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Chapter 2: Valuation overview
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What are we valuing?
Enterprise value (EV): valuing the company’s productive activities
Equity: valuing the shares
Debt: valuing the obligations of the company
Other: options, minority interest, preferred stock, etc.
Enterprise value
Value of the company’s core business activities
Calculated as PV of its future free cash flows (FCF)
Methods of measuring Enterprise Value (EV)
Accounting approach uses book values
Efficient market approach: replace accounting items with their market values
Discounted cash flow (DCF) approach: EV = PV(future FCFs)
3. Simplified DCF (Chapter 4)
4. DCF via pro forma simulation (Chapter 5)
1. Accounting Approach
Step 1: separate operational vs liquid financial assets (cash + marketable securities) in short-term assets and short-term liabilities
Step 2: Move operational current assets to left-side of balance sheet
Step 3: Combine short- and long-term debt items into single financial debt item
Step 4: Calculate net financial debt = financial debt – liquid financial assets
Step 5: Left-hand side of resulting balance sheet is firm’s Enterprise Value
1. Accounting approach
1. Accounting approach
1. Accounting approach
2. Efficient markets approach
Step 1: Like the accounting approach, move productive assets on the left, financial assets on the right
Step 2: To the extent possible, replace accounting book values with market values
2. Efficient markets approach
2. Efficient markets approach
2. Efficient markets approach
2. Efficient markets approach
2. Efficient markets approach
Discounted Cash Flow approaches
Discounted cash flow (DCF) approaches
Simplified DCF approach: quick, useful, enlightening
Full pro forma approach: model future financial statements
What is Free Cash Flow (FCF)? Cash from firm’s core business activities
Profit after tax + Depreciation – Current assets + Current liabilities – CapEx + (1 – tax rate) * Net interest
EBITDA * (1 – tax rate)+Depreciation*tax rate – Current assets + Current liabilities – CapEx
CF Operations – CapEx + (1 – tax rate) * Net interest (from Chapter 4)
Discounted Cash Flow approaches
For all cash flow approaches:
Discounted Cash Flow approaches
Two adjustment to formula:
Terminal value: The PV of cash flows from year N onwards
Mid-year discounting: Cash flows occur at mid-year, not at end-year
Discounted Cash Flow approaches
Most common terminal value model
3. Simplified Approach to DCF valuation
Covered in Chapter 4
Only 4 parameters
Current free cash flow, FCF
Derive from Consolidated Statement of Cash Flows
Weighted average cost of capital, WACC
Short-term FCF growth
Long-term FCF growth
3. Simplified Approach to DCF valuation
4. DCF via Pro Forma model
Model relevant items of the Balance Sheet, Income Statement
Derive free cash flows (FCF)
Covered in Chapter 5
4. DCF via Pro Forma model
4. DCF via Pro Forma model
4. DCF via Pro Forma model – valuation
Assets Liabilities and equity
Short-term assets Short-term liabilities
Cash 1,000Accounts payable 1,500
Marketable securities 1,500Taxes payable 200
Inventories 1,500Current portion of long-term debt 1,000
Accounts receivable 3,000Short-term debt 500
Fixed assets Long-term debt 1,500
Land 150Pension liabilities 800
Plant, property and equipment at
Minus accumulated depreciation -700Preferred stock 200
Net fixed assets Minority interest 100
Goodwill 1,000Stock at par 1,000
Accumulated retained earnings 3,500
Stock repurchases -350
Total assets 9,950Total liabilities and equity 9,950
XYZ CORP BALANCE SHEET
Assets Liabilities and equity
Liquid assets (cash +
marketable securities)
2,500 Financial debt
