Present Value: Net Income: Calculating Free Cash Flow from Financial Statements To reconcile cash: change in cash

Calculating Free Cash Flow from Financial Statements To reconcile cash: change in cash = FCF- Financial Cash Flow
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• Perpetuity = # = (Sales-cogs-SG&A-Interest expense)(1-T) Effective Tax Rate= Taxes on profit for the year/ profit before taxes Financial Cash Flow:
$ !"
• Growing Perpetuity = # Free Cash Flow: = income taxes/income before taxes • After tax net interest expense (outflow if positive)
$%&
!"# + FCF Direct: FCF: • Dividend (outflow)
• Annuity = 1− 1+r
$
!" ,-& + • Sales • Operating income (EBIT) • ∆ in non-operating assets (outflow if positive)
• Growing Annuity= # 1− • -cogs • x (1-T) • ∆ in non-operating liabilities (outflow if negative)
$%& ,-$
Value: • -depreciation • =NOPAT • ∆ in ST investments (outflow if positive)
• Enterprise Value = equity + debt – excess cash • -∆ in net fixed assets • ∆ in ST debt (outflow if negative)
• =EBIT
.+/.$0$12. 3456.-.78.22 8429 %:.;/ • NFA = GFA – Accumulated Depreciation • = change in portion of LT debt + change in notes payable
• Stock Price= • (1-T)
# => 294$.2 • -∆ in NWC • ∆ in LT debt (outflow if negative)
• Or equity value/# of shares • =NOPAT • ∆ in prepaid equity capital (outflow if negative)
Liquidation or salvage value of fixed assets: (in capex of FCF)
• Firm Value= enterprise value + excess cash • +depreciation • Capital Gain= sale price- book value • = change in shareholders equity - retained earnings in this period
Terminal Value: • -capex • Book Value = Purchase price- accumulated depreciation • Retained earnings = previous retained earnings + NI- dividends
"!"mn# Cost:
• cdNKef@g h@gid(TV+) = • - ∆ in NWC • After tax cash flow from asset sale = sale price – (T*capital gain) C D
(o488%&pqp ) • ?@AA = r + r 1−t
Net Working Capital: C-D C C-D D D
• PO = βA + (βA − βD)
• FG = FH + IG(FK%FL ) E
Multiples: NWC= current assets (less cash and ST investments) - current liabilities • Fixed/constant debt to capital ratio
• Assets with similar characteristics should have similar • FM = FH + IM(FK%FL ) D
(less debt and notes payable) • Unlevered beta • PO = βA + (βA − βD)(1-t)
multiples E
• Multiples can be compared across assets = cash + inventory + receivables – payables • NO = NL + PQ (NK%NL ) • Fixed dollar amount of debt
• value422./2 = average(
3456. qyz{|}|~Ä
)×characteristic422./ Current Assets: Current liabilities: • Levered beta • Permanent debt
894$48/.$121/8 qyz{|}|~Ä
• Accounts receivable • accounts payable, notes payable Tax shield = tax* NWC • rR = expected return on the equity market • If capital structure changes:
• Value= enterprise value expense in final year Measures 2 sources of risk: • Solve the asset beta implied by original structure
• characteristic = EBITDA • Inventory • accrued expenses
• accrued income taxes • Use when NWC is not • Business risk measured by asset cost of • Use asset beta to find new levered equity beta
• Trailing PE • Prepaid expenses • Cost of debt:
fully recovered capital/asset beta (unlevered beta)
• b=
ÉÑÖÑÉÜáÉ • Other current assets • unearned revenue • Financial risk arises from the firm’s capital • Rd of similar firms in the industry
Oàâä • dividend payable • Interest rate for bond
àä structure
• Market based Trailing PE Ratio=
Oàâä • To determine overvaluation: •
D
NO = rb + C rb − rD • Interest expense/debt outstanding
,-& ∗;
