Why Corporate Valuation

1
Why Corporate Valuation?????? ?????? ?????
???????

• You make financial decisions every day
• Brokers advice and trading decisions
• Investorsbuy and sell decisions
• Managersimplement operating decisions
• Financial staffevaluate acquisitions
• Success or failure depends on whether you
  correctly identify value

2
Goals????? ?? ??? ?????? ????????

• Provide brokers, investors and managers with the
  basic knowledge to value a company
• Use free cash flow valuation
• Use dividend discount models
• Use multipliers
• Use WACC
• Use Growth
• Use other pricing models

3
Our plan of attack??? ?????

• Finance requires a circular approach you need
  to know finance in order to do financial
  analysis. You need to know how to do financial
  analysis to understand finance.

4
Three types of value????? ????? ??????

• Book value the companys historical value as
  shown on its financial statements.
• Market value the current price at which an asset
  can be bought or sold.
• Intrinsic value estimate of the value an
  individual buyer places on an asset.

5
Objective?????

• Objective is to provide a sound basis for
  estimating the intrinsic value of a stock.
• This intrinsic value is also called its
  fundamental value.
• The process is known as fundamental valuation

6
The three basic concepts of valuation???? ??????
?????? ???????

• Investors can only spend cash so "Cash is good
  and more cash is better."
• Cash today is worth more than cash tomorrow.
• Risky cash flows are worth less than safe cash
  flows.
• These three imply the value of a company depends
  on the size, timing, and riskiness of its cash
  flows.

7
Valuation of a Simple Company????? ???? ????? ?
?????

• Investors are
• Debtholders
• Stockholders

8
More investors????????? ????? ????????

• Simple Co.s shares of stock also compete in the
  market for investors.
• Stockholders are the owners of the firm, and the
  value of ownership is the value of the asset,
  less any debt that is owed.
• For example Suppose Simple Co. is worth 501
  million. It owes 150 million to debtholders.
  So Simple Co.s equity is worth 501 150 351
  million.

9
The Corporate Valuation Model????? ????? ???????

• PV of cash flows available to all
  investorscalled free cash flows (FCFs).
• Discount free cash flows at the average rate of
  return required by all investorscalled the
  weighted average cost of capital (WACC)

10
Steps in the corporate value model????? ???????
????? ????? ???????

• Determine weighted average cost of capital
• Estimate expected future free cash flows
• Find value of company

11
Estimating the Weighted Average Cost of Capital
(WACC)???? ?????? ?????? ?????? ??? ?????

• Company has two types of investors
• Debtholders
• Stockholders
• Each type of investor expects to receive a return
  for their investment
• The return an investor receives is a cost of
  capital from companys viewpoint.

12
Cost of Debt????? ??????

• Simple Co.s cost of debt rD 9.
• But Simple Co. can deduct interest, so cost to
  Simple Co. is after-tax rate on debt.
• If tax rate is 40, then after-tax cost of debt
  is
• After-tax rD 9(1-0.4) 5.4.

13
Cost of Equity????? ???????

• Cost of equity, rs, is higher than cost of debt
  because stock is riskier.
• Simple Co. rs 12

14
Weighted Average Cost of Capital?????? ??????
?????? ??????? ?? ??????? ????????

• WACC is average of costs to all investors,
  weighted by the target percent of firm that is
  financed by each type.
• For Simple Co., target percent financed by
  equity
• wS 70
• For Simple Co., target percent financed by debt
• wD 30

(More.)
15
WACC (Continued) ???? ?????? ?????? ?????? ???
?????

• WACC wD rD (1-T) wS rS
• 0.3(9)(1 - 0.4) 0.7(12)
• 10.02

16
Free Cash Flow (FCF)???????? ??????? ?????

• FCF is the amount of cash available from
  operations for distribution to all investors
  (including stockholders and debtholders) after
  making the necessary investments to support
  operations.
• A companys value depends upon the amount of FCF
  it can generate.

17
Calculating FCF???? ???????? ??????? ?????

• FCF net operating profit after taxes minus
  investment in operating capital

18
Operating Current Assets?????? ????????? - ?????
?????

• Operating current assets are the CA needed to
  support operations.
• Op CA include cash, inventory, receivables.
• Op CA exclude short-term investments, because
  these are not a part of operations.

19
Operating Current Liabilities?????? ?????????
????? ?????

• Operating current liabilities are the CL
  resulting as a normal part of operations.
• Op CL include accounts payable and accruals.
• Op CA exclude notes payable, because this is a
  source of financing, not a part of operations.

