Today’s mission  To get everyone to understand the basics of DCF valuation

Table of Contents 1)What’s Valuation? 2)The Frame Works of the DCF method 3)Case Study: Disco

What’s Valuation?

What is valuation?  The determination of the economic value or asset of a firm

Why Value Value?  A firm’s main target or goal is to maximize shareholder value  Shareholder influence is big in many countries

Types of valuation  Discounted cash flow method  Economic Profit Method  Abnormal Earnings method  Comparable Multiples

The Frameworks for DCF Valuation

What is the DCF method?  Estimates the value of assets based on expected future free cash flows  Discounting it to present value by its cost of capital

The Concept of Present Value(1) If you were given the choice of receiving $100 today or $100 in one year, which would you choose?

Economics Answer: Receive it today TodayOne year from now If interest is 5 percent *1.05 Future value

105/1.05 Discount 100(Present value) /1.05 Discount

In simple terms…..

What are the drivers of valuation?  Breaking down the Enterprise Value formula operating free cash flow ○ NOPLAT created by the firm’s primary division subtrated by its capital spending WACC ○ Weighted average cost of capital

Breaking it down further….. FCF=NOPLAT-Capital Investment Capital Investment=NOPLAT*Investment rate We get…. If we substitute the above equation into the Enterprise value formula we get

The Drivers  ROIC(return on invested capital) The return for every dollar invested  G(growth) NOPLAT growth

What we need  To get ROIC and growth we need NOPLAT, invested capital Rearrange income statement and balance sheet

Rearranging Financial Statements

The balance sheet  Separate the operating investments and non operating investments  Separate by operating assets and liabilities, non operating assets liabilities

The income statement  Separate operating from non operating costs  Subtract operating costs from total revenue to get Net operating Profits less adjusted taxes

Free Cash Flow Free Cash flow=NOPLAT+ Operating costs that don’t incur cash-invested Capital

Multiples  Take Multiples(ratios) between revenue and other income statement parts like costs, EBITDA

Finding the Discount rate

What is the Discount rate?  The discount rate is used for determining the present value of the future cash flows we forecast  In the case of DCF we use WACC(The Weighted average of the cost of capital)

WACC  WACC is the opportunity cost of investors choosing between returns on two different assets to invest in D/V=percentage of fianncing that is debt E/V=Pecentage of financing that is equity T=Tax Kd=cost of debt Ke=cot of equity

Dissecting WACC Cost of equity Beta risk: a number describing a relation of its returns with those financial market as a whole Market risk premium Risk free rate Beta

Forecasting the Future

Why do we do it?  To find future cash flows and discount them to the present

How do we do it?  Forecasting Future Revenues  Using multiples

Future Revenues(1)  looking at sales in by region  Looking at sales by division  Looking at sales by rivals

Future revenues(2)  Finding drivers of revenue Population, product demand, GDP, political aspects  Looking at internal changes Change in corporate governance, IPO,SPO

Putting Everything To Together

Terminal Value  Enterprise Value=FCF + Terminal Value  Terminal value is the present value at a future point in time of all future cash flows with growth constant

Determining Enterprise Value EV=Operating Segment Value +terminal value + extra cash +securities +other non operating asset value

Case Study: Disco

Disco background  Japanese company  Traded on Tokyo Stock exchange  Number one firm in precision cutting

Sales by division

Sales by region

ROIC

Disco’s drivers  Main clients semi conductor manufacturers Semi conductor demand might be a driving force  population

Semi conductors

Population  Population for Japan, Asia, Europe and North America had respective correlations with revenue of Disco by 0.92,0.94,0.96,0.99

Population estimates(UN)

Using population  Taking population growth as growth estimates in Disco’s revenue we get….

Operating free cash flow

Terminal Value and WACC  WACC=2%  Terminal Value=79560(milliios of yen)

Putting everything together  Enterprise Value=168032(millions of yen)  Ideal stock of price=4962

Stock price today=4260 yen Which means……. BUY