Valuation: Lecture Note Packet 1 Intrinsic...
Transcript of Valuation: Lecture Note Packet 1 Intrinsic...
![Page 1: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/1.jpg)
Valuation: Lecture Note Packet 1Intrinsic Valuation
AswathDamodaranUpdated:September2016
Aswath Damodaran 1
![Page 2: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/2.jpg)
2
Theessenceofintrinsicvalue
¨ Inintrinsicvaluation,youvalueanassetbaseduponitsfundamentals(orintrinsiccharacteristics).
¨ Forcashflowgeneratingassets,theintrinsicvaluewillbeafunctionofthemagnitudeoftheexpectedcashflowsontheassetoveritslifetimeandtheuncertaintyaboutreceivingthosecashflows.
¨ Discountedcashflowvaluationisatoolforestimatingintrinsicvalue,wheretheexpectedvalueofanassetiswrittenasthepresentvalueoftheexpectedcashflowsontheasset,witheitherthecashflowsorthediscountrateadjustedtoreflecttherisk.
Aswath Damodaran
2
![Page 3: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/3.jpg)
3
Thetwofacesofdiscountedcashflowvaluation
¨ Thevalueofariskyassetcanbeestimatedbydiscountingtheexpectedcashflowsontheassetoveritslifeatarisk-adjusteddiscountrate:
wheretheassethasann-yearlife,E(CFt)istheexpectedcashflowinperiodtandrisadiscountratethatreflectstheriskofthecashflows.
¨ Alternatively,wecanreplacetheexpectedcashflowswiththeguaranteedcashflowswewouldhaveacceptedasanalternative(certaintyequivalents)anddiscounttheseattheriskfree rate:
whereCE(CFt)isthecertaintyequivalentofE(CFt)andrf istheriskfree rate.
Aswath Damodaran
3
![Page 4: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/4.jpg)
4
RiskAdjustedValue:TwoBasicPropositions
¨ Thevalueofanassetistherisk-adjustedpresentvalueofthecashflows:
1. The“IT”proposition: IfITdoesnotaffecttheexpectedcashflowsortheriskinessofthecashflows,ITcannotaffectvalue.
2. The“DUH”proposition:Foranassettohavevalue,theexpectedcashflowshavetobepositivesometimeoverthelifeoftheasset.
3. The“DON’TFREAKOUT” proposition:Assetsthatgeneratecashflowsearlyintheirlifewillbeworthmorethanassetsthatgeneratecashflowslater;thelattermayhoweverhavegreatergrowthandhighercashflowstocompensate.
Aswath Damodaran
4
![Page 5: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/5.jpg)
5
DCFChoices:EquityValuationversusFirmValuation
Assets Liabilities
Assets in Place Debt
Equity
Fixed Claim on cash flowsLittle or No role in managementFixed MaturityTax Deductible
Residual Claim on cash flowsSignificant Role in managementPerpetual Lives
Growth Assets
Existing InvestmentsGenerate cashflows todayIncludes long lived (fixed) and
short-lived(working capital) assets
Expected Value that will be created by future investments
Equity valuation: Value just the equity claim in the business
Firm Valuation: Value the entire business
Aswath Damodaran
5
![Page 6: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/6.jpg)
6
EquityValuation
Assets Liabilities
Assets in Place Debt
EquityDiscount rate reflects only the cost of raising equity financingGrowth Assets
Figure 5.5: Equity Valuation
Cash flows considered are cashflows from assets, after debt payments and after making reinvestments needed for future growth
Present value is value of just the equity claims on the firm
Aswath Damodaran
6
![Page 7: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/7.jpg)
7
FirmValuation
Assets Liabilities
Assets in Place Debt
Equity
Discount rate reflects the cost of raising both debt and equity financing, in proportion to their use
Growth Assets
Figure 5.6: Firm Valuation
Cash flows considered are cashflows from assets, prior to any debt paymentsbut after firm has reinvested to create growth assets
Present value is value of the entire firm, and reflects the value of all claims on the firm.
