
N‐1 N N+1NOPLAT € 1,664 € 1,649 € 1,932Invested capital at the start of the fiscal year € 8,000 € 9,000 € 10,800Return on Invested Capital 20.8% 18.3% 17.9%
Net Investment € 1,400 € 1,800 ‐€ 300NOPLAT € 1,664 € 1,649 € 1,932Investment rate 84.1% 109.2% ‐15.5%
Growth rate (ROIC x IR) 17.5% 20.0% ‐2.8%
Figure 107: WACC estimates (euro in ‘000s) N‐2 N‐1 N N+1
Equity (adjusted book value) € 4,000 € 4,986 € 5,934 € 7,139
Invested Capital € 8,000 € 9,000 € 10,800 € 10,700
Equity ratio 0.50 0.55 0.55 0.67
Required on equity 24% 23% 23% 20%
Weigted cost of equity 12.1% 12.5% 12.5% 13.3%
Interest‐bearing debt € 4,000 € 4,014 € 4,866 € 3,561
Invested Capital € 8,000 € 9,000 € 10,800 € 10,700
Interest‐bearing debt ratio 0.50 0.45 0.45 0.33
Required return on debt 7.8% 9.1% 9.5% 7.1%
Kd x (1‐t) 5.5% 6.4% 6.6% 5.0%
Weighted cost of debt (after‐taks) 2.7% 2.8% 3.0% 1.7%
Weighted Average Cost of Capital 14.9% 15.4% 15.5% 15.0%
N‐1 N N+1Net Investment € 1,400 € 1,800 ‐€ 300NOPLAT € 1,664 € 1,649 € 1,932
Investment rate 84.1% 109.2% ‐15.5%
N‐1 N N+1Earnngs before Interest and taxex (EBIT) € 2,377 € 2,355 € 2,760‐ Real taks rate x EBIT ‐€ 713 ‐€ 707 ‐€ 828
NOPLAT € 1,664 € 1,649 €1,932
+ Depreciations (and amortizations) + € 400 + €500 + €500‐ Investments (cf. fixed assets) ‐ €1,400 ‐€ 1,000 ‐ € 700
‐ Changes in working capital requirements ‐ € 400 ‐ € 1,300 ‐ (€ ‐500)
FREE CASH FLOW € 264 € ‐152 €2,232
Entity Value= +…+ + .
PRACTICAL EXAMPLE
157
Calculate value of company based on Free Cash Flow
NOPLAT : 308.202,99 196.609,69min gem investering per jaar per hypothese - Average investment per year per hypothese -100.000,00 -100.000,00min toename WCR - min increase WCR -19.119,00afschrijvingen - depreciations 437.163,27
Free cashflow 514.653,96
Waarde volgende de FCF - FCF valuationFCF/wacc 5.088.917,35min rentedragende schulden - interest bearing debts -1.160.024,00
waarde volgens FCF berekening - FCF valuation 3.928.893,35
maar als de waarde lager is dan het EV dan nemen we de waarde van het EV 1.206.195,00Using Capital and Reserves if valuation < Capital and Reserves
Bijgevolg weerhouden we de waarde volgens FCF berekening op 3.928.893,35
CONCLUSIONS
Equity cash flow represents all available cash for company shareholders– We recommend you to be very careful in using equity cash flows for company valuation.
Free cash results from cash flow generated by company business operations after all required reinvestments have been paid for.
Valuation quality largely depends on the quality of associated assumptions. In addition, selected valuation methods differ in terms of reliability regarding value estimates as various assumptions affect estimates in different ways
Work with multiple valuation methods as well as data sets that cover multiple years and include historical averages
158
NET PRESENT VALUEFor a correct understanding of discounted cash flows models, we need to consider the ‘Net Present Value’ Net Present Value (or NPV) = frequently used to determine whether new investments make financial sense or if it is profitable to continue existing projects.Present Value =
159
Net present value = ‐ initial investment
NPV> 0 The project is executed/sustained
NPV = 0 Management is indifferent
NPV < 0 Th project is rejected
Business valuation – Using financial analysis to measurea company’s value P 147 and following
FINANCIAL ANALYSIS AND
COMPANY VALUATIONHistorical data serves as starting points for valuation and should be adjusted to represent future situationsEstimate future NOPLAT and net investments to estimate company valueWCR• Preparations for takeover negotiations pay off by improving bargaining positions
with respect to earnings forecasts
Growth rate• Distinguish between active and passive future ownership for company valuation
and to incorporate relevant data on time, effort and risks for establishing growth rates and weighted average costs of capital
BetaEquity Value Entity Value
160
3-STEP-METHOD
161Business valuation – Using financial analysis to measurea company’s value P 148 and following
NOPLAT AND ROIC
ADJUSTMENTS1. Conduct separate valuations for operational and non‐operational assets
– Remove non‐operational assets from Invested Capital
– Remove any included non‐operational income from EBIT
2. Capitalize amortizations of Research & Development expenses– Include R&D investments in invested capital
3. Capitalize operating leases– Companies that lease assets will be characterized by relatively low operating profits and by artificially high returns on
capital
– Capitalizing operating leases with economic profit valuation
• Operational leases should be capitalized to reflect real profits from operations and to represent all economic debt associated with company operations
– =>Adding debt that is ‘avoided’ by leasing assets to company capital investments
– =>Recalculating rental expenses in terms of interest fees
– By adding present values of economic profit to all invested capital and including all asset value of operating leases, we may arrive at entity values
– Finally, we may calculate equity values by subtracting all financial debt and include added debt that is implied by capitalizing operational leases to invested capital.