20
Balance Sheet Assets????? ?????? ?????? - ??????

• 2001 2002 2003
• Op. CA 162,000.0 168,000.0 176,400.0
• Total CA 162,000.0 168,000.0 176,400.0
• Net PPE 199,000.0 210,042.0 220,500.0
• Tot. Assets 361,000.0 378,042.0 396,900.0

21
Balance Sheet Claims ????? ?????? ??????
?????? ????? ????????

• 2001 2002 2003
• Op. CL 57,911.5 62,999.7 66,150.0
• Total CL 57,911.5 62,999.7 66,150.0
• L-T Debt 136,253.0 143,061.0 150,223.0
• Total Liab. 194,164.5 206,060.7 216,373.0
• Equity 166,835.5 171,981.3 180,527.0
• TL Eq. 361,000.0 378,042.0 396,900.0

22
Income Statement????? ?????

• 2001 2002 2003
• Sales 400,000.0 420,000.0 441,000.0
• Costs 344,000.0 361,994.2 374,881.6
• Op. prof. 56,000.0 58,005.8 66,118.4
• Interest 11,678.7 12,262.8 12,875.5
• EBT 44,321.3 45,743.0 53,242.9
• Taxes (40) 17,728.4 18,297.2 21,297.2
• NI 26,592.7 27,445.8 31,945.7
• Dividends 21,200.0 22,300.0 23,400.0
• Add. RE 5,392.7 5,145.8 8,545.7

23
NOPAT (Net Operating Profit After Taxes)???????
????????? ??? ???????

• NOPAT is the amount of after-tax profit generated
  by operations.
• NOPAT is the amount of net income, or earnings,
  that a company with no debt or interest-income
  would have.
• NOPAT (Operating profit) (1-T)
• EBIT (1-T)

24
Calculating NOPAT???? ??????? ????????? ???
???????

• NOPAT (Operating profit) (1-T)
• EBIT (1-T)
• NOPAT03 66.1184 (1-0.4) 39.67104 million.

25
Calculating Operating Capital???? ??? ?????
????????

• Operating capital (also called total operating
  capital, or just capital) is the amount of assets
  required to support the companys operations,
  less the liabilities that arise from those
  operations.
• The short-term component is net operating working
  capital (NOWC).
• The long-term component is factories, land,
  equipment.

26
Net Operating Working Capital???? ???? ??? ?????
??????

• NOWC Operating current assets
• Operating current liabilities
• This is the net amount tied up in the things
  needed to run the company on a day-to-day basis.

27
Net Operating Working Capital???? ???? ??? ?????
??????

• NOWC Operating CA Operating CL
• NOWC03 176.4 66.15
• 110.25 million

28
Operating Capital ???? ??? ????? ????????

• Operating capital
• Net operating working capital (NOWC) plus
• Long-term capital, such as factories, land,
  equipment.

29
Operating Capital ???? ??? ????? ????????

• Operating Capital NOWC LT Op. Capital
• Capital03 110.25 220.50
• 330.75 million
• This means in 2003 Simple Co. had 330.75 million
  tied up in capital needed to support its
  operations. Investors supplied this money. It
  isnt available for distribution.

30
Investment in Operating Capital????????? ?? ???
????? ????????

• Operating capital in 2002 was 315.0423 million
• Operating capital in 2003 was 330.75 million
• Simple Co. had to make a net investment of
  330.75 315.0423 15.7077 million in
  operating capital in 2003.

31
Calculating FCF???? ???????? ??????? ?????

• FCF NOPAT Investment in operating capital
• FCF03 39.67104 (330.75 315.0423)
• 39.67104 15.7077
• 23.96334 million

32
Uses of FCF????????? ???????? ??????? ?????

• There are five ways for a company to use FCF
• 1. Pay interest on debt.
• 2. Pay back principal on debt.
• 3. Pay dividends.
• 4. Buy back stock.
• 5. Buy nonoperating assets (e.g., marketable
  securities, investments in other companies, etc.)

33
Non-operating income ??? ??? ??????
NOPAT ????? ?????? ??? ???????
Dividends ??????? ???????
Working Capital ????????? ?? ??? ????? ??????
Buy back stock ????? ???? ??????
Pay interest ??? ????? ??????
Fixed Assets ????????? ?? ?????? ???????
Buy non-op assets ???? ???? ??? ???????
Pay principal ??? ??????
Free Cash Flow ???????? ??????? ?????
Reinvestmen ????? ?????????
34
How Did Simple Co. use its FCF???? ???????
?????? ??????? ???????? ??????? ?????

• Paid dividends 23.4 million
• Paid after-tax interest of 12,875.5 (1-0.4)
  7.7253 million
• For a total of 31.1253 million! This is 7.162
  million more than the 23.9 million FCF
  available! Where did it come from?
• Simple Co. increased its borrowing by 150.223
  143.061) 7.162 million to make up the
  difference.

35
Corporate Valuation????? ??????

• Forecast financial statements and use them to
  project FCF.
• Discount the FCFs at the WACC
• This gives the value of operations

36
Value of Operations???? ???? ????? ??????
Of course, this requires projecting free cash
flows out forever.
37
Constant growth??? ????

