Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 1 Agenda Last session This lecture Next “Valuation depends mainly on understanding the business, its industry, and the general economic environment, and then doing a prudent job of forecasting. Correct methodology is only a small, but necessary, part of the valuation process” p.292

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 2 CMK 8 Framework for valuation Models DCF enterprice Economic Profit (EP) APV (changing cap.structure) DCF equity (fin.institutions) add on’s options nominal vs. real pre-post tax formulae instead of explicit forecast

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 3 Framework for valuation DCF enterpricemodel value of operations based on free cash flow forecast discounted back with risk adjusted rate less value of debt regulated for non-operating assets / liabilities The discount rate reflects the opportunity cost of all capital (WACC, tax shield), eg. exhibit 8.5. Forecast for 100 years OR utilize a formula for the last 90 years - giving the continuing value, whose formula is composed of NOPLAT, growth, ROIC - and WACC p.136

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 4 Framework for valuation Growth rate = ROnewIC * investment rate, p Investment rate = Net Investments / NOPLAT = (Gross Investments - depreciation) / NOPLAT Key drivers of value are ROIC (relative to WACC) and growth, exhibit 8.8. ECONOMIC PROFIT MODEL V = capital invested + PV-value created in the future - debt +/- non-operating assets/liabilities economic profit = invested capital*(ROIC- WACC) or NOPLAT-(inv.cap.*WACC)

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 5 Framework for valuation ADJUSTED PV MODEL (APV) values based only on cost of equity and then adds value of tax benefit of debt (tax shield) DCF-equity MODEL values the equity DIRECTLY based on cost of equity BUT get the leverage right ! 5 STEP “how to do” in ch.9-13

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 6 Step 1 (ch.9) Analyzing Historical Performance Reorganize accounting statements to be able to calculate NOPLAT, free cash flow & operating capital Focus on key value drivers i.e. ROIC and growth Break them down into their component drivers i.e. ROIC into cap.turnover and profit margin, cf. exhibit 9.8 Distinguish operating from non-operating Ending with consistency between NOPLAT and operating invested capital How is the liquidity balance, p (Donaldson)

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 7 Analyzing Historical Performance NOPLAT: Convert tax to cash basis as tax expensed on operating profit (eg. exhibit 9.4) Add quasi-equity (reserves, provisions, deferred income tax) to invested capital, adjust NOPLAT if necessary to secure consistency (eg. exhibit 9.10 & p. 179) Extraordinary items should not be included in NOPLAT calculations Goodwill amortization is not deducted in NOPLAT (operating capital should be calculated both inclusive and exclusive goodwill resulting in two ROIC-measures) ROIC = NOPLAT / Invested capital FCF = NOPLAT - Net investments = (NOPLAT + depreciation) - Gross Investments

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 8 Analyzing Historical Performance Do not correct for inflation unless in a high inflation environment IF lumpy investments - spread it out or utilize CFROI Valuation, cf. p Expensed investments (R&D, marketing) could be capitalized and depreciated, p Foreign exchange translation effects are treated as non-operating cash flow Operating leases should be capitalized if material, p Minority interest: earnings = financing cost; cash flow (dividend) = financing flow, p. 180.

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 9 Analyzing Historical Performance: Output NOPLAT & Free Cash Flow-statements Cash flow available to investors = Total financing flow, Exhibit 9.7 Operating invested capital (ex. & incl. Goodwill) Total investor funds (assets) = Total investor funds (liabilities), Exhibit 9.3 Debt, equity, non-operating liabilities and assets. ROIC, ROIC-tree, and growth (in revenues and NOPLAT) + Economic Profit Credit health and liquidity Look for trends and compare with industry Linking economic measures (ROIC & growth) to historic development in: Industry Competitors Stock markets

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 10 Step 2 (ch.10) Cost of Capital WACC Market weights should be used Use target capital structure Look out for changes in inflation, systematic risk, capital structure, and market weights over the time horizon CAPM for cost of equity Market risk premium 4 - 5% in US Risk free rate: use a 10-year Treasury bond Check your beta ! And leverage it correct (p ) Debt in foreign exchange is valued with foreign exchange interest rates and converted at spot rate

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 11 Step 3 (ch.11) Forecast performance How the company may develop Length and level of detail the explicit forecast should cover a full cycle one or two explicit periods + terminal period (see ch. 12) the forecast should be explicit until steady state Have a strategic perspective considering the industry (Ghemawat) and competitive position (e.g. 2*Porter)

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 12 Forecast performance Historical performance ROIC, growth in revenues, EBITA, NOPLAT, investments, free cash flow, etc. Strategic context SWOT, competitive advantages, competitors, industry structure (Porter), value chain, PEST (politics, economics, social & technology), etc. Changes Future performance ROIC, growth in revenues, EBITA, NOPLAT, investments, free cash flow, etc. Value Cause Continuity, consistency

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 13 Forecast performance Good idea to develop a strategic perspective about the company’s future performance, eg: ”Demand is increasing rapidly because of changing demographics, yet prices will remain stable …”, p (or Heineken, p. 252) Should be formulated with basis in the strategic context Should be consistent with the historical performance Future performance should be derivable from the strategic perspective Follow the advise on p. 241 in establishing exh & p Alternative scenarios, e.g. exhibit 11.7 Check for consistencies, e.g. exhibit 11,25, 11.27, 9.19

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 14 Step 4 (ch.12) Continuing Value PV of cash flow after the explicit forecast period Simplified assumptions make formulas do the impossible job Different formulas for different approaches For DCF enterprise the value-driver formula = NOPLAT t+1 (1-g/ROIC)/ WACC-g Also non-cash flow based approaches in special situations (Price to earnings, Market to book, liquidation value, replacement cost)

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 15 Step 5 (ch.13) Calculating and interpreting the results Discount FCF using WACC Discount continuing value using WACC Add value of non operating assets Subtract value of non operating liabilities Mid-year adjustment. Subtract value of debt Compare with present market value Evaluate debt-equity forecast / balance sheet Compare the scenarios and assess the likelihood Define your margin of error / test sensitivity

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 16 Aggarwal 16 Justifying strategic investments Has the manufacturing setup an impact on value ? Different types of man.systems - fig.16-1 Optimality of manufacturing setup - fig.16-2

Institut for Regnskab, Tom Hansen Corporate Valuation, , p. 17 NEXT October Workshop Dialogue and coaching Exercise 12.4 Lectures: Options (chap. 20, Kasanen, 2* Luehrman) Remember mid stage report on 21 October One pager (1 A4) per group to me How is things going ·information gathering, work plan, outline of report, model building, valuation method, etc.