162
CONCLUSIONManagerial balance sheets allow for better links between financial company performance and management decisionsThe first step: calculating and monitoring NLFThe second step: calculating company WCRThe third step: what extent NLF covers WCRThe fourth step: monitoring EBIT and EBITDA developmentsThe fifth step: calculating net operating cash flowStep six: calculate if net operating cash flow generates sufficient financial resources to cover maturing debt obligationsStep seven illustrate the use of this information for creating or checking balance sheet forecasts
– Economic profit models : all investments will contribute value to companies, if return on required resources exceeds all associated costs of these resources
– Discounted cash flow methodes: Discounted cash flow methods establish entity or equity values by considering future free cash flow or future equity cash flow. Discount rates are used to calculate present values of future cash flow
163
TAX RATE
164
Historical tax rate of the companyExample:
Result 100 000
Taxes 33,99% 33 990
Tax burden: 33,99%
Result 100 000‐ Tantièmes (loyalties) 90 000Taxable result 10 000
Taxes 33,99% 3 399
Tax burden: 3,399%
When calculating the historical tax rate of the company, make sure you calculate the tax burden before loyalties (tantièmes) are taken into account.
FINANCIAL MODELING
165
TAKING INFLATION INTO ACCOUNT
VOKS = Cash FlowH = inflation rateKr = Cost of equity / WACC%I = taking initial investment into account (because we are calculating a NET present value)
166
Financieel beheer – intersentia p 335
BETA UNLEVERED
Bu = Be(1+(1‐t)(VV/EV))
167
STANDARD DEVIATION
168
SIMPLE EXAMPLE
STANDARD DEVIATIONNumbers : 9,2,5,4,12,7,8,11,9,3,7,4,12,5,4,10,9,6,9,4
169
SIMPLE EXAMPLE
STANDARD DEVIATION
170
SIMPLE EXAMPLE
STANDARD DEVIATIONSum up the (in this example) 20 results
171
SIMPLE EXAMPLE
STANDARD DEVIATION
172
COVARIANCE
A mesure to see the correlation between two independent variablesSimplified formula
173
COVARIANCE
Formula extended for observations that stretch over multiple observations (e.g. years):
Cov (x,y) =
– xi and yi are the observed values of x and y for observation period i– ∑ is the sum over the different observa on periods
174
COVARIANCE
Example
Result = positive: indicates that turnover and EBIT tend to move in the same direction for this company over the observed years
175
N‐3 N‐2 N‐1 NNet sales (turnover) € 7,100 € 8,110 € 8,700 € 9,200EBIT € 1,700 € 2,202 € 2,377 € 2,355
Average valuesNet sales (turnover) € 8,278EBIT € 2,159
N‐3 N‐2 N‐1 N(xi ‐ E[x]): Turnover ‐ average turnover ‐1,178 ‐168 423 923(yi ‐ E[y]: EBIT ‐ average EBIT ‐459 44 219 197
(xi ‐ E[x]) (yi ‐ E[y]) 539,884 ‐7,286 92,316 181,271
∑ (xi ‐ E[x]) (yi ‐ E[y]) 806,185Number of observed periods 4Covariance 201,546
COVARIANCE
The covariance of two variables divided by the product of their standard deviations
176
CORRELATION
177
CORRELATION BETWEEN
TURNOVER AND FCFρ(turnover, FCF) = ,
178
N‐3 N‐2 N‐1 NNet sales (turnover) € 8,110 € 8,700 € 9,200FCF € 641 € 264 ‐€ 152
Average valuesNet sales (turnover) € 8,670FCF € 251
Covariance N‐3 N‐2 N‐1 N(xi ‐ E[x]): Turnover ‐ average turnover ‐560 30 530(yi ‐ E[y]): FCF ‐ average FCF 390 13 ‐ 403
(xi ‐ E[x]) (yi ‐ E[y]) ‐218,549 386 ‐213,661
∑ (xi ‐ E[x]) (yi ‐ E[y]) ‐431,824Number of observed periods 3Covariance ‐143,941
CORRELATION BETWEEN
TURNOVER AND FCFρ(turnover, FCF) = ,
179
Std (turnover) N‐3 N‐2 N‐1 N(xi ‐ E[x]): Turnover ‐ average turnover ‐560 30 530(xi ‐ E[x])² 313,600 900 280,900
∑ (xi ‐ E[x])² 595,400Number of years 3Variance (turnover) 198,467Standard deviation (turnover) € 445
Std FCF N‐3 N‐2 N‐1 N(xi ‐ E[x]): FCF ‐ Average FCF € 390 € 13 ‐€ 403(xi ‐ E[x])² € 152,308 € 166 € 162,516
∑ (xi ‐ E[x])² 314,990Number of years 3Variance (FCF) 104,997Standard Deviation (FCF) € 324
CORRELATION BETWEEN
TURNOVER AND FCFρ(turnover, FCF) = ,
Always make the common sense considerations on made investments and impact on turnover when interpreting the correlation between turnover and free cash flow.