• If free cash flows are expected to grow at a
  constant rate of 5, then this is easy
• 2003 2004 2005 2006 2007 2008
• FCF 23.963 25.161 26.419 27.740 29.127 30.584
• There is an easy formula for the present value of
  free cash flows that grow forever at a constant
  rate

38
Constant Growth Formula????? ??????? ???? ????
??????

• The summation can be replaced by a single formula

39
The value of operations ???? ???? ????? ??????
40
Value of Equity???? ???? ????????

• Sources of Corporate Value
• Value of operations 501.225 million
• Value of non-operating assets 0 (in this case)
• Claims on Corporate Value
• Value of Debt 150.223 million
• Value of Equity ?
• Value of Equity 501.225 - 150.223 351.002
  million, or just 351 million.

41
Value of Equity???? ???? ????????

• Price per share
• Equity / of shares
• 351 million / 10 million shares
• 35.10 per share

42
A picture of the breakdown of Simple Co.s
value??? ?????? ????? ?????? ?? ??? ??????
43
Return on Invested Capital (ROIC)?????? ??? ???
????? ????????

• ROIC can be used to evaluate Simple Co.s
  performance
• ROIC NOPAT / Total operating capital in place
  at the beginning of the year

44
Return on Invested Capital (ROIC)?????? ??? ???
????? ????????

• ROIC03 NOPAT03 / Capital02
• ROIC03 39.67104 / 315.0423 12.6.
• This is a good ROIC because it is greater than
  the return that investors require, the WACC,
  which is 10.02. So Simple Co. added value
  during 2003.

45
Economic Value Added (EVATM) (also called
Economic Profit)?????? ?????????? ??????? ??
????? ?????????

• EVA is another key measure of operating
  performance.
• EVA is trademarked by Stern Stewart, Inc.
• It measures the amount of profit the company
  earned, over and above the amount of profit that
  investors required.
• EVA NOPATt WACC(Capitalt-1)

46
Calculating EVA???? ?????? ?????????? ???????

• EVA NOPAT- (WACC)(Begng. Capital)
• EVA03 NOPAT03 (0.1002)(Capital02)
• EVA03 39.67104 (0.1002)(315.0423)
• 39.67104 31.56742
• 8.1038 million

(More)
47
Economic profit ????? ?????????

• This shows that in 2003 Simple Co. earned about
  8 million more than its investors required.
• Another way to calculate EP is
• EVAt (ROIC WACC)Capitalt-1
• (0.125923 0.1002)315.0423
• 8.1038 million

48
Intuition behind EVA???? ????? ?????????

• If the ROIC WACC spread is positive, then the
  firm is generating more than enough profit, and
  is increasing value. But, if the ROIC WACC
  spread is negative, then the firm is destroying
  value, in the sense that investors would be
  better off taking their money and investing it
  elsewhere.

49
Valuing a basic company????? ???? ???? ??????

• Here we will price a company with more detailed
  operations and financial statements line items.
• The purpose is to advance our ability to value
  real life companies one step at the time.

50
Basic Co.'s Balance Sheet Assets ????? ??????
?????? - ??????
51
Basic Co.'s Balance Sheet Liabilities?????
?????? ?????? - ??????
2001 2002 2003
52
Basic Co.'s Income Statement ????? ?????
53
Basic Co.s free cash flow?????? ?????? ????

• Free cash flow is cash potentially available for
  distribution to stockholders and creditors
• Dividends and stock repurchases
• Interest and principal payments

54
Free cash flow calculation???? ?????? ?????? ????

• FCF calculated as
• NOPAT investment in operating capital
• For 2003
• NOPAT2003 Operating profit taxes on o.p.
• 586.62(1 0.40) 351.97

55
Free cash flow calculation???? ?????? ?????? ????

• Net operating working capital
• NOWC2003 (cash inventory AR) (AP
  Accrued expenses) 1,128.11
• Total operating capital in 2003
• NOWC net long-term operating capital (which
  is PPE for Basic Co.)
• 1,128.11 2,256.23 3,384.34
• TOC in 2002 is 3,104.89

56
Free cash flow calculation???? ?????? ?????? ????

• FCF NOPAT net investment in operating capital
• 351.97 (3,384.34 - 3,104.89)
• 72.52 million

57
Free cash flow calculation???? ?????? ?????? ????

2001

2002

2003


58
Uses of FCF????????? ?????? ?????? ????

• How was this 72.52 million used?
• Paid 106 million to debtholders in interestbut
  after-tax amount was only 64 million because it
  is deductible.
• Paid 105 million in dividends.
• For a total of 169 million, which is quite a bit
  more than its FCF of 73 million. It borrowed
  the rest, for a total new borrowing of 169 - 73
  96 million.

59
Basic Co.s operating performance?????? ????????
??????

• ROIC NOPATt/Capitalt-1
• ROIC2002 NOPAT2002/Capital2001
• 322.91/2,797.2
• 11.5
• ROIC2003 NOPAT2003/Capital2002
• 351.97/3,104.89
• 11.3

60
Basic Co.s operating performance?????? ????????
??????

• If ROIC is greater than the cost of capital
  (WACC) then Basic Co. is adding value. Since
  WACC is 10, ROIC shows that Basic Co. is earning
  more than its investors require.

