Valuation for special firms. Issues to be addressed in this chapter. How if the base case scenario does not hold? Negative earnings Insufficient financial information No comparable firms to provide valuation approximation The remedies might sacrifice precision in valuation.
Free Cash Flow to the Firm = EBIT (1 - tax rate)
– (Capital Expenditures - Depreciation) – Change in Non-cash Working Capital
Cost of Capital = k equity (Equity/(Debt + Equity) ) + k debt (Debt/(Debt + Equity))
Expected Growth EBIT = Reinvestment Rate * Return on Capital
Return on Capital = EBIT (1-t) / Capital Invested
Terminal value n = FCFF n+1 / (Cost of Capital n+1 - g n )
= $52,701 million
Firm Value = $78,982/1.0916**3 = $60,721 million
Equity Value = $60,721 million - 26,281 million = $34,440 million
This is an approximation because it assumes cash flows over the first three years, while Daimler normalizes earnings, will be zero.
The firm would continue to lose money over the next 3 years, but its pre-tax (and pre-depreciation) operating margins will converge on the industry average of 17% for fast food restaurants, by the end of the fifth year. The expected margins over the next 5 years are as follows:
The cumulated present value of the cash flows is $943.87. Netting out the debt of $763 million yields a value for the equity of $ 180.87 million. Dividing by the number of shares outstanding provides an estimate of value of $2.34 per share.
Illustration 4: Amazon.com:
Amazon’s beta can be first close to 1.6 (internet companies) and gradually decreases to 1.0 (book stores)
Amazon’s debt ratio is maintained 1.2％ from years 1 to 5;
and gradually increases to 15％from years 6 to 10.
Value of Firm
- Value of Debt
= Value of Equity
-Value of Options granted to Employees
= Value of Equity in Common Stock
/ Number of Shares outstanding
= Value per Share
Having estimated the equity value of Amazon.com to be $14,847 million, we can estimate the value per share. As of December 1998, the firm had options outstanding on 38 million shares, with a weighted average life of 8.4 years and a weighted exercise price of $ 13.375. Using a standard deviation in the stock price of 50% and the current stock price19 of $ 84, we estimated the value of these options, allowing for dilution to be $ 2,892 million.
Value of Equity in Common Stock $ 11,955 million
/ Number of Shares outstanding 340.79 million
= Value of Equity per Share $ 35.08