180
Covariance (Turnover ‐ FCF) €² ‐143,941.33Std (Turnover) € 445.50Std (FCF) € 324.03Correlation ‐1.00
CORRELATION BETWEEN
TURNOVER AND ECFρ(turnover, FCF) = ,
181
N‐3 N‐2 N‐1 NNet sales (turnover) € 8,110 € 8,700 € 9,200ECF € 598 € 122 € 907
Average valuesNet sales (turnover) € 8,670ECF € 542
Covariance N‐3 N‐2 N‐1 N(xi ‐ E[x]): Turnover ‐ average turnover ‐560 30 530(yi ‐ E[y]): ECF ‐ average ECF 56 ‐ 420 365
(xi ‐ E[x]) (yi ‐ E[y]) ‐31,173 ‐12,610 193,273
∑ (xi ‐ E[x]) (yi ‐ E[y]) 149,490Number of observed periods 3Covariance 49,830
CORRELATION BETWEEN
TURNOVER AND ECFρ(turnover, FCF) = ,
182
Std (Turnover) N‐3 N‐2 N‐1 NTurnover € 8,110 € 8,700 € 9,200Average turnover € 8,670
(xi ‐ E[x])² 313,600 900 280,900
∑ (xi ‐ E[x])² 595,400Number of years 3Variance (turnover) 198,467Standard deviation (turnover) € 445
Std ECF N‐3 N‐2 N‐1 N(xi ‐ E[x])² 3,099 176,680 132,982
∑ (xi ‐ E[x])² 312,761Number of years 3Variance (ECF) 104,254Standard Deviation (ECF) € 323
CORRELATION BETWEEN
TURNOVER AND ECFρ(turnover, FCF) = ,
The correlation between the turnover and ECF is 0.35. There is as such a weak linear relationship: when turnover increases, equity cash flow increases to a small amount.
However, the main considerations formulated above with the free cash flow (regarding data sample size and considerations about investments) also apply for the ECF. Additionally, the mutations in financial debt play an extra major factor. The increase in ECF in year N is mainly due to additional financial debt.
183
Covariance (Turnover ‐ ECF) € 49,830.00Std (Turnover) € 445.50Std (ECF) € 322.88Correlation 0.35
CORRELATION BETWEEN
TURNOVER AND ECFTurnover vs EBIT most straightforward: less amount of additional considerations– Positive correlation (> 0,5) :
increasing turnover = increasing EBIT– Negative correlation (< 0,5): important trigger to contemplate whether
to increase operational beta in cost of equity calculations or not
Key when making conclusions concerning FCF and ECFLimited data sample: consider the drivers of FCF and ECF before interpreting the correlation
184
CORRELATION BETWEEN
TURNOVER AND ECF
185
PV OF FINITIVE ANNUITY
186
CALCULATING CURRENT VALUE
OF DEBT EXAMPLE€ 1 billion debt€ 60 million interest expenses – maturity of 6 years(6 % Intrest)Current cost of debt is 7,5 % (including intrest coverage ratio=default spread)
187
PV OF FINITIVE
GROWING ANNUITY
188
PV OF INFINITE
GROWING ANNUITY
189
190
EXPECTED RETURN –
VERWACHT RENDEMENTE(Ri) = verwachte rendement voor aandeel iN = het aantal waarnemingen in de steekproefRt = het historische rendement op dag t
191
RISK/VARIANCE OF THE SHARE
Var (Ri) = variance of the share
192
BETA TURNOVER VS
EBIT/FCF/ECFTurnover EBITTurnover FCFTurnover ECF
193Handboek financieel beheer – intersentia p 204
BETA TURNOVER VS
EBIT/FCF/ECFβi = ,
βEBIT = ,
ρ(turnover, EBIT) = ,
194Handboek financieel beheer – intersentia p 204
RELATIONSHIP REAL RATES –
NOMINAL RATESReal = ((1+nominal)/ (1+ inflation))‐1Nominal = ((1+ real) x (1+ inflation))‐1
The relationship between real and nominal rates therefore is not arithmetic. The rates do not just add up as there is a compounding effect. For example, if the real rate is 3% and the inflation rate is 4%, the nominal rate is not 7% (3% + 4%) but 7.12%.
