A Complete Corporate Valuation for a Simple Company
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A Complete Corporate Valuation for a Simple Company. Three types of value. Book value: the company’s historical value as shown on its financial statements. Market value : the current price at which an asset can be bought or sold.

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A Complete Corporate Valuation for a Simple Company

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A complete corporate valuation for a simple company

A Complete Corporate Valuation for a Simple Company

DES Chapter 2


Three types of value

Three types of value

  • Book value: the company’s 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.

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Objective

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—Warren Buffet is very successful at identifying a company’s fundamental value!

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The three basic concepts of valuation

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.

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Steps in the corporate valuation

Steps in the corporate valuation

  • Determine weighted average cost of capital

  • Estimate expected future free cash flows---cash flows available to all investors—called free cash flows (FCFs).

  • Discount free cash flows at the average rate of return required by all investors

  • Find value of company

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Estimating the weighted average cost of capital wacc

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 company’s viewpoint.

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Cost of debt

Cost of Debt

  • MPR’s cost of debt: rD = 9%.

  • But MPR can deduct interest, so cost to MPR 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%.

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Cost of equity

Cost of Equity

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

    • MPR: rs = 12%

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Weighted average cost of capital

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 MPR, target percent financed by equity:

    • wS = 70%

  • For MPR, target percent financed by debt:

    • wD = 30%

(More….)

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Wacc continued

WACC (Continued)

WACC= wD rD (1-T) + wS rS

= 0.3(9%)(1 - 0.4) + 0.7(12%)

= 10.02%

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Free cash flow fcf

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 company’s value depends upon the amount of FCF it can generate.

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Calculating fcf

Calculating FCF

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

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Financial statements

Financial Statements

  • Balance sheet

    • Assets (all of MPR’s assets are used in operations)

      • Operating assets

        • Operating current assets

        • Property, plant, and equipment (PPE)

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Operating current assets

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.

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Operating current liabilities

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.

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Balance sheet assets

Balance Sheet: Assets

200720082009

Op. CA162,000.0168,000.0176,400.0

Total CA162,000.0168,000.0176,400.0

Net PPE199,000.0210,042.0220,500.0

Tot. Assets361,000.0378,042.0396,900.0

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Balance sheet claims

Balance Sheet: Claims

200720082009

Op. CL57,911.562,999.766,150.0

Total CL 57,911.5 62,999.7 66,150.0

L-T Debt136,253.0143,061.0150,223.0

Total Liab.194,164.5206,060.7216,373.0

Equity166,835.5171,981.3180,527.0

TL & Eq.361,000.0378,042.0396,900.0

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Income statement

Income Statement

200720082009

Sales400,000.0420,000.0441,000.0

Costs344,000.0361,994.2374,881.6

Op. prof.56,000.058,005.866,118.4

Interest11,678.712,262.812,875.5

EBT44,321.345,743.053,242.9

Taxes (40%)17,728.418,297.221,297.2

NI26,592.727,445.831,945.7

Dividends21,200.022,300.023,400.0

Add. RE5,392.75,145.88,545.7

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Nopat net operating profit after taxes

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)

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Calculating nopat

Calculating NOPAT

NOPAT= (Operating profit) (1-T)

= EBIT (1-T)

NOPAT09= 66.1184 (1-0.4) = 39.67104 million.

DES Chapter 2


Calculating operating capital

Calculating Operating Capital

  • Operating capital (also called total operating capital, or just capital) is the amount of assets required to support the company’s 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.

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Net operating working capital

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.

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Net operating working capital1

Net Operating Working Capital

NOWC = Operating CA – Operating CL

NOWC09 = $176.4 – $66.15

= $110.25 million

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Operating capital

Operating Capital

  • Operating capital =

    • Net operating working capital (NOWC) plus

    • Long-term capital, such as factories, land, equipment.

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Operating capital nowc lt op capital

Operating Capital = NOWC + LT Op. Capital

Capital09 = $110.25 + $220.50

= $330.75 million

This means in 2009 MPR had $330.75 million tied up in capital needed to support its operations. Investors supplied this money. It isn’t available for distribution.

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Investment in operating capital

Investment in operating capital

  • Operating capital in 2008 was $315.0423 million

  • Operating capital in 2009 was $330.75 million

  • MPR had to make a net investment of $330.75 – $315.0423 = $15.7077 million in operating capital in 2009.

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Calculating fcf1

Calculating FCF

FCF = NOPAT – Investment in operating capital

FCF09 = $39.67104 – (330.75 – 315.0423)

= $39.67104 – $15.7077

= $23.96334 million

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There are five ways for a company to use 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.)

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A complete corporate valuation for a simple company

Non-operating income

NOPAT

Dividends

Buy back stock

Working Capital

Pay interest

Fixed Assets

Buy non-op assets

Pay principal

Free Cash FlowBucket

ReinvestmentBucket

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How did mpr use its fcf

How Did MPR 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?

  • MPR increased its borrowing by $150.223 – $143.061) = $7.162 million to make up the difference.

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Corporate valuation

Corporate Valuation

  • Forecast financial statements and use them to project FCF.

  • Discount the FCFs at the WACC

    This gives the value of operations

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Value of operations

Value of Operations:

Of course, this requires projecting free cash flows out forever.

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Constant growth

Constant growth

  • If free cash flows are expected to grow at a constant rate of 5%, then this is easy:

    200920102011201220132014

    FCF 23.96325.16126.41927.74029.12730.584

    There is an easy formula for the present value of free cash flows that grow forever at a constant rate…

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Constant growth formula

Constant Growth Formula

  • The summation can be replaced by a single formula:

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The value of operations

The value of operations

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Value of equity

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.

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Value of equity1

Value of Equity

Price per share

= Equity / # of shares

= $351 million / 10 million shares

= $35.10 per share

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A picture of the breakdown of mpr s value

A picture of the breakdown of MPR’s value

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Return on invested capital roic

Return on Invested Capital (ROIC)

ROIC can be used to evaluate MPR’s performance:

ROIC = NOPAT / Total operating capital in place at the beginning of the year

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Roic calculation

ROIC calculation

ROIC09 = NOPAT09 / Capital08

ROIC09 = 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 MPR added value during 2009.

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Economic value added eva tm also called economic profit

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.

  • EP = NOPATt – WACC(Capitalt-1)

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Calculating eva

Calculating EVA

EVA = NOPAT- (WACC)(Begng. Capital)

EVA09 = NOPAT09 – (0.1002)(Capital08)

EVA09 = $39.67104 – (0.1002)(315.0423)

= $39.67104 – $31.56742

= $8.1038 million

(More…)

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Economic profit

Economic profit…

This shows that in 2009 MPR earned about $8 million more than its investors required.

Another way to calculate EP is

EPt = (ROIC – WACC)Capitalt-1

= (0.125923 – 0.1002)$315.0423

= $8.1038 million

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Intuition behind ep

Intuition behind EP

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.

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Applications of the corporate valuation model

Applications of the corporate valuation model

  • Mergers and acquisitions

    • Evaluate how much a target is worth under various operating scenarios

  • Value-based management

    • Make decisions with the goal of increasing the company’s value

  • Fundamental investing

    • Identify firms that are worth more than the current stock price

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