DCF Evaluation

In discounted cash flow (DCF) valuation, the value of an asset is the present value of expected future cash flows on the asset, discounted back at the rate that reflects the riskiness of these cash flows. There are 3 important variables that are required to value an asset
y Discount rate y Expected Cash Flow y Timing of Cash Flow

WACC

WACC

Return on Equity

Cost of Debt

Beta equity

Risk Premium

=rd*(1-tc)

Cost of Equity
Beta Estimation

ITC has four major businesses and the beta was calculated by taking the industry betas for each of the different business. The following steps have been taken for Beta estimation.
i. Cigarette Business In the cigarette business ITC is the largest player in this sector and no other industry can be compared to ITC. Hence for the estimation of Beta we have taken the Beta Equity of ITC itself. The D/E ratio of ITC has been taken and unlevered to calculate the Beta Asset. The Beta Asset was calculated to be .74 approximately. The formula used for Beta Asset calculation is given below: asset= equity/{1+D/E(1-Tc)} Personal Healthcare In the personal healthcare business, we have compared ITC with Emami, Marico and Godrej Consumers. The Beta equities have been unlevered taking the D/E ratios of respective companies. The average Beta asset has been calculated by taking the weighted average of the

ii.

individual Beta assets. The weights have been calculated by taking the sales ratios of the companies. The average Beta asset is .313 iii. Paper In the paper business, JK Paper, Ballarpur, West Coast Paper and Sirpur Paper have been used. The method used is similar to the one described in the Personal Healthcare business. The Beta asset so calculated is equal to .508 iv. Lifestyle Retail In the Lifestyle business, Pantaloon, Shoppers Stop and Provogue have been used as comparables. The Beta equities have been unlevered and beta asset is calculated. The weighted average beta asset is .811.

Once the Beta assets have been calculated for each of the businesses, they are re-levered to calculate the Beta equity. The weighted average of individual beta assets is calculated. The weights are the individual revenues of each of the sectors of ITC. The weighted average asset=.62 The Debt-Equity ratio of ITC is 0.01. We have used the market values of equity to calculate the debt equity ratio. The beta equity is calculated in the following way equity = asset*{1+D/E(1-Tc)} equity =.63
Risk Free Rate

The risk free rate is taken as the India s 10 year Government Bond yield. The 10-year bond has been selected as it is the most liquid bond in India and has averaged 7.91% in the past. We have taken the current yield as the risk free rate. Thus Rf = 8.4%
Risk Premium

In order to calculate the Risk premium first we have calculated the market return. The weekly data of BSE sensex has been taken to calculate the weekly returns of sensex for the past 10 years. The data has been taken from 1st January 2001 till the current date. We have calculated the geometric mean returns for the past 10 years. The standard deviation of the weekly returns has been annualized to calculate Rm. The value of Rm = 25.09% Thus market risk premium is: Rm - Rf = 25.09 - 8.4 = 16.69% Therefore Cost of Equity: Re = Rf + equity*(Rm - Rf). Re = 18.92%

Cost of Debt
The cost of debt has been calculated by taking the interest expense of the current year (2011) and dividing it by the average debt of the past two years. The cost of debt before tax is calculated as Rd= 10.62%. The after tax cost of debt is: Kd = Rd*(1- Tc) = 7.05%

Debt-Equity Weights
The debt has been calculated by taking the total debt on the balance sheet as in 2011. The equity has been calculated by multiplying the total number of outstanding shares by the average price of the share in the current year.

Thus D/V = 0.01 and E/V = 0.99

WACC
The WACC has been calculated using the following formulae: WACC = Kd*D/V + Re*E/V Thus WACC = 18.91%

Expected Cash Flow

Expected Cash Flow

growth rate

terminal value

Competitive advantage period

Growth Rate

stable growth rate

stable growth rate

There are 3 ways of estimating this Company s past historical growth rates Analyst s estimates Product of reinvestment rate and return We have estimated the growth rate using historical growth rates. One disadvantage of this method is that past growth rates cant estimate the future growth of the company.
2011 2010 2009 2008 2007 2006 2005 2004 Growth rates in sales 0.16 0.16 0.13 0.16 0.22 0.29 0.18 0.10 Average growth rate in top line 17.66% Assumption: The growth rate increases till 20% as it is seen that the growth in top line is gradually increasing. Growth rate by 2020 20% 1.25% Steps in which the growth rate steadily increases to 20% 2003 0.19

Here the assumption of 20% maximum growth rate is assumed because the FMCG industry is becoming more competitive and with talks of FDI in organized retail this industry may become more competitive.