61
Projections??????

• Next chapter will have the nuts and bolts of
  projections. For now, assume that your financial
  analyst has already made the projections on the
  following page.

62
Income statement projections?????? ?????? ?????
??????? ???????
63
Balance sheet projections?????? ?????? ??????
?????? ??????? ???????
Balance Sheets




Actual

Projected

Projected
Projected
Projected

2003

2004

2005

2006

2007

Cash

45.12

48.73

51.66

54.76

58.04

Inventory

631.74

6
82.28

723.22

766.61

812.61

Accounts receivable

1,128.11

1,218.36

1,291.46

1,368.95

1,451.09

Total current assets

1,804.98

1,949.38

2,066.34

2,190.32

2,321.74

Gross PPE

3,443.32

3,867.49

4,271.98

4,700.75

5,155.24

Accumulated depreciation

1,187.09

1,430
.77

1,689.06

1,962.85

2,253.07

Net PPE

2,256.22

2,436.72

2,582.92

2,737.90

2,902.17

Total assets

4,061.20

4,386.09

4,649.26

4,928.22

5,223.91


64
Balance sheet projections?????? ?????? ??????
?????? ??????? ???????
Liabilities

Actual

Projected

Projected

Projected

Projected


2003

2004

2005

2006

2007

Accounts payable

451.24

487.34

516.58

547.58

580.43

Accrued expenses

225.62

243.67

258.29

273.79

290.22

Short
-
term debt

381.71

476.04

557.55

643.90

735.40

Total current liabilities

1,058.57

1,207.05

1,332.42

1,465.27

1,606.05

Long
-
term debt

1,000.00

1,000.00

1,000.00

1,000.00

1,000.00

Total liabilities

2,058.57

2,207.05

2,332.42

2,465.27

2,606.05

Commo
n stock

600.00

600.00

600.00

600.00

600.00

Retained earnings

1,402.63

1,579.04

1,716.84

1,862.95

2,017.86

Total common equity

2,002.63

2,179.04

2,316.84

2,462.95

2,617.86

Total liabilities and equity

4,061.20

4,386.09

4,649.26

4,928.22

5,223.91


65
FCF Projections?????? ??????? ?????? ????
66
ROIC Projections?????? ??????? ??? ??? ?????
????????
Actual

Projected

Projected

Projected

Projected


2003

2004

2005

2006

2007

ROIC

(NOPAT/Beginning capital)

11.3

11.2

11.0

11.0

11.0

Growth in Sales

9.0

8.0

6.0

6.0

6.0

Growth in NOPAT

9.0

8.0

6.0

6.0

6.0

Growth in total net op. cap.

9.0

8.0

6.0

6.0

6.0

Growth in FCF

376.6

50.8

67.9

6.0

6.0







Growth in dividends
-34.5
28.8
41.7
6.0
6.0







Long term projected growth is 6
67
Horizon Value???? ????? ?????? ??? ??? ?????
??????
68
Value of operations?????? ??????? ?????? ??????
69
Value of equity???? ???? ???????

• Vequity VOPS non-operating assets
• debt
• 4,272.92 0 debt
• Debt 381.71 million short term 1 million
  long-term bonds at 900.15 each
• 381.71 900.15 1,281.86 million
• Vequity 4,272.92 - 1,281.86
• 2,991.06 million

70
Per share equity??? ?????

• 10 million shares outstanding
• Value per share 29.91

71
Alternate valuation method??? ???? ???????

• Method of multiples
• Not as reliable as the free cash flow model weve
  developed
• But it is frequently used by less-sophisticated
  analysts

72
Why project financial statements?????? ??????
???????? ???????

• Forces you to articulate your assumptions
• Helps you understand your firms value drivers
• Requires you to verify that your assumptions are
  economically reasonable
• Identifies external funding needed
• Provides data needed to project FCF and perform a
  valuation

73
What are the characteristics of a good
forecast??? ?? ??????? ?????? ??????

• Economic plausibility
• The statements must reflect how the firm might
  realistically operate in the future.
• Accounting consistency
• Do the financial statements balance?
• Do they articulate?
• Are they a good model of the firms finances?

74
Projecting partial financial statements??????
?????? ????? ????? ?? ?????? ??? ???? ???????

• Income statement Forecast method
• Net sales Forecast growth
• Cost of goods sold Percent of sales
• SGA Percent of sales
• Depreciation Percent net PPE
• Operating profit Calculated

75
Projecting partial financial statements??????
?????? ????? ????? ?? ?????? ??? ???? ???????

• Balance Sheet Forecast method
• Cash Percent of sales
• Inventory Percent of sales
• Accounts receivable Percent of sales
• Net PPE Percent of sales
• Accounts payable Percent of sales
• Accrued expenses Percent of sales