Aswath Damodaran
7
![Page 8: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/8.jpg)
8
FirmValueandEquityValue
¨ Togetfromfirmvaluetoequityvalue,whichofthefollowingwouldyouneedtodo?
a. Subtractoutthevalueoflongtermdebtb. Subtractoutthevalueofalldebtc. Subtractthevalueofanydebtthatwasincludedinthecostof
capitalcalculationd. Subtractoutthevalueofallliabilitiesinthefirm¨ Doingso,willgiveyouavaluefortheequitywhichisa. greaterthanthevalueyouwouldhavegotinanequityvaluationb. lesserthanthevalueyouwouldhavegotinanequityvaluationc. equaltothevalueyouwouldhavegotinanequityvaluation
Aswath Damodaran
8
![Page 9: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/9.jpg)
9
CashFlowsandDiscountRates
¨ Assumethatyouareanalyzingacompanywiththefollowingcashflows forthenextfiveyears.Year CFtoEquity InterestExp (1-taxrate) CFtoFirm1 $50 $40 $902 $60 $40 $1003 $68 $40 $1084 $76.2 $40 $116.25 $83.49 $40 $123.49TerminalValue $1603.0 $2363.008
¨ Assumealsothatthecostofequityis13.625%andthefirmcanborrowlongtermat10%.(Thetaxrateforthefirmis50%.)
¨ Thecurrentmarketvalueofequityis$1,073andthevalueofdebtoutstandingis$800.
Aswath Damodaran
9
![Page 10: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/10.jpg)
10
EquityversusFirmValuation
¨ Method1:DiscountCFtoEquityatCostofEquitytogetvalueofequity¤ CostofEquity=13.625%¤ ValueofEquity=50/1.13625+60/1.136252 +68/1.136253 +
76.2/1.136254 +(83.49+1603)/1.136255 =$1073¨ Method2:DiscountCFtoFirmatCostofCapitaltogetvalue
offirm¤ CostofDebt=Pre-taxrate(1- taxrate)=10%(1-.5)=5%CostofCapital=13.625%(1073/1873)+5%(800/1873)=9.94%¤ PVofFirm=90/1.0994+100/1.09942 +108/1.09943 +116.2/1.09944 +
(123.49+2363)/1.09945 =$1873¤ ValueofEquity=ValueofFirm- MarketValueofDebt
=$1873- $800=$1073
Aswath Damodaran
10
![Page 11: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/11.jpg)
11
FirstPrincipleofValuation
¨ DiscountingConsistencyPrinciple:Nevermixandmatchcashflowsanddiscountrates.
¨ Mismatchingcashflowstodiscountratesisdeadly.¤ Discountingcashflowsafterdebtcashflows(equitycashflows)attheweightedaveragecostofcapitalwillleadtoanupwardlybiasedestimateofthevalueofequity
¤ Discountingpre-debtcashflows(cashflowstothefirm)atthecostofequitywillyieldadownwardbiasedestimateofthevalueofthefirm.
Aswath Damodaran
11
![Page 12: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/12.jpg)
12
TheEffectsofMismatchingCashFlowsandDiscountRates
¨ Error1:DiscountCFtoEquityatCostofCapitaltogetequityvalue¤ PVofEquity=50/1.0994+60/1.09942 +68/1.09943+76.2/1.09944 +
(83.49+1603)/1.09945 =$1248¤ Valueofequityisoverstatedby$175.
¨ Error2:DiscountCFtoFirmatCostofEquitytogetfirmvalue¤ PVofFirm=90/1.13625+100/1.136252 +108/1.136253 +
116.2/1.136254 +(123.49+2363)/1.136255 =$1613¤ PVofEquity=$1612.86- $800=$813¤ ValueofEquityisunderstatedby$260.
¨ Error3:DiscountCFtoFirmatCostofEquity,forgettosubtractoutdebt,andgettoohighavalueforequity¤ ValueofEquity=$1613¤ ValueofEquityisoverstatedby$540
Aswath Damodaran
12
![Page 13: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/13.jpg)
DISCOUNTEDCASHFLOWVALUATION:THEINPUTS
Thedevilisinthedetails..
Aswath Damodaran 13
![Page 14: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/14.jpg)
14
DiscountedCashFlowValuation:TheSteps
1. Estimatethediscountrateorratestouseinthevaluation1. Discountratecanbeeitheracostofequity(ifdoingequityvaluation)oracostof
capital(ifvaluingthefirm)2. Discountratecanbeinnominaltermsorrealterms,dependinguponwhether
thecashflowsarenominalorreal3. Discountratecanvaryacrosstime.