• Fundamental based Trailing PE ratio= • PEG ratio = ratio of PE scaled by expected • Without corporate taxes D
$å%& E
growth in EPS ¶dß@ ®L ß©d dfßdN™Ne´d ef ™dNLdAß K@N¨dß´: ¶Æ = B + B
ç- ç%é ∗èêO ∗é E+D E E+D D
•
NO% ç%é ∗èêO
= ëC Cash Conversion Cycle • Net debt= debt – excess cash. If net debt is less than 0, Bd is assumed to be 0
• PEG = = DI + DSO + DPO
• If market based PE ratio is lower than íìîíïñíó òôöõñú íùôûüûò† ∗, • For an all equity firm: βA= βE
fundamental based PE ratio, the firm is • Undervalued If PEG <1 • DI= inventory/average daily cogs To calculate new WACC with more debt and a new debt to value ratio:
undervalued • Overvalued if PEG >1 • DSO= accounts receivable/average • Calculate old debt beta
• Forward PE= • 4 types of multiples: daily sales revenue • Use old debt to solve for old asset beta using old capital structure
àä • Use calculated asset beta to solve for new levered equity beta given new capital
• Market Based Forward PE Ratio= 1. Liquidity- ability to meet ST obligations • DPO= accounts payable/average daily
Oàâç
2. Leverage- ability to meet LT obligations structure
• Fundamental Based Forward PE Ratio
; cogs
$å%& 3. Asset Use- intensity and efficiency of asset usage • Recalculate a new cost of debt and equity
é 4. Profitability- ability to control expenses and revenues
Pro Formas: • Solve for the wacc using new cost of debt, equity and capital structure
•
NO% ç%é ∗èêO Simplified assumptions for valuation: To calculate equity cost of capital from a comparable company’s info:
Firms who's earnings are expected to grow
• • Sales growth rate (forecast) • Calculate comp company’s asset beta
faster will have higher PE’s
Degree of Operating Leverage: degree to which a % change in • Growth of operating costs (forecast or percent sales) • Reveler comparable company’s asset beta with the D/V ratio of your firm
• Riskier firms with higher leverage will have units of sales (Q) leads to a $ change in OCF • (calculate equity beta)
lower PE’s • OR growth of operating margin (forecast)
"! • Use equity beta CAPM formula to solve for equity cost of capital
• Firms with a higher payout will have higher • DOL= 1 + °!" • Working capital growth (turnover or % sales)
NPV
PE’s • % change in OCF = DOL x % change in Q • Growth of fixed assets forecast or % of sales) • Only take projects with positive NPV’s
• Company’s with high PE’s (higher than industry peers) are either: • Depreciation growth (forecast or % of assets) • If project size doubles, NPV doubles
• Overvalued Sales = industry size x market share x price per unit
IRR
• Only take projects with an IRR greater than the discount rate
• Earnings are expected to grow at a faster rate
• Company is less risky/lower Re
To Project Working Capital: • IRR is most important alternative to NPV
• If NPV is positive or all values of the discount rate, the IRR rule cannot be used
0$=¢.8/.: 245.2
• Company has a higher dividend payout ratio • Projected accounts receivable=day sales outstanding * :4£2 1+ 4 £.4$
• Can’t be used to compare projects of different scales
Simples approach: • Unreliable for nonconventional cash flows and mutually exclusive projects
0$=¢.8/.: !°§• • The IRR rule is only guaranteed to work for a standalone project if all of the project’s negative
• Firms with PE ratios less than their expected growth rate are • Projected Inventory= days in inventory *
:4£2 1+ 4 £.4$ cash flows precede its positive cash flows. If not, the IRR rule can lead to incorrect decisions.