76
Developed Products, Inc.????? ????? ????? ?????
????? ??????

77
Developed Products, Inc.????? ?????? ??????
????? ????? ????? ??????

Actual

Actual

Actual

2001

2002

2003

Balance sheet

Cash

42

47

50

Short-term investments

10

15

25

Inventory

75

85

100

Accounts receivable

65

70

75

Total current assets

192

217

250

Net PPE

275

280

300


Total assets

467

497

550

78
Developed Products, Inc.????? ?????? ??????
????? ????? ????? ??????

Actual

Actual

Actual

2001

2002

2003

Balance sheet

Accounts payable

80

70

75

Accrued expenses

8

10

10

Short
-
term debt

50

30

25

Total current liabilities

138

110

110

Long
-
term debt

54

84

99

Total liabilities

192

19
4

209

125

125

125

Common stock

Retained earnings

150

178

216

Total common equity

275

303

341

Total liabilities and equity

467

497

550


79
Choosing inputs for the model?????? ?????? ??????

• Projecting the sales growth rate
• Projecting operating profit
• Projecting operating capital
• Projecting taxes

80
Projections and Free Cash Flow???????? ?????
??????
Ratios to calculate operating profit 2001 2002
2003 Avg. Proj. Sales growth rate na 12.4 5.9 9
.2 11.0 COGS / Sales 61.9 66.2 64.0 64.0 62
.5 SGA / Sales 23.8 21.7 21.5 22.3 22.5 De
preciation / Net PPE 14.9 15.0 15.0 15.0
15.0
81
Projections and Free Cash Flow???????? ?????
??????
Ratios to calculate operating capital 2001 200
2 2003 Avg. Proj. Cash / Sales 5.0 5.0
5.0 5.0 3.0Inventory/ Sales 8.9
9.0 10.0 9.3 11.0Accts. Rec. / Sales
7.7 7.4 7.5 7.6 7.6Net PPE /
Sales 32.7 29.7 30.0 30.8 34.0Accts. Pay./
Sales 9.5 7.4 7.5 8.1 8.1Accruals
/ Sales 0.9 1.1 1.0 1.0 1.0
82
Projections and Free Cash Flow???????? ?????
??????
Ratios to calculate operating taxes 2001 2002
2003 Avg. Proj.Tax Rate (Taxes/EBT) 40.0 39
.1 40.0 39.7 39.7
83
Free Cash Flow Calculations?????? ?????? ??????
???? ????????? ???????? ??? ????? ??????
Developed Products, Inc. Actual Actual Actual
ProjectedIncome Statement 2001 2002 2003 2004 Net
Sales 840.0 944.0 1000.0 1110.0CGS 520.0 625.0 6
40.0 693.8Selling, general administrative
200.0 205.0 215.0 249.8Depreciation 41.0 42.0 45
.0 56.6 Operating profit 79.0 72.0 100.0 109.9
84
Free Cash Flow Calculations?????? ?????? ??????
???? ????????? ???????? ??? ????? ??????
Actual Actual Actual Proj.Balance
sheet 2001 2002 2003 2004 Cash 42.0 47.0 50.0 33.3
Inventory 75.0 85.0 100.0 122.1Accts.
receivable 65.0 70.0 75.0 84.4Net
PPE 275.0 280.0 300.0 377.4Accts.
payable 80.0 70.0 75.0 89.9Accrued
expenses 8.0 10.0 10.0 11.1
85
Actual Actual Actual Proj. 2001 2002 2003 2004
Operating Income 79.0 72.0 100.0 109.9 Tax on
Operating Income (40) 31.6 28.1 40.0
43.6 NOPAT 47.4 43.9 60.0 66.3 Net
Operating WC 94.0 122.0 140.0 138.8 Net
Operating Long Term Assets 275.0
280.0 300.0 377.4 Total Net Operating
Assets 369.0 402.0 440.0
516.2Investment in net operating
assets na 33.0 38.0 76.2 Free Cash
Flow na 10.4 22.0 -9.9 ROIC na 11.89
14.93 15.06
86
Balancing the Balance Sheet?????? ????? ??????
??????

• The plug approach
• Based on the assumed financial policies, there
  are only two items left to make the balance sheet
  balance.
• Short-term investments
• Short-term debt

87
Balancing the Balance Sheet?????? ????? ??????
??????

• Suppose projected total assets (ignoring
  short-term investments) are greater than
  projected total liabilities and equity (ignoring
  short-term debt).
• Then there are not enough sources of funding to
  pay for the planned asset purchases.

88
Balancing the Balance Sheet?????? ????? ??????
??????

• First liquidate any short-term investments
• Then borrow using short-term debt to cover any
  remaining shortfall.

89
Plug????? ??????

• In this case, short-term debt is used to plug
  the shortfall in liabilities.

90
Balancing the Balance Sheet?????? ????? ??????
??????

• Suppose projected total assets (ignoring
  short-term investments) are less than projected
  total liabilities and equity (ignoring short-term
  debt).
• Then the firm has more financing than it needs to
  implement its operating plan.

91
Balancing the Balance Sheet?????? ????? ??????
??????

• First pay off any short-term debt
• Then put any remaining funds into short-term
  investments.

