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A Complete Corporate Valuation for a Simple Company

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A Complete Corporate Valuation for a Simple Company

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- 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.

DES Chapter 2

- 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!

DES Chapter 2

- 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.

DES Chapter 2

- 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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- 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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- 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, rs, is higher than cost of debt because stock is riskier.
- MPR: rs = 12%

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- 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….)

DES Chapter 2

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

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

= 10.02%

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

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- Balance sheet
- Assets (all of MPR’s assets are used in operations)
- Operating assets
- Operating current assets
- Property, plant, and equipment (PPE)

- Operating assets

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

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- 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 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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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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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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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

DES Chapter 2

- 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)

DES Chapter 2

NOPAT= (Operating profit) (1-T)

= EBIT (1-T)

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

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- 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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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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NOWC = Operating CA – Operating CL

NOWC09 = $176.4 – $66.15

= $110.25 million

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

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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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- 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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FCF = NOPAT – Investment in operating capital

FCF09 = $39.67104 – (330.75 – 315.0423)

= $39.67104 – $15.7077

= $23.96334 million

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

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- 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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- The summation can be replaced by a single formula:

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- 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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Price per share

= Equity / # of shares

= $351 million / 10 million shares

= $35.10 per share

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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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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.

DES Chapter 2

- 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)

DES Chapter 2

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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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

DES Chapter 2

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.

DES Chapter 2

- 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

DES Chapter 2