1. THE CREATION AND CALIBRATION OF VALUE
ENTREPRENEURIAL FINANCE
Leach & Melicher
Chapter 9
THE CREATION AND CALIBRATION OF VALUE
© 2003 South-Western College Publishing

2. CHAPTER 9: LEARNING OBJECTIVES
Explain how the time pattern of cash flows relates to venture value
Describe how valuation incorporates projections of near and long-term success
Extract the necessary valuation data from projected financial statements
Put the pieces together for a unified treatment of financial projections and valuation

3. WHAT IS A VENTURE WORTH?
Going-concern value: present value of the venture’s expected future cash flows
Present value (PV): value today of all future cash flows discounted to the present at the investor’s required rate of return

4. BASIC MECHANICS OF VALUATION
Discounted cash flow (DCF): valuation approach involving discounting future cash flows for risk and delay
Explicit forecast period: two- to ten-year period in which the venture’s financial statements are explicitly forecast
Terminal (or horizon) value: value of the venture at the end of the explicit forecast period
Stepping stone year: first year after the explicit forecast period

5. BASIC MECHANICS OF VALUATION

6. BASIC MECHANICS OF VALUATION
Reversion value: present value of the terminal value
Net present value (NPV): present value of a set of future flows plus the current undiscounted flow

7. EQUITY VALUATION CASH FLOWS
Net Income
+ Depreciation and Amortization Expense
- Change in Net Working Capital (w/o surplus cash)
- Capital Expenditures
+ Net Debt Issues

8. EQUITY VALUATION CASH FLOWS
Equity Valuation Cash Flow for PDC Company
Net Income $6,372
+ Deprec. & Amort. Exp. +4,600
- Change in NWC (w/o surplus cash) +2,415
- Capital Expenditures - 6,900
+ Net Debt Issues
= Equity Valuation Cash Flow $6,487

9. EQUITY VALUATION: MAXIMUM DIVIDEND METHOD
Maximum dividend method (MDM): valuation method involving explicitly forecasted dividends to provide surplus cash of zero
Value of venture = equity valuation cash flow + sum of discounted maximum dividend/issue stream

10. EQUITY VALUATION: MAXIMUM DIVIDEND METHOD
Formally project all cash surpluses as paid out as dividends
Balance sheet will have zero for all surplus cash balances
Venture’s equity can be valued directly using dividends/issue line in CF Statement (or by equity VCF method)
No excess cash in end

11. PDC PROJECTED INCOME STATEMENTS w/ Yearly Surplus Cash Paid as Dividends

12. PDC PROJECTED INCOME STATEMENTS w/ Yearly Surplus Cash Paid as Dividends

13. EQUITY VALUATION: MAXIMUM DIVIDEND METHOD

14. PDC’s PROJECTED BALANCE SHEET w/ Yearly Surplus Cash Paid as Dividends

15. PDC’s PROJECTED BALANCE SHEET w/ Yearly Surplus Cash Paid as Dividends

16. PDC’s PROJECTED CASH FLOW STATEMENT w/ Yearly Surplus Cash Paid as Dividends

17. PDC’s PROJECTED CASH FLOW STATEMENT w/ Yearly Surplus Cash Paid as Dividends

18. PDC’s Spreadsheet for Equity Valuation Cash Flows & Value

19. EQUITY VALUATION: PSEUDO DIVIDEND METHOD (PDM)
PDM: valuation method involving zero explicitly forecasted dividends and an adjustment to working capital to strip surplus cash
Pseudo dividends, or dividends that could be paid but are retained inside the venture are valued
Pseudo dividends do not appear on any projected financial statement

20. EQUITY VALUATION: PSEUDO DIVIDEND METHOD (PDM)
Formally retain all cash surpluses in surplus cash account
Project all dividends at zero
Value venture’s equity using equity VCF with working capital calculations that omit surplus cash
Projected balance sheets indicate surplus cash balances treated by valuation as already paid. Can’t be added to terminal value or stripped out again.

21. PDC PROJECTED INCOME STATEMENTS w/ Retained Surplus Cash

22. PDC PROJECTED INCOME STATEMENTS w/ Retained Surplus Cash

23. PDC’s PROJECTED BALANCE SHEET w/ Retained Surplus Cash

24. PDC’s PROJECTED BALANCE SHEET w/ Retained Surplus Cash

25. PDC’s PROJECTED CASH FLOW STATEMENT w/ Retained Surplus Cash

26. PDC’s PROJECTED CASH FLOW STATEMENT w/ Retained Surplus Cash

27. PDC’s Spreadsheet for Equity Valuation Cash Flows & Value

28. EQUITY VALUATION: DELAYED DIVIDEND APPROXIMATION (DDA)
Valuation method involving zero dividends in the explicitly forecasted period with initial dividend at the terminal
Treats all required & surplus cash as investments in the venture’s working capital and provides same return as cash invested in venture operations

29. EQUITY VALUATION: DELAYED DIVIDEND APPROXIMATION (DDA)
Formally retain all cash surpluses on balance sheet & in valuation
Pay catch-up dividend in last year of explicit forecasting period and pay all surplus cash thereafter as explicit dividends
Value firm by its dividends (or equity VCF)

30. EQUITY VALUATION: DELAYED DIVIDEND APPROXIMATION (DDA)
Resulting value will be lower than that found by other approaches due solely to delay in crediting venture for creating surplus cash (which eventually becomes dividend or other flow to equity)

31. PDC PROJECTED INCOME STATEMENTS w/ First Dividend in Year 5

32. PDC PROJECTED INCOME STATEMENTS w/ First Dividend in Year 5

33. PDC PROJECTED INCOME STATEMENTS w/ First Dividend in Year 5

34. PDC PROJECTED INCOME STATEMENTS w/ First Dividend in Year 5

35. PDC’s PROJECTED BALANCE SHEET w/ First Dividend in Year 5

36. PDC’s PROJECTED BALANCE SHEET w/ First Dividend in Year 5

37. PDC’s PROJECTED BALANCE SHEET w/ First Dividend in Year 5

38. PDC’s PROJECTED BALANCE SHEET w/ First Dividend in Year 5

39. PDC’s PROJECTED CASH FLOW STATEMENT w/ First Dividend in Year 5

40. PDC’s PROJECTED CASH FLOW STATEMENT w/ First Dividend in Year 5

41. PDC’s PROJECTED CASH FLOW STATEMENT w/ First Dividend in Year 5

42. PDC’s PROJECTED CASH FLOW STATEMENT w/ First Dividend in Year 5

43. PDC’s Spreadsheet for Equity Valuation Cash Flows & Value

44. PDC’s Spreadsheet for Equity Valuation Cash Flows & Value