92
Plug ????? ??????

• In this case, short-term investments (also called
  marketable securities) are used to plug the
  shortfall in assets.

93
Interest Income and Expense??? ?????? ???????

• Interest expense depends on debt, but debt
  changes throughout the year.
• Base it on beginning of year debt in this
  chapter. Chapter 8 explains how to base interest
  on the average level of debt during the year.
• Interest income depends on short-term
  investments, but this changes throughout the year
  too. In this chapter, base it on beginning of
  year short-term investments.

94
Explicit Non-operating Assumptions?????? ?????

• Interest rates
• 3 on short-term investments
• 9 on all debt
• Dividends were 16 million in 2003. They will
  grow by 10 to 17.6 million in 2004.

95
Explicit Non-operating Assumptions?????? ?????

• Long-term debt will decline from 18.9 of
  operating assets to 15 of operating assets.
• Projected operating assets cash accounts
  receivable inventories net PPE 33.3
  84.4 122.1 377.4 617.2 million.
• Projected long-term debt 0.15(617.2) 92.6
  million.

96
Assumptions so far.????????
97
Assumptions so far.????????
98
Completing the Income Statement???? ????? ?????
99
Preliminary Balance Sheet????? ???? ???? ?????
100
Preliminary Balance Sheet????? ???? ???? ?????

2001

2002

2003

2004

Accounts payable

80.0

70.0

75.0

89.9

Accrued expenses

8.0

10.0

10.0

11.1

Short
-
te
rm debt

50.0

30.0

25.0


-


Total current liabilities

138.0

110.0

110.0

101.0

Long
-
term debt

54.0

84.0

99.0

92.6

Total liabilities

192.0

194.0

209.0

193.6

125.0

125.0

125.0

125.0

Common stock

Retained earnings

150.0

178.0

216.0

258.4

Total common equity

275.0

303.0

341.0

383.4

Total liabilities and
467.0

497.0

550.0

577.0

equity


101
Balance Sheets Don't Balance????? ?????? ??????
??? ??????

• Total assets (excluding short-term investments)
  617.2
• Total liabilities and equity (excluding
  short-term debt) 577.0
• Advanced Products financing plan is 40.2
  million short.

102
Plug ????? ??????

• Add short-term debt 40.2 million.
• Dont have any short-term investments.

103
Final Projections?????? ??????
104
Final Projections?????? ??????

2001

2002

2003

2004

Accounts payable

80.0

70.0

75.0

89.9

Accrued expenses

8.0

10.0

10.0

11.1

Short
-
term debt

50.0

30.0

25.0

40.2

Total current liabilities

138.0

110.0

110.0

141.2

Long
-
term debt

54.0

84.0

99.0

92.6

Total liabilities

192.0

194.0

209.0

233.8

125.0

125.0

125.0

125.0

Common stock

Retained earnings

150.0

178.0

216.0

258.4


Tot
al common equity

275.0

303.0

341.0

383.4


Total liabilities and
467.0

497.0

550.0

617.2

equity
105
?????? ???? ????? ????????

• Multiyear Projections and Valuation
• ?????? ???? ????? ????????

106
Short-term, Longterm?????? ?????? ?????? ??????
?????

• There are three types of time periods in these
  projections
• The short-term, in which there is plenty of
  specific information on which to base projections
• The steady state, in which the firm is assumed to
  be at constant growth and some form of
  competitive equilibrium. It starts with the last
  year of projections.
• The long-term is between the short term and the
  steady state--general firm and industry
  information is used to base projections.

107
Ratios - projected ??? ??? ???????? ?????? ?????
????????? ????????
108
Projected Ratios?????? ??????? ????? ?? ????????
????????? ????????
109
Projecting operating taxes?????? ????? ???????

• Taxes have averaged 39.7 of pre-tax income, and
  are projected to remain there.

110
Dividend growth rate?????? ????? ??? ???????
???????

• Advanced Products is stabilizing its historically
  erratic dividend policy. Growth for 2004 through
  2007 is set at 10. 2008 growth is projected to
  be 8, and dividend growth is projected to be 6
  thereafter.

111
Target debt ratio and interest?????? ???????
?????????

• Historically, 16 of operating capital has been
  financed with long-term debt. This is expected
  to be reduced to 15.
• Short-term and long-term debt is expected to cost
  9, and the yield on short-term investments is
  expected to be 3.

112
Balancing?????? ????? ?????? ?????? ????????

• Projected assets too big? Short-term debt is the
  plugafter driving short-term investments to
  zero.
• Projected liabilities too big? Short-term
  investments are the plugafter driving short-term
  debt to zero.