2. Estimatethecurrentearningsandcashflowsontheasset,toeitherequityinvestors(CFtoEquity)ortoallclaimholders(CFtoFirm)
3. Estimatethefutureearningsandcashflowsonthefirmbeingvalued,generallybyestimatinganexpectedgrowthrateinearnings.
4. Estimatewhenthefirmwillreach“stablegrowth” andwhatcharacteristics(risk&cashflow)itwillhavewhenitdoes.
5. ChoosetherightDCFmodelforthisassetandvalueit.
Aswath Damodaran
14
![Page 15: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/15.jpg)
15
GenericDCFValuationModel
Cash flowsFirm: Pre-debt cash flowEquity: After debt cash flows
Expected GrowthFirm: Growth in Operating EarningsEquity: Growth in Net Income/EPS
CF1 CF2 CF3 CF4 CF5
Forever
Firm is in stable growth:Grows at constant rateforever
Terminal ValueCFn.........
Discount RateFirm:Cost of Capital
Equity: Cost of Equity
ValueFirm: Value of Firm
Equity: Value of Equity
DISCOUNTED CASHFLOW VALUATION
Length of Period of High Growth
Aswath Damodaran
15
![Page 16: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/16.jpg)
16
Sameingredients,differentapproaches…
Input DividendDiscountModel
FCFE (Potentialdividend)discountmodel
FCFF (firm)valuationmodel
Cashflow Dividend Potential dividends=FCFE=Cashflowsaftertaxes,reinvestmentneedsanddebtcashflows
FCFF=Cash flowsbeforedebtpaymentsbutafterreinvestmentneedsandtaxes.
Expected growth Inequityincomeanddividends
InequityincomeandFCFE
InoperatingincomeandFCFF
Discountrate Costofequity Costofequity Costofcapital
Steadystate Whendividendsgrowatconstantrateforever
When FCFEgrowatconstantrateforever
WhenFCFFgrowatconstant rateforever
Aswath Damodaran
16
![Page 17: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/17.jpg)
17
Starteasy:TheDividendDiscountModel
Net Income* Payout ratio= Dividends
Cost of Equity
Expected dividends = Expected net income * (1- Retention ratio)
Length of high growth period: PV of dividends during high growth Stable Growth
When net income and dividends grow at constant rate forever.
Value of equity
Rate of return demanded by equity investors
Expected growth in net income
Retention ratio needed to sustain growth
Aswath Damodaran
17
![Page 18: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/18.jpg)
18
Movingonup:The“potentialdividends”orFCFEmodel
Free Cashflow to EquityNon-cash Net Income- (Cap Ex - Depreciation)- Change in non-cash WC- (Debt repaid - Debt issued)= Free Cashflow to equity
Cost of equity
Expected FCFE = Expected net income * (1- Equity Reinvestment rate)
Length of high growth period: PV of FCFE during high growth Stable Growth
When net income and FCFE grow at constant rate forever.
Value of Equity in non-cash Assets+ Cash = Value of equity
Rate of return demanded by equity investors
Expected growth in net income
Equity reinvestment needed to sustain growth
Aswath Damodaran
18
![Page 19: Valuation: Lecture Note Packet 1 Intrinsic Valuationpeople.stern.nyu.edu/adamodar/pdfiles/eqnotes/basics.pdf · Valuation: Lecture Note Packet 1 Intrinsic Valuation Aswath Damodaran](https://reader035.fdocuments.us/reader035/viewer/2022062413/5a705ace7f8b9ac0538be7ae/html5/thumbnails/19.jpg)
19
Tovaluingtheentirebusiness:TheFCFFmodel
Aswath Damodaran
19
Free Cashflow to FirmAfter-tax Operating Income- (Cap Ex - Depreciation)- Change in non-cash WC= Free Cashflow to firm
Cost of capital
Expected FCFF= Expected operating income * (1- Reinvestment rate)
Length of high growth period: PV of FCFF during high growth Stable Growth
When operating income and FCFF grow at constant rate forever.
Value of Operatng Assets+ Cash & non-operating assets- Debt= Value of equity
Weighted average of costs of equity and debt
Expected growth in operating ncome
Reinvestment needed to sustain growth