undervalued 0$=¢.8/.: !°§• Payback Period:
• Projected Accounts Payable= days payable outstanding * • Only take projects that repay initial investment in less than set # of years
:4£2 1+ 4 £.4$ • Ignores time value of money, Biased against long-term projects
 Equity Beta Example enterprise calculation with multiple growing annuity’s Calculating wacc from a comparable company :
• UVU1 = $752 ∗ 1 + 20% = $902.40 Step 1: Calculate comparable company’s Bd and Ba
• Problems with Beta: can be backwards looking,
…. • 12=13 + 45 !,6/
reflect historic leverage, imprecise • UVU4 = $752 ∗ 1 + 20% 3 ∗ 1 + 10% 1 = $1429.4 • 7% = 2% + 42 ∗ 6% à Bd = 0.08333
• All else equal …. •
2
= 20% −→
2
=
20%
= 25%
2+! ! 80%
• The more discretionary the product, the • UVU8 = $752 ∗ 1 + 20% 3 ∗ 1 + 10% 5 = $2092.79 With permanent debt:
higher the beta FCF in years 1-3 are a 3-year growing annuity with a 20% growth rate, those in 4-8 are a 5-year growing •
2
4!=4? + (4? - 42 ) 1 − @
!
• The higher the proportion of costs are annuity with a 10% growth rate. • 1.25= AB+(25%)(AB-.08333)(1-.4) à AB= 1.1957
fixed, the higher the beta The terminal value in year 8 (using 9.4479 as a multiple) is: Step 2: Calculate new company’s Bd and Be:
]
• The greater the proportion of debt, the • +[\ = UVU\ ∗ = 2092.79 ∗ 9.4479 = $19,722.37 • E= $40* 10,000 shares = $400,000
]^._\``% • D= $200,000*95% = $190,000
higher the beta Enterprise Value=
YTM can be used for debt with low probability of bankruptcy. • 12 = 13 + 45 ∗ !,6/
b^c.`^ ]ec^% f $]`cb.`^ ]e]^% _ ] ]bhcc.fh
• ∗ 1− + ∗ 1− ∗ + = $17,588.98 • 6.5% = 2% + 45 ∗6% à Bd = .75
When probability of bankruptcy is high, account for probability of (b.c_dc^%) ]eb.c_% b.c_%d]^% ]eb.c_% ]eb.c_% g ]eb.c_% i
Use Bd to solve for Be
default: E
• AD = AB + AB − AE
!(#$) = 1 − ) *+, + ) *+, − . = *+, − / ∗ . D
FHIIII
p= probability of bond default • F. G + F. FHKL−. LK à Be= 1.4073
JIIIII
L= expected loss per $1 of debt in default Step 4: use Be to solve for re:
Example: • 1!=13 + 4! !,6/ = 2% +1.4073*6% à re= 10.44%
• No default: $1 à $(1+YTM) = $1.14 Step 3: calculate the wacc:
D E
• Default: $1 à $1 x 60% = $0.60 • MNOO = E+D ∗ PD + E+D ∗ PE F − Q
JIIIII FHIIII
• The expected loss in default (L) = $1.14-$0.60 = $0.54 • ∗ FI. JJ% + ∗ R. KK% ∗ F−. J = S. TJ%
KHIIII KHIIII
• That is 54% loss on $1 investment in this bond
• Thus the cost of debt is: Calculating FCF from financial statements:
• !(#$) = 1 − ) + / *+, − .
• = (1-4%) *14% + 4%*(14%-54%) = 11.84%
• Note that YTM-L = recovery rate -1 = 60% -1 = -40% IDX technologies is a privately held developer. Estimate the value of IDX
Free Cash Flow: per share using a discounted FCF approach and the following data:
• Debt: $22 Million
• Excess Cash: $114 million
• Shares Outstanding: 50 million
• Expected FCF in 2014: $48 Million
• Expected FCF in 2015: $54 million
• Future FCF growth rate beyond 2015: 6%
• Weighted average cost of capital: 9.4%

What is the enterprise value at the end of 2014?

Example: Calculating Incremental Earnings:

Incremental earnings this year = (profit mini mochi

munch + profit of other products – advertising
expenses)(1-tax rate) = ($8.1million*33% + $1.5 million
*22% - $6.1million)*(1-35%) = -$2,013,050

Incremental earnings next year =(profit mini mochi

munch + profit of other products – advertising
expenses)(1-tax rate) = ($6.1million*33% + $1.5
What is the enterprise value at the end of 2013?
million*22%)*(1-35%) = $1,522,950