113
Historical Income Statement????? ????? ??????
???????
114
Projected Income Statement ????? ????? ????????

115
Historical Assets?????? ????? ?????
116
Projected Assets?????? ????????
117
Historical liabilities?????? ????? ??????? ?????
?????
118
Projected Liabilities ?????? ????? ???????
????????
119
Free Cash Flow???? ???????? ??????? ????? ?????
120
Free Cash Flow???? ???????? ??????? ????? ??????
Projected
2004
2005
2006
2007
2008
2009
Operating Income
109.9
123.2
133.1
135.6
129.2
136.9
Tax on Operating
43.6
48.9
52.9
53.8
51.3
54.4
Income
NOPAT
66.3
74.3
80.3
81.8
77.9
82.6
Net Operating WC
138.8
149.9
160.3
157.8
167.3
177.3
Net Operating Long
Term Assets
377.4
377.6
395.1
422.7
448.1
475.0
Total Net Operating
Capital
516.2
527.5
555.4
580.6
615.4
652.3
Investment in net
operating capital
76.2
11.3
27.9
25.2
34.8
36.9
Free Cash Flow
-9.9
63.0
52.3
56.6
43.1
45.7
growth in FCF
-144.9
na
-16.9
8.2
-23.9
6.0
ROIC
15.1
14.4
15.2
14.7
13.4
13.4
121
Cost of Equity????? ???? ???????

• Using the capital asset pricing model (CAPM)
• Advanced Productss beta is 1.4.
• The risk-free rate is 6.
• The market risk premium is 5.
• rS rRF beta (RPM)
• 6 1.4 (5.0) 13

122
Cost of Capital????? ?????? ?????? ??? ?????

• Target debt is 19.8, target equity is 80.2
• WACC (1-T)rDwD rSwS
• (1 - 0.397)(9.0)(0.198)
  (13)(0.802)
• 11.5

123
Valuation???????
(9.89)
62.95
52.34
56.61
43.07
124
Valuation???????

• Present value at the WACC of 11.5 is 622.79
  million.
• This is as of the end of 2003
• Debt at end of 2003 is 124 million, short-term
  investments are 25 million

125
Valuation???????

• Equity 622.79 25 124 523.79 million.
• There are 10 million shares, so per share is
  52.38 per share.
• Compared to the existing market price of 40.12,
  this Advanced Products appears to be a good
  investment at this time.

126
????? ??? ?????? ???????? ??????? ??????????
??????? ??????????? ??????? ?????????????? ???
??? ?????

• Technical Issues in Projecting Financial
  Statements and Forecasting Financing Needs for
  Valuation

127
Extensions?????? ?? ?????? ??? ??????? ??????
??? ???????? ???? ??????? ?????? ????? ???????
??????

• This part describes extensions to
• ???? ????? ????
• Projections based on the proportional percent of
  sales method
• Alternative financing policies
• Calculations of interest expense and interest
  income

128
Extensions to Proportional Percent of Sales
Method?????? ???????? ???????? ??? ???? ??? ????
????? ????????

• Linear with intercept
• Non-linear
• Lumpy assets

129
Alternative Financing Policies??? ??????? ????
???? ?????? ?????? ?? ????? ???????

• Dividend policies
• Constant growth
• Fixed payout
• Residual
• Equity issuance and repurchase
• Debt as fixed percent of market value

130
Interest Income and Expense?????? ???? ??? ????
??????? ????? ??????

• Based on average levels of debt and short-term
  investments

131
When Projections Arent a Proportional Percentage
of Sales?????? ???????? ???? ??? ????? ??????
??????? ?? ????????

• Linear with intercept
• SGA fixed expenses sales (variable costs of
  sales)
• a b(sales)

132
Estimating a and b?????? ???????? ????????
???????? (???? excel)

• In Excel, use the INTERCEPT and the SLOPE
  functions to find the values of a and b.
• Use these values of a and b to project SGA.
• SGA 55.4 0.1610(Sales)

133
??? ?????? ?????? ???????? ?????????
SGA 55.4 0.1610(sales) ??? ????? ????????
SGA 0.2252(sales) ??? ????? ?????? ??????? ??
???????? ?? ????????? ?? ?????? ???????
134
Nonlinear Models????? ?????? ???????? ????? ????

• Quadratic model
• Useful for assets that must increase at a
  decreasing rate with sales
• Often inventory behaves like this

135
Inventory Example???? ?????? ???????? ????????
???????? ????? ????????? ???????
1995 1996 1997 1998 1999 2000
2001 2002 Sales 50 60 70
80 90 100 110 120 Sales2
2,500 3,600 4,900 6,400 8,100 10,000 12,100
14,400 Inventory 11 13 15 18
20 22 24 25 Using the
LINEST function in Excel, the equation that best
fits the inventory and sales data is Inventory
-0.00071(Sales2) 0.331(Sales) 4.10
136
Inventory Example???? ?????? ???????? ????????
???????? ????? ????????? ??????????

• Or, alternately, if you used a log fit Inventory
  -55.8 16.9(lnsales)
• Notice that in the graph on the next slide, the
  quadratic and the log projections agree quite
  closely through sales levels of 225 or so, but
  diverge rapidly after that.

137
??? ?????? ?????? ????????? ????? ???
138
Comparison with Linear Models?????? ?? ???????
??????

