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Valuation

Valuation. FIN 449 Michael Dimond. Calculating Free Cash Flow to Equity. FCFE = Net income – Net investment + Net debt issued . Net Investment. Net investment = (Capital expenditures – Depreciation) + Increase in noncash working capital. CapEx. Line item on Statement of Cash Flows?

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Valuation

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  1. Valuation FIN 449Michael Dimond

  2. Calculating Free Cash Flow to Equity FCFE = Net income – Net investment + Net debt issued

  3. Net Investment Net investment = (Capital expenditures – Depreciation) + Increase in noncash working capital

  4. CapEx Line item on Statement of Cash Flows? Calculate the changes (from year to year) of ALL long-term assets shown on the balance sheet. Find the total amount (for a given year) shown in the “Investing” section of the Statement of Cash Flows. Issues?

  5. Depreciation “Basic definition” of net cash flow = net income + depreciation Non-cash expense In the “balance sheet” approach to define capital expenditures, depreciation is usually not incorporated explicitly. Why not? If the “Statement of Cash Flows” approach is used, one must explicitly subtract depreciation from capital expenditures (shown in the “Operating” section of the Statement of Cash Flows)

  6. Non-cash Working Capital Noncash working capital = (current assets – cash) – current liabilities… what else? Noncash working capital = (current assets – cash) – (current liabilities – interest bearing debt included in current liabilities) Why? Why not include cash?

  7. Net Debt Issued “Net” debt issued implies that one must take both debt issuances AND repayments into account Discussion: Constant Debt Ratio Suppose a firm always finances new investment with a fixed debt ratio (say, 30% debt and 70% equity, for example). The general equation for FCFE couldbe expressed as follows: FCFE = Net income – (1 – debt ratio)(Net investment) OR FCFE = Net income – (equity ratio)(Net investment)

  8. Free Cash Flow to Equity FCFE = Net income – Net investment + Net debt issued

  9. Damodaran has resources online • http://pages.stern.nyu.edu/~adamodar/ • His spreadsheets are not always as helpful as you might want… • An example of a valuation summary he did in 2008

  10. What Damodaran’s valuation summary looks like: September 2008

  11. What Damodaran’s valuation summary looks like: October 2008

  12. Bear in mind, these were a summary. We will ultimately want something more detailed for a working document.

  13. What does the DCF Model look like? • What drives the figures? • How sensitive are they to basic inputs?

  14. To start, compute historic FCFF & FCFE for the past 5 years FCFF = NI + Int(1-t) + Depr - ΔFA - ΔNWC FCFE = NI + Depr - ΔFA - ΔNWC + ΔDebt - PfdDiv FCFF = FCFE + Int(1-t) - ΔDebt + PfdDiv FCFE = FCFF - Int(1-t) + ΔDebt - PfdDiv • How accurate would it be to extrapolate the future cash flows from the past FCFE figures? • In other words, can we simply assume FCFE will grow X% forever? • Here are the historic FCFE for a company: • Instead, we project the drivers of these figures for the future. • Compute FCFF & FCFE based on the forecast figures

  15. Relationships in financials drives FCFF & FCFE We will start with financial statements and forecast expected reportings, then adjust to find expected future cash flows

  16. Relationships in financials drives FCFF & FCFE We will start with financial statements and forecast expected reportings, then adjust to find expected future cash flows

  17. We need to assess sensitivity to assumptions • What drives the figures? • How sensitive are they to basic inputs?

  18. We need to assess sensitivity to assumptions • What drives the figures? • How sensitive are they to basic inputs?

  19. Building the sensitivity table

  20. Building the sensitivity table What’s in the yellow cell in the middle of the table? (easier to click cells than type references) = ( NPV( $E223, $H$206, $I$206, $J$206, $K$206, $L$206+ ($L$206*(1+I$218)/($E223-I$218)) ) +$G$209) /$G$211 You should be able to paste the foumula into the remaining cells in the table and get the correct results. equals group everything together PV of cash flows Ke from the sensitivity table CF1 CF2 CF3 CF4 CF5 plus… terminal value, using %s in table close the NPV function add the cash divide by the number of shares

  21. Coming up Strawman exercise Template on the course webpage Final version due via email by midnight Sunday 4/20 Mini-projects 1 & 2 Begin valuation #1

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