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    Principles of Corporate Valuation

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    Subhrodeep Das
    1. The value of a firm is the present value of its expected future distributable cash flows discounted at the weighted average cost of capital (WACC). 2. There are two main approaches to valuing a firm: the free cash flow to firm (FCFF) approach which uses WACC, and the adjusted present value (APV) approach which separately values the unlevered firm and financing side effects. 3. To value a firm, future free cash flows are projected, discounted using WACC or APV, and a terminal value is estimated to capture value beyond the projection period. Non-operating assets are then added to determine total firm value.

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    Principles of Corporate Valuation

    Uploaded by

    Subhrodeep Das
    46 views14 pages
    1. The value of a firm is the present value of its expected future distributable cash flows discounted at the weighted average cost of capital (WACC). 2. There are two main approaches to valuing a firm: the free cash flow to firm (FCFF) approach which uses WACC, and the adjusted present value (APV) approach which separately values the unlevered firm and financing side effects. 3. To value a firm, future free cash flows are projected, discounted using WACC or APV, and a terminal value is estimated to capture value beyond the projection period. Non-operating assets are then added to determine total firm value.

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    1. The value of a firm is the present value of its expected future distributable cash flows discounted at the weighted average cost of capital (WACC). 2. There are two main approaches to valuing a firm: the free cash flow to firm (FCFF) approach which uses WACC, and the adjusted present value (APV) approach which separately values the unlevered firm and financing side effects. 3. To value a firm, future free cash flows are projected, discounted using WACC or APV, and a terminal value is estimated to capture value beyond the projection period. Non-operating assets are then added to determine total firm value.

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    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    46 views14 pages

    Principles of Corporate Valuation

    Uploaded by

    Subhrodeep Das
    1. The value of a firm is the present value of its expected future distributable cash flows discounted at the weighted average cost of capital (WACC). 2. There are two main approaches to valuing a firm: the free cash flow to firm (FCFF) approach which uses WACC, and the adjusted present value (APV) approach which separately values the unlevered firm and financing side effects. 3. To value a firm, future free cash flows are projected, discounted using WACC or APV, and a terminal value is estimated to capture value beyond the projection period. Non-operating assets are then added to determine total firm value.

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    of 14

    Session 18.

    Principles of Corporate
    Valuation
    PGP, IIM INDORE
    Firm Valuation
    The value of the firm is the present value of expected future
    (distributable) cash flow discounted at the WACC
    Firm Valuation Models
    Free Cash Flows to Firm
    ◦ Also called the WACC approach
    ◦ 𝑉𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎 𝐹𝑖𝑟𝑚 / Asset
    𝐹𝐶𝐹1 𝐹𝐶𝐹2 𝐹𝐶𝐹3 𝐹𝐶𝐹𝑛
    + + + …… +
    (1+𝑟)1 (1+𝑟)2 (1+𝑟)3 (1+𝑟)𝑛
    ◦ EBIT(1-t) + Depreciation – Capital expenditure – Change in Net working Capital
    ◦ Discount at WACC
    ◦ D/E ratio is assumed constant
    Estimating Terminal Values
    •A publicly traded firm potentially has an infinite life. The value is therefore the
    present value of cash flows forever.
    • Most projects have finite lives
    •Since we cannot estimate cash flows forever, we estimate cash flows for a “growth
    period” and then estimate a terminal value, to capture the value at the end of the
    period
    Approaches to Estimating Terminal Value
    1. Terminal Value as a Growing Perpetuity
    2. Terminal Value as a Stable Perpetuity
    3. Terminal Value as a multiple
    ◦ Price-to-earnings, EV/EBITDA, and other multiples
    Valuation Example
    Current Revenue, Earnings and Investment
    Forecasts (in $ '000s)
    Year: 0 1 2 3
    1 Sales 40,123 46,351 50,155 52,345
    2 Cost of goods sold 22,879 24,678 27,560 29,459
    3 Other costs 8,025 8,426 8,848 9,290
    4 EBITDA (1 - 2 - 3) 9,219 13,247 13,747 13,596
    5 Depreciation 5,678 5,690 5,770 5,770
    6 Profit before tax (EBIT) (4 - 5) 3,541 7,557 7,977 7,826

    a Change in working capital 45 54 105 120


    b Investment (chg. in gross fixed assets) 6547 7345 7450 7870
    Corporate tax rate is 35%. WACC is 12% and the sustainable long-term growth rate is 4%. Estimate the
    value of the firm’s operations
    Free cash flows
    Free cash flow calculation Year 1 Year 2 Year 3
    NOPAT (EBIT*(1-tc)) 4911.888 5185.334 5086.939

    Plus. Depreciation 5,690 5,770 5,770


    Less. Change in NWC 54 105 120
    Less. Capex 7345 7450 7870

    FCF 3,203 3,400 2,867


    Value of Operations
    Free cash flow calculation Year 0 Year 1 Year 2 Year 3

    FCF 3,203 3,400 2,867


    PV FCF (Year 1 to Year 3) 2859.721 2710.726 2040.63
    i. Sum PVs FCFs (Year 1 to Year 3) 7611.07699
    ii. Terminal Value (Horizon Value) 37270.2
    iii. PV of Terminal Value 26528.1934

    Value of Operations (i + ii) 34139.2704


    Adjusted Present Value
    Adjusted Present Value Approach
    APV approach: 𝑉𝐿 = 𝑉𝑈 + 𝑉𝐹𝑆𝐸
    The value of an unlevered firm (all-equity firm) plus the present value
    of the financing side effects (V_FSE).
    Side effects of financing:
    ◦ Interest tax shields
    ◦ The Costs of Financial Distress
    ◦ Subsidies, etc.
    Adjusted Present Value (APV)
    APV analyses financial manoeuvres separately and then adds their value to that of the business
    Value of the firm with no Leverage
    ◦ Evaluate the business as if it were financed entirely with equity
    ◦ Free Cash flows to firm discounted at the unlevered cost of equity, i.e., 𝐾𝐴 (Cost of equity of an all-
    equity firm)

    Add Financing side effects (FSE)


    ◦ Present Value of Interest tax-shields generated by raising a given amount of debt
    ◦ Discounted at 𝐾𝐷
    ◦ Discount rate is Kd when debt level (in value) is fixed or reducing
    Summary: APV, and WACC
     Guidelines:
     Use FCF (WACC) approach if the firm’s target debt-to-value ratio is
    constant or known.
     Use APV if the level of debt is known and D/V is not constant
     In the real world, the FCF (WACC approach) is, by far, the most
    widely used.
    Firm Value
    Value of Non-operating assets
    • Intrinsic valuation (using FCFF, APV approaches) gives Value of Operations (also called Core Enterprise
    Value)
    ◦ Value (Firm) = Value of Operations + Value of Non-operating Assets

    Non-operating assets
    ◦ Excess cash (non-operating cash), marketable securities, equity stake in affiliates (minority stake
    investments)

    Equity Value
    ◦ Firm Value – Debt = Equity Value
    ◦ Equity Value / Outstanding Shares = Equity Value per share
    References
    Brealey, R. A., Myers, S. C., Allen, F., & Mohanty, P. (2015). Principles of corporate finance. Tata
    McGraw-Hill Education. Referred to as BM hereafter.
    ◦ BM: Ch 19

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