What three aspects of cash flows affect an investment’s value?
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What three aspects of cash What three aspects of cash flows affect an flows affect an investment’s value? investment’s value? Amount Amount of expected cash flows of expected cash flows (bigger is better) (bigger is better) Timing Timing of the cash flow stream of the cash flow stream (sooner is better) (sooner is better) Risk Risk of the cash flows (less of the cash flows (less risk is better) risk is better)
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What three aspects of cash flows affect an investment’s value?. Amount of expected cash flows (bigger is better) Timing of the cash flow stream (sooner is better) Risk of the cash flows (less risk is better). Free Cash Flows (FCF). Free cash flows are the cash flows that are: - PowerPoint PPT Presentation
Transcript of What three aspects of cash flows affect an investment’s value?
What three aspects of cash What three aspects of cash flows affect an investment’s flows affect an investment’s
value?value? Amount Amount of expected cash flows of expected cash flows
(bigger is better)(bigger is better) TimingTiming of the cash flow stream of the cash flow stream
(sooner is better)(sooner is better) RiskRisk of the cash flows (less risk is of the cash flows (less risk is
better)better)
Free Cash Flows (FCF)Free Cash Flows (FCF)
Free cash flows are the cash flows Free cash flows are the cash flows that are:that are:– Available (or free) for distributionAvailable (or free) for distribution– To all investors (stockholders and To all investors (stockholders and
creditors)creditors)– After paying current expenses, taxes, After paying current expenses, taxes,
and making the investments necessary and making the investments necessary for growth.for growth.
Determinants of Free Cash Determinants of Free Cash FlowsFlows
Sales revenuesSales revenues– Current levelCurrent level– Short-term growth rate in salesShort-term growth rate in sales– Long-term sustainable growth rate in Long-term sustainable growth rate in
salessales Operating costs (raw materials, Operating costs (raw materials,
labor, etc.) and taxeslabor, etc.) and taxes Required investments in operations Required investments in operations
(buildings, machines, inventory, etc.)(buildings, machines, inventory, etc.)
What is free cash flow What is free cash flow (FCF)? (FCF)?
Why is it important?Why is it important? FCF is the amount of cash available FCF is the amount of cash available
from operations for distribution to all from operations for distribution to all investors (including stockholders and investors (including stockholders and debtholders) after making the debtholders) after making the necessary investments to support necessary investments to support operations.operations.
A company’s value depends upon the A company’s value depends upon the amount of FCF it can generate.amount of FCF it can generate.
What are the five uses of What are the five uses of FCF?FCF?
1. Pay interest on debt.1. Pay interest on debt.
2. Pay back principal on debt.2. Pay back principal on debt.
3. Pay dividends.3. Pay dividends.
4. Buy back stock.4. Buy back stock.
5. Buy nonoperating assets (e.g., 5. Buy nonoperating assets (e.g., marketable securities, investments marketable securities, investments in other companies, etc.)in other companies, etc.)
What are operating current What are operating current assets?assets?
Operating current assets are the CA Operating current assets are the CA needed to support operations.needed to support operations.– Op CA include: cash, inventory, receivables.Op CA include: cash, inventory, receivables.– Op CA exclude: short-term investments, Op CA exclude: short-term investments,
because these are not a part of operations.because these are not a part of operations.
What are operating current What are operating current liabilities?liabilities?
Operating current liabilities are the CL Operating current liabilities are the CL resulting as a normal part of operations.resulting as a normal part of operations.– Op CL include: accounts payable and Op CL include: accounts payable and
accruals.accruals.– Op CL exclude: notes payable, because this Op CL exclude: notes payable, because this
is a source of financing, not a part of is a source of financing, not a part of operations.operations.
Net Operating Working Net Operating Working Capital (NOWC)Capital (NOWC)
NOWCNOWC0505 = ($7,282 + $632,160 + $1,287,360)= ($7,282 + $632,160 + $1,287,360)
- ($324,000 + $284,960)- ($324,000 + $284,960)
= $1,317,842.= $1,317,842.
NOWCNOWC0404 = $793,800.= $793,800.
= -Operating
CAOperating
CLNOWC
Total net operating capital Total net operating capital (also called operating (also called operating
capital)capital) Operating Capital= NOWC +Operating Capital= NOWC + Net fixed Net fixed
assets.assets. Operating Capital 2005 = $1,317,842 Operating Capital 2005 = $1,317,842
+ $939,790 = $2,257,632.+ $939,790 = $2,257,632. Operating Capital 2004 = $1,138,600.Operating Capital 2004 = $1,138,600.
Net Operating Profit after Net Operating Profit after Taxes (NOPAT)Taxes (NOPAT)
NOPAT = EBIT(1 - Tax rate)NOPAT = EBIT(1 - Tax rate)
NOPATNOPAT0505 = $17,440(1 - 0.4)= $17,440(1 - 0.4)
= $10,464.= $10,464.
NOPATNOPAT0404 = $125,460.= $125,460.
Free Cash Flow (FCF) for Free Cash Flow (FCF) for 20052005
FCF = NOPAT - Net investment inFCF = NOPAT - Net investment in
operating capitaloperating capital
= $10,464 - ($2,257,632 - = $10,464 - ($2,257,632 - $1,138,600)$1,138,600)
= $10,464 - $1,119,032= $10,464 - $1,119,032
= -$1,108,568.= -$1,108,568.
How do you suppose investors reacted?How do you suppose investors reacted?
What is the weighted What is the weighted average cost of capital average cost of capital
(WACC)? (WACC)? The weighted average cost of capital The weighted average cost of capital
(WACC) is the average rate of return (WACC) is the average rate of return required by all of the company’s required by all of the company’s investors (stockholders and creditors)investors (stockholders and creditors)
What factors affect the What factors affect the weighted average cost of weighted average cost of
capital?capital? Capital structure (the firm’s relative Capital structure (the firm’s relative
amounts of debt and equity)amounts of debt and equity) Interest ratesInterest rates Risk of the firmRisk of the firm Stock market investors’ overall Stock market investors’ overall
attitude toward risk attitude toward risk
What determines a firm’s What determines a firm’s value?value?
A firm’s value is the sum of all the A firm’s value is the sum of all the future expected free cash flows future expected free cash flows when converted into today’s dollars:when converted into today’s dollars:
Value =
FCF1 FCF2 FCF∞
(1 + WACC)1
(1 + WACC)∞
(1 + WACC)2
+ +…
What are financial assets?What are financial assets?
A financial asset is a contract that entitles A financial asset is a contract that entitles the owner to some type of payoff.the owner to some type of payoff.– DebtDebt– EquityEquity– DerivativesDerivatives
In general, each financial asset involves In general, each financial asset involves two parties, a provider of cash (i.e., two parties, a provider of cash (i.e., capital) and a user of cash.capital) and a user of cash.