195Handboek financieel beheer – intersentia p 204
THREE STAGE GROWTH MODEL
196
THREE STAGE GROWTH MODEL
197
SUSTAINABLE GROWTH
Gs = sustainable growth rate= Bs X ROEs (return on equity)
Bs= plowback ratioBs= (Annual earnings – annual dividends)
annual earnings
198
EXERCISE 1: STANDARD
DEVIATION AND CORRELATION
199Handboek financieel beheer – intersentia p 204
Turnover EBIT
2005 85.000,00 EUR 40.000,00 EUR
2006 36.000,00 EUR 20.000,00 EUR
2007 120.000,00 EUR 85.000,00 EUR
2008 90.000,00 EUR 75.000,00 EUR
2009 100.000,00 EUR 80.000,00 EUR
2010 130.000,00 EUR 90.000,00 EUR
STANDARD DEVIATION
SOLUTION (turnover)Mean = ( 85.000,00 EUR + 36.000,00 EUR + 120.000,00 EUR + 90.000,00 EUR + 100.000,00 EUR + 130.000,00 EUR) =
561.000,00 EUR / 6 = 93.500,00 EUR
200
STANDARD DEVIATION
SOLUTION (TURNOVER)
201
STANDARD DEVIATION
SOLUTION (TURNOVER)Variance = (1/6) x 5.467.500.000,00 =
911.250.000,00
Standard deviation =square root of 911.250.000,00 EUR=30.186,92 EUR
202Handboek financieel beheer – intersentia p 204
CORRELATION SOLUTION
– PART 1
203
CORRELATION SOLUTION
– PART 2
204
CORRELATION SOLUTION
– PART 34305000000
Vierkantswortel(5467500000x 4000000000)
Correlation = 0,920552929
205
BETA EBIT
Beta EBIT = COV ( EBIT, TUROVER)VARIANCE ( TURNOVER)
COV = SUM(( EBIT –Mean EBIT)x( TURNOVER‐MeanTURNOVER))n‐1
VAR = SUM (TUROVER – MEAN TURNOVER)²n‐1
206
BETA EBIT
COV
207
Cov = 4.305.000.000,005
=861.000.000,00 EUR
BETA EBIT
Variance of turnover=
= 5.467.500.000,005
= 1.093.500.000,00
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BETA EBIT
BETA EBIT = 861.000.000,00 = 0,7873799..1.093.500.000,00
If the turnover increases by 1 EUR, EBIT will increase by0,7873799… EUR
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EXERCISE 2 – STANDARD
DEVIATION AND CORRELATION
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Turnover EBIT
2005 1.000.000,00 EUR 20.000,00 EUR
2006 36.000,00 EUR 1.000,00 EUR
2007 250.000,00 EUR 50.000,00 EUR
2008 90.000,00 EUR 30.000,00 EUR
2009 100.000,00 EUR 80.000,00 EUR
2010 300.000,00 EUR 80.000,00 EUR
STANDARD DEVIATION
SOLUTION (EBIT)Mean = (20.000,00 EUR + 1.000,00 EUR + 50.000,00 EUR + 30.000,00 EUR + 80.000,00 EUR + 80.000,00 EUR)
= 261.000,00 EUR / 6 = 43.500,00 EUR
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STANDARD DEVIATION
SOLUTION (EBIT)
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STANDARD DEVIATION
SOLUTION (EBIT)Variance = (1/6) X 5.247.500.000,00
= 874.583.333,33
Standard Deviation = Square root of 874.583.333,33 EUR=29.573,36 EUR
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CORRELATION SOLUTION –
PART 1
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CORRELATION SOLUTION –
PART 2
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CORRELATION SOLUTION –
PART 3‐10020000000
Vierkantswortel(646200000000 x 5247500000)
=‐0,172071134
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ESTIMATING COST OF DEBT
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ESTIMATING COST OF DEBT
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ESTIMATING COST OF DEBT
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ESTIMATING COST OF DEBT
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GECUMULEERDE
ACTUALISATIEFACTOR
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CORRELATION SOLUTION –
PART 3€ 1 billion debt€ 60 million interest expenses – maturity of 6 years (6 % Intrest)Current cost of debt is 7,5 % (including intrest coverage ratio=default spread)
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THE END
THANK YOU FOR YOUR ATTENTION!
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ISBN 978-1-78068-016-3
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