Current portion of long-
Current assets, operational Short-term debt 500
Inventories 1,500 Long-term debt 1,500
Accounts receivable 3,000 Total financial debt 3,000
Minus, current liabilities, operational
Accounts payable -1,500
Taxes payable -200 Pension liabilities 800
Net working capital 2,800
<-- =SUM(B6:B10)
Preferred stock 200
Fixed assets 1,950 Minority interest 100
Goodwill 1,000 Equity 4,150
Left-hand side of rewritten
balance sheet
=B11+B13+B15+SUM
Right-hand side of
rewritten balance sheet
=E7+E10+SUM(
XYZ BALANCE SHEET
Operational current liabilities moved to left side
All financial liabilities in one account on right side
Assets Liabilities and equity
Net working capital
2,800 Total financial debt 3,000
Minus liquid assets -2,500
Fixed assets 1,950 Net debt 500
Goodwill 1,000 Pension liabilities 800
Preferred stock 200
Minority interest 100
Equity 4,150
Enterprise value 5,750
<-- =B3+B5+B7
Enterprise value 5,750
<-- =E5+E7+SUM(E9:E12)
XYZ ENTERPRISE VALUE BALANCE SHEET
Current assets Current liabilities
Cash and cash equivalents
3,057,000Accounts payable 16,946,000
Short-term investments
Short-term debt 9,648,000
Net receivables
19,533,000Other current liabilities 1,967,000
14,544,000Total current liabilities 28,561,000
Other current assets
Total current assets
38,128,000Long-term debt 24,944,000
Other liabilities 14,539,000
Long-term investments
13,211,000
Property, plant and equipment
14,395,000Minority interest 46,000
7,080,000Total liabilities 68,090,000
Intangible assets
Other assets
2,107,000Stocks, options, warrants 473,000
Deferred long-term asset charges
2,157,000Common stock 4,273,000
Retained earnings 25,219,000
Treasury stock -10,281,000
Other stockholder equity -6,328,000
Total equity 13,356,000
Total assets
81,446,000Total equity and liabilities 81,446,000
CATERPILLAR CORP., BALANCE SHEET
31 December 2011
Net working capital 16,158,000<--
=19533000+1454
4000+994000-
Net financial debt 31,535,000<--
=9648000+24944000-
Long-term investments 13,211,000 Other liabilities 14,539,000
Property, plant and equipment 14,395,000
Goodwill 7,080,000 Minority interest 46,000
Intangible assets 4,368,000
Other assets 2,107,000 Equity 13,356,000
Deferred long-term asset charges 2,157,000
Enterprise value 59,476,000
<-- =SUM(B2:B8)
Enterprise value 59,476,000
<-- =SUM(E2:E7)
CATERPILLAR CORP., 2011 ENTERPRISE VALUE BALANCE SHEET
Book values
Net working capital 16,158,000<--
=19533000+1454
4000+994000-
Net financial debt 31,535,000<--
=9648000+24944000-
Long-term investments 13,211,000 Other liabilities 14,539,000
Property, plant and equipment 14,395,000
Goodwill 7,080,000 Minority interest 46,000
Intangible assets 4,368,000
Other assets 2,107,000 Equity 56,599,878
<-- Market cap
Deferred long-term asset charges 2,157,000
Enterprise value 59,476,000
<-- =SUM(B2:B8)
Enterprise value 102,719,878
<-- =SUM(E2:E7)
CATERPILLAR CORP., 2011 ENTERPRISE VALUE BALANCE SHEET
Replace equity book value with equity market value
Number of shares outstanding 624,722.72
<-- thousand shares
Price per share 90.60
<-- 30dec2011
Equity value ("Market Cap") 56,599,878
<-- =B2*B3, thousand $
Cash and cash equivalents 3,057,000
Short-term debt and current portion of long-term debt
Long-term debt 24,944,000
Net debt 31,535,000
<-- =SUM(B7:B8)-B6
Other liabilities 14,539,000
Minority interest 46,000
Preferred stock 0
Enterprise value: Equity + Net debt
+ Minority Interest + Preferred
102,719,878<-- =SUM(B4,B9,B11,B13)
CATERPILLAR VALUATION OF EQUITY AND FINANCIAL LIABILITIES:
EFFICIENT MARKETS APPROACH
Most figures in thousand $
Net working capital 16,158,000<--
=19533000+1454
4000+994000-
Net financial debt 31,535,000<--
=9648000+24944000-
