Agenda

1
Agenda

• Exam DATE ??
• Last session
• this lecture
• next
• who presents ?
• Mid stage report 1A4
• Valuation depends mainly on understanding the
  business, its industry, and the general economic
  environment, and then doing a prudent job of
  forecasting. Correct methodology is only a
  small, but necessary, part of the valuation
  process p.292

2
CMK 8 Framework for valuation

• Models
• DCF enterprice
• Economic Profit (EP)
• APV (changing cap.structure)
• DCF equity (fin.institutions)
• add ons
• options
• nominal vs. real
• pre-post tax
• formulae instead of explicit forecast

3
Framework for valuation

• DCF enterpricemodel
• value of operations based on forecast
• less value of debt
• discounted back with riskadjusted rate
• regulated for non-operating assets/liabilities
• The discount rate reflects the opportunity cost
  of all capital (WACC, tax shield))
• Forecast for 100 years OR utilize a formula for
  the last 90 years - giving the continuing value,
  whose
• formula is composed of NOPLAT, growth, ROIC - and
  WACC p.136

4
Framework for valuation

• Growth rate ROnewIC investment rate
• Key drivers of value are ROIC (relative to WACC)
  and growth p.140
• ECONOMIC PROFIT MODEL
• V capital invested PVvalue created in the
  future
• economic profit invested capital(ROIC-WACC) or
  NOPLAT-(inv.cap.WACC)

5
Framework for valuation

• ADJUSTED PV MODEL (APV)
• values based only on cost of equity and then adds
  value of tax benefit of debt
• DCFequity MODEL
• values the equity DIRECTLY based on cost of
  equity
• BUT get the leverage right !
• 5 STEP how to do in ch.9-13

6
Step 1 (ch.9) Analyzing Historical Performance

• Focus on key value drivers i.e. ROIC and growth
• break them down into their component drivers i.e.
  ROIC into cap.turnover and profit margin
• how is the liquidity balance (Donaldson)
• destinguish operating from non-operating
• ending with consistency between NOPLAT and
  operating invested capital

7
Analyzing Historical Performance

• Convert tax to cash basis as tax expensed on
  operating profit
• add quasi-equity (reserves,provisions, deferred
  income tax)
• exclude extraordinary items and add goodwill
  amortizations
• capitalize expensed investments (RD,marketing)
• FCF NOPLAT - Net investments
• check the investment rate
• FX translation effects are treated as
  non-operating cash flow
• look for trends and compare with industry

8
Analyzing Historical Performance

• Do not correct for inflation effect unless in a
  high inflation environment
• IF lumpy investments - spread it out or utilyze
  CFROI Valuation

9
Step 2 (ch.10) Cost of Capital

• WACC
• market weights
• target capital structure
• only systematic risk
• look out for changes in inflation, systematic
  risk, capital structure, and market weights
• FX is valued with FX interest rates and converted
  at spot rate
• market risk premium 2 -5 US
• check your beta ! And leverage it correct
• p.309

10
Step 3 (ch.11) Forecast performance

• How the company may develop
• length and level of detail
• steady state
• full cycle
• perhaps two periods
• what about terminal period (see ch. 12)
• have a strategy model e.g.strategic perspective
  considering the industry (Ghemawat) and
  competitive position (e.g. 2Porter)
• what drives the forecast (demand, technology, ?)
• alternative scenarios
• check for consistency

11
Step 4 (ch.12) Continuing Value

• PV of cash flow after the explicit forecast
  period
• simplified assumptions makes formulas do the
  impossible job
• different formulas for different approaches
• for DCFenterprise the value-driver formula
  NOPLAT t1(1-g/ROIC)/ WACC-g
• also non-cash flow based approaches in special
  situations (PtB, PtE, liquidation value,
  replacement cost)
• p.277 Where is value created !

12
Step 5 (ch.13) Calculating and interpreting the
results

• Discount FCF using WACC
• discount continuing value using WACC
• add value of nonoperating assets
• subtract value of debt
• check for consistence with forecast
• compare with present market value
• evaluate debt-equity forecast
• compare the scenarios and assess the likelihood
• define your margin of error/ test sensitivity

13
Aggarwal 16 Justifying strategic investments

• Has the manufacturing setup an impact on value ?
• Different types of man.systems -fig.16-1
• optimality of man.setup -fig.16-2
• Exit NPV assesses the risk of loss due to
  uncertain events