Valuation Summary

Topics: Free cash flow, Discounted cash flow, Capital asset pricing model Pages: 5 (1372 words) Published: April 15, 2013
Valuation methods:
1. Introduction:
-Enterprise value = Equity (number of shares * shares price, or, if not traded, Market value of the Equity) + Debt ( without accounst payable)

2. Main Valuation Methods:

A) Fundamental Method or Discounted Cash flow method:
Enterprise value = Present value=CF11+r+CF21+r^2+…+CFn 1+r^n.+ Terminal Value

In the cash flow calculation the working capital = Acc receivable + inventory – Acc payable (you don’t include cash because even if sales vary it doesn’t mean cash vary in the same shape)… In this model the r= WACC (weighted average cost of capital)

How do we calculate the WACC?

E is market value of Equity. If the company is traded, E equals its market capitalization (number of shares x share price). If the company is not trade, then we must estimate E using the Price Earning Ratio (PER) of companies in the same sector and then make E=PER x Net profit of the company; Debt is market value of debt. In practical terms, we can assume that the book value of debt equals the market value of Debt :

WACC=Ke*EE+D+Kd*DE+D*(1-taxe rate)

What Does Ke Cost Of Equity Mean?
Ke cost of equity is the return a firm theoretically pays to its equity investors such as shareholders. To determine Ke we use the CAPM model

What Does Kd Cost Of Debt Mean?
The effective rate that a company pays on its current debt. To determine Kd we can use the current bank interest rate the company is paying.

How to calculate the Ke return or cost of equity? : CAPM model:

Capital asset pricing model:
CAPM's starting point is the risk-free rate Rf (typically a 20 or 30-year government bond yield, the longest possible period). The right formula to compute this Ke is:
Ke=Rftoday+βEquity Risk Premium+ size premium. With β being the B of the Equity (or levered beta). The Equity risk premium can be calculated using IBBOTSON Valuation Yearbook. The most accurate estimate is the “Long Horizon Equity Risk Premium (supply side)” because it includes an estimate of TODAY’s expectations on equity risk premia, not purely based on historical data but also on current market data. The “size premium” is the return of small company stocks in excess of that predicted by the CAPM. It is the additional return that cannot be explained by the betas of small companies.” This change to CAPM formula results in a higher Cost Of Equity for small stocks due to both higher Beta and size premium that increases as the company gets smaller. It can be determined each year looking at IBBOTSON Valuation Year Book (table “Size Premia according to the company’s market capitalization) The beta of the equity can be calculated under the assumption that two companies in the same industry tend to have the same Beta of the ASSETS (or levered beta). The Beta of the assets (corrected for cash, the right one to use) can be found for free on Damodaran Online, Data set section. (see links below). The Beta of the assets for the corresponding industry or sector needs to be re-levered according to the D/E structure of the firm we want to value. There are two main formulas that are being used in professional valuations:

* Practitioners formula : βu = βl * ED+E so β= βl=βu*(1+ DE)

* Damodaran formula: β= βl=βu+βu* DE*1-T

So if there is no debt in the company: WACC=Ke and βa= βe.

How do we calculate the FREE CASH FLOWS?

The correct method to calculate the Unlevered Free Cash Flow for valuation purposes is:

NOPLAT (net income without the interest )
+ depreciation+ amortization
- ∆Net working capital
– capex.

NOPLAT stands for Net Operating Profit les Adjusted Taxes. The Way to calculate the NOPLAT for year t is:

1- Take the projected Profit and Loss statement for year t 2- Remove all the financial expenses (interests) or financial income 3- Recalculate the taxes (“adjusted taxes”)
4- Determine the new After tax profit after removing interests and adjusting taxes accordingly: This is...
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