Long-term investments Other liabilities 14,539,000
Property, plant and equipment
Goodwill Minority interest 46,000
Intangible assets
Other assets Equity 56,599,878
<-- Market cap
Deferred long-term asset charges
Enterprise value 102,719,878
<-- =SUM(B2:B8)
Enterprise value 102,719,878
<-- =SUM(E2:E7)
CATERPILLAR CORP., 2011 ENTERPRISE VALUE BALANCE SHEET
Right-hand side revalued at market values
Left-hand side brought into balance with right-hand side by adjusting long-term assets
86,561,878<-- =E10-B2
Computed with Excel's NPV function
FCFTerminalvalue
FCFTerminalvalue
144444424444443
growth rate of cash flows, years N+1, N+
WACC-LTgrowth
Free cash flow (FCF)
year ending 31 Dec. 2012
Growth rate of FCF, years 1-5 8.00%<-- Optimistic about short-term growth
Long-term FCF growth rate 5.00%<-- More pessimistic about long-term growth
Weighted average cost of capital, WACC 10.70%
Year 201220132014201520162017
FCF 640,738691,997747,357807,145871,717<-- =F8*(1+$B$3)
Terminal value 16,057,940<-- =G8*(1+B4)/(B5-B4)
Total 640,738691,997747,357807,14516,929,657<-- =G8+G9
Enterprise value 13,063,055<-- =NPV(B5,C10:G10)*(1+B5)^0.5
Add back initial cash and marketable
securities
73,697<-- From current balance sheet
Subtract out 2012 financial liabilities 1,379,106<-- From current balance sheet
Equity value 11,757,646<-- =B12+B13-B14
Per share (1 million shares outstanding) 11.76<-- =B15/1000000
ABC CORP. VALUATION
Sales growth 10%
Current assets/Sales 15%
Current liabilities/Sales 8%
Net fixed assets/Sales 77%
Costs of goods sold/Sales 50%
Depreciation rate 10%
Interest rate on debt 10.00%
Interest paid on cash and marketable securities 8.00%
Tax rate 40%
Dividend payout ratio 40%
Year 012345
Income statement
1,000 1,100 1,210 1,331 1,464 1,611
Costs of goods sold
(500) (550) (605) (666) (732) (805)
Interest payments on debt
(32) (32) (32) (32) (32) (32)
Interest earned on cash and marketable securities
6 9 14 20 26 33
Depreciation
(100) (117) (137) (161) (189) (220)
Profit before tax
374 410 450 492 538 587
(150) (164) (180) (197) (215) (235)
Profit after tax
225 246 270 295 323 352
(90) (98) (108) (118) (129) (141)
Retained earnings
135 148 162 177 194 211
PRO FORMA FINANCIAL MODEL
Balance sheet
Cash and marketable securities
80 144 213 289 371 459
Current assets
150 165 182 200 220 242
Fixed assets
1,070 1,264 1,486 1,740 2,031 2,364
Depreciation
(300) (417) (554) (715) (904) (1,124)
Net fixed assets
770 847 932 1,025 1,127 1,240
Total assets
1,000 1,156 1,326 1,513 1,718 1,941
Current liabilities
80 88 97 106 117 129
320 320 320 320 320 320
450 450 450 450 450 450
Accumulated retained earnings
150 298 460 637 830 1,042
Total liabilities and equity
1,000 1,156 1,326 1,513 1,718 1,941
Year 012345
Free cash flow calculation
Profit after tax 246270295323352
Add back depreciation 117137161189220
Subtract increase in current assets (15)(17)(18)(20)(22)
Add back increase in current liabilities 89101112
Subtract increase in fixed assets at cost (194)(222)(254)(291)(333)
Add back after-tax interest on debt 1919191919
Subtract after-tax interest on cash and mkt. securities (5)(9)(12)(16)(20)
Free cash flow
176188201214228
Valuing the firm
Weighted average cost of capital 20%
Long-term free cash flow growth rate 5%
Year 012345
FCF 176188201214228
Terminal value 1,598<-- =G58*(1+B55)/(B54-B55)
Total 1761882012141,826
Enterprise value, present value of row 60 1,348<-- =NPV(B54,C60:G60)*(1+B54)^0.5
Add in initial (year 0) cash and mkt. securities 80<-- =B27
Asset value in year 0 1,428<-- =B63+B62
Subtract out value of firm's debt today (320)<-- =-B36
Equity value 1,108<-- =B64+B65
Share value (100 shares) 11.08<-- =B66/100
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