Corporate Valuation Institut for Regnskab, IC Pontoppidan Agenda Exam DATE ?? Last session this lecture next –who presents ? –Mid stage report: 1A4 “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

Corporate Valuation Institut for Regnskab, IC Pontoppidan 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

Corporate Valuation Institut for Regnskab, IC Pontoppidan Framework for valuation DCF enterpricemodel value of operations based on forecast less value of debt discounted back with riskadjusted rate regulated for non-operating assets/liabilities The discount rate reflects the opportunity cost of all capital (WACC, tax shield)) 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

Corporate Valuation Institut for Regnskab, IC Pontoppidan Framework for valuation Growth rate = ROnewIC # investment rate Key drivers of value are ROIC (relative to WACC) and growth p.140 ECONOMIC PROFIT MODEL V = capital invested + PVvalue created in the future economic profit = invested capital#(ROIC- WACC) or NOPLAT-(inv.cap.#WACC)

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

Corporate Valuation Institut for Regnskab, IC Pontoppidan Step 1 (ch.9) Analyzing Historical Performance 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 how is the liquidity balance (Donaldson) destinguish operating from non-operating ending with consistency between NOPLAT and operating invested capital

Corporate Valuation Institut for Regnskab, IC Pontoppidan Analyzing Historical Performance Convert tax to cash basis as tax expensed on operating profit add quasi-equity (reserves,provisions, deferred income tax) exclude extraordinary items and add goodwill amortizations capitalize expensed investments (R&D,marketing) FCF = NOPLAT - Net investments check the investment rate FX translation effects are treated as non- operating cash flow look for trends and compare with industry

Corporate Valuation Institut for Regnskab, IC Pontoppidan Analyzing Historical Performance Do not correct for inflation effect unless in a high inflation environment IF lumpy investments - spread it out or utilyze CFROI Valuation

Corporate Valuation Institut for Regnskab, IC Pontoppidan Step 2 (ch.10) Cost of Capital WACC market weights target capital structure only systematic risk look out for changes in inflation, systematic risk, capital structure, and market weights FX is valued with FX interest rates and converted at spot rate market risk premium 2 -5 % US check your beta ! And leverage it correct p.309

Corporate Valuation Institut for Regnskab, IC Pontoppidan Step 3 (ch.11) Forecast performance How the company may develop length and level of detail –steady state –full cycle –perhaps two periods what about terminal period (see ch. 12) have a strategy model e.g.strategic perspective considering the industry (Ghemawat) and competitive position (e.g. 2#Porter) what drives the forecast (demand, technology, ?) alternative scenarios check for consistency

Corporate Valuation Institut for Regnskab, IC Pontoppidan Step 4 (ch.12) Continuing Value PV of cash flow after the explicit forecast period simplified assumptions makes 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 (PtB, PtE, liquidation value, replacement cost) p.277 Where is value created !

Corporate Valuation Institut for Regnskab, IC Pontoppidan Step 5 (ch.13) Calculating and interpreting the results Discount FCF using WACC discount continuing value using WACC add value of nonoperating assets subtract value of debt check for consistence with forecast compare with present market value evaluate debt-equity forecast compare the scenarios and assess the likelihood define your margin of error/ test sensitivity

Corporate Valuation Institut for Regnskab, IC Pontoppidan Aggarwal 16 Justifying strategic investments Has the manufacturing setup an impact on value ? Different types of man.systems -fig.16-1 optimality of man.setup -fig.16-2 Exit NPV assesses the risk of loss due to uncertain events