Competitive Advantage Period

We assumed that Competitive advantage period as 10 years; the reason for taking 10 years is because of the fact that FDI s in Organized Retail may become fully operational by that time.
Stable Growth Rate

The stable growth rate is assumed to be 10 %. This figure is bit over estimated value and this 10% is chosen because of the increasing purchasing power of Consumers and their increased demand for Products.

Forecasting of Cash Flows

Operating Margin
Operating Margin Avg op Margin 2011 0.37 0.38 2010 0.36 2009 0.34 2008 0.35 2007 0.35

200 0.3

The average operating margin for the past 10 years is 38% and we assumed that the same op margin would be maintained in the coming yeas as well.
Depreciation
Depreciation as % of sales Average 2011 0.03 0.036 2010 0.03 2009 0.04 2008 0.03 2007 0.03

200 0.0

Here the depreciation is taken as % of sales for the past 10 years and average Depr as % of sales is calculated which will be maintained by company going forward
Capex and WC
2011 Capex as % of sales WC as % of sales Capex/depr Average Capex as % of sales Avg WC as % of Sales 0.04 0.10 1.43 0.09 0.14 2010 0.08 0.04 2.24 2009 0.10 0.22 2.98 2008 0.14 0.19 4.28 2007 0.07 0.23 2.37 2006 0.07 0.20 2.00 2005 0.10 0.11 2.45 2004 0.08 0.00 1.96 2003 0.11 0.14 2.50

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

202 1

Rev enu e EBI T Depreciatio n

22273.66

26257.14

31011. 75 11665. 27 1129.4 0 2732.9 1 4395.5 6 673.91 9387.8 4 3926.5 3 5461.3 1

36697.51

43509.8 1 16366.5 0 1584.56

51687. 68 19442. 66 1882.3 8 4554.9 8 7326.1 4 1159.1 2 15610. 94 6544.4 0 9066.5 4

61524.0 7 23142.6 8 2240.61

73378.7 2 27601.8 8 2672.33

87694.3 1 32986.7 9 3193.68

105016.6 3

8378.38 811.17

9876.80 956.24

13804.01 1336.46

39502.69 3824.53

Capex

1962.87

2313.91

3233.97

3834.31

5421.81

6466.51 10400.6 0 1680.26 22127.4 5

7728.07 12429.6 8 2029.07 26423.3 3 11103.3 5 15319.9 8

9254.60

WC Change in WC Operating CFs Hypothetica l Taxes FCF F Terminal value PV fact or PV Of CF' s Fir m val ue Net deb t Equ ity Val ue Outstanding Shares Pri ce tar get

3157.04 2479.31

3721.65 564.61

5201.46 805.89

6167.02 965.57 13151.1 8

8720.34 1394.20 18567.2 7

14884.92 2455.24

4747.38

7954.51

11100.61

31617.38

2820.16

3324.53

4646.43

5508.96

7789.83 10777.4 5

9290.79 12836.6 5

13296.61

1927.21

4629.98

6454.18

7642.22

18320.78

126 019. 96 474 03.2 3 458 9.44 111 05.5 2 178 61.9 0 297 6.98 379 10.1 7 159 55.9 3 219 54.2 4 270 736. 14

1.00

0.84

0.71

0.59

0.50

0.42

0.35

0.30

0.25

0.21

0.18 517 43.9 3

1927.21

3893.36

3861.7 8

3837.75

3821.20

3812.1 2

3810.54

3816.52

3830.18

3851.68

88206.27

-2302.30

90508.57 768.07

Crores Crores Current Share Price

198.65 117.84

Sensitivity Analysis

From the sensitivity analysis, the target price is approximately equal to current share price for WACC of 13 % and Growth rate of 6%. Since the analysis done is with respect to the Closing of March 31st 2011, The share price at that point of time is around 207 which is in Sync with target price of 207.8542 for WACC of 14% and growth rate of 8%.