• The linear and nonlinear models agree on the
  fitted data through 2002, but disagree in their
  projections.
• The choice of which to usea linear model or a
  nonlinear modeldepends on how you really expect
  the asset (in this case, inventory) to grow as
  the firm grows.

139
??? ?????? ?????? ??????????? - ??????
140
Lumpy Assets?????? ???????? ???????? ???????
??????

• Not all assets can be purchased or acquired in
  bits and pieces.
• For example, usually an entire plant must be
  built at one timenot half a plant one year, and
  another half several years later.

141
??? ?????? ?????? ???????? ??????? ??????
142
Lumpy Assets?????? ???????? ??????? ??????

• When there is excess capacity, then assets dont
  have to grow very much to support sales. So
  either
• Input the actual level of assets, or
• Choose a ratio of asset/sales, such as Net PPE /
  Sales, that initially declines (reflecting the
  fact that the firm wont have to add assets to
  support sales), and then has a large increase to
  reflect the addition of a lumpy asset.

143
???? ??????? ??????? ??????? ?????
????????????? ???? ????? ??????? The Starting
Point for Corporate Valuation Historical
Financial Statements
144
Overview of Valuation Process - PalTel?????
??????? ???? ????????? ??????????

• Input historical financial statements into the
  file PalTel (for corp val 9-11, WACC, default
  inputs).xls. (This file will be called Paltel.xls
  for short.)
• Provide projections for key performance drivers.
• Obtain preliminary intrinsic value estimate.
• Refine projections and perform sensitivity
  analysis to determine impact of plausible
  alternative performance scenarios.

145
Steps to Estimate Value Using the Corporate
Valuation Spreadsheet????? ??????? ????????
?????? Excel

• The valuation spreadsheet has seven interrelated
  worksheets, each of which performs an essential
  function
• (1) Proj Val
• (2) Inputs
• (3) WACC
• (4) Hist Analys
• (5) Condensed
• (6) Comprehensive
• (7) Actual

146
Steps to Estimate Value (Continued)????? ???????
Step 1 Find the actual historical financial
statements for a company, and insert them into
the Actual worksheet. Step 2 Put the actual
financial statements into a standardized format
using the Comprehensive worksheet. The
comprehensive format has just about all the
entries needed to capture variations in the
formats of most companies financial statements.
(continued)
147
Steps to Estimate Value (Continued)????? ???????
Step 3 The spreadsheet will condense the
standardized format into statements on the
Condensed sheet. These sheets have enough detail
to accurately value a firm but do not have so
much detail that the analysis becomes overly
complicated. Step 4 The Hist Analys worksheet
begins the analysis by calculating the historical
free cash flows and key ratios.
(continued)
148
Steps to Estimate Value (Continued)????? ???????
Step 5 The WACC worksheet is structured to lead
you through the calculation of the firms cost of
capital. Step 6 Project the financial
statements by choosing key inputs, such as the
growth rate in sales, the ratio of costs/sales,
interest rates, etc., on the Inputs worksheet.
(continued)
149
Steps to Estimate Value (Continued)????? ???????
Step 7 The Proj Val worksheet takes your
chosen inputs for the key ratios and projects the
financial statements, calculates free cash flows
and performs a valuation analysis.
150
Analyze the Historical and Current
Situation.????? ?????? ?????? ??????? ??????
??????? ???? ?????? ??????

• Corporate information resources
• Company Website
• The stock Market Website
• SCA
• Shuaa Capital
• Al shabacah
• AMF

151
Analyze the Historical and Current
Situation.????? ?????? ?????? ??????? ??????
??????? ???? ?????? ??????

• Input ratio data for competitors (but this is
  already done this for you in Paltel.xls).
• Check average of historical ratios.
• Check trend of historical ratios.
• Check most recent ratio, compared with
  competitors/industry.
• Use graph button to look at historical ratios.

(continued)
152
Analyze the Historical and Current
Situation.????? ?????? ?????? ??????? ??????
??????? ???? ?????? ??????

• What can you say about the companys past
  performance with respect to
• Profitability (NOPAT/Sales and other ratios)?
• Efficiency (Operating capital/sales and other
  ratios)?
• Comparison to its industry?

(continued)
153
Analyze the Historical and Current
Situation.????? ?????? ?????? ??????? ??????
??????? ???? ?????? ??????

• What are important issues?
• What are signs of financial strength?
• Signs of financial weakness?
• Signs of a growing versus a declining industry?
• What is the life cycle of a firm?

(continued)
154
Analyze the Historical and Current
Situation.????? ?????? ?????? ??????? ??????
??????? ???? ?????? ??????

• Important aspects for projections
• Sales growth
• Profitability changes
• Asset Utilization
• Working Capital
• Debt level

(continued)
155
Analyze the Historical and Current
Situation.????? ?????? ?????? ??????? ??????
??????? ???? ?????? ??????

• More issues to examine
• ROIC over timedoes the company have good
  investment opportunities?
• Cash accumulation
• Extraordinary items
• Free Cash Flow
• Dividend policy