1. Daves Chapter 4 Estimating the Value of ACME
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2. Steps in a valuation Estimate cost of capital (WACC)
Debt
Equity
Project financial statements and FCF
Calculate horizon value
Discount at WACC to Calculate VOPS
Calculate value of equity
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3. Estimating the required return on the components of WACC
ACME has debt and equity
Cost of capital for each type of financing depends on its risk, as perceived by investors, and taxes.
Higher risk securities = higher required return.
If payments (like interest) are deductible, then cost to firm is lowered.
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4. Acme's WACC
Debt: Acme has 2 types: short-term and long-term. S/T i = 9%.
L/T: 8%, semi-annual coupon, 26 years left to maturity, % of par each. What is its cost of debt?
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5. Bond prices
In general, bond price depends on its coupon payments, its maturity, and its risk (YTM).
Bonds pay $40 every 6 months, and maturity in 26 years.
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6. Bond prices M is the maturity value, or $1,000 for ACME
rC is the coupon rate, or 0.08, which is 8% for ACME
n is the maturity, or 26 x 2 = 52 6-month periods.
rD is the discount rate.
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7. ACME’s bond price
A financial calculator or a spreadsheet can be used to solve for rD, which is 4.5% for a 6-month period, or 9% per year.
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8. Bond prices & i VB = bond’s price today = $900.15
M=Maturity Value = FV = <$1,000>
rc = Coupon %= 8% = Pmt = .08($1,000)/2 = $80/2=<$40>
n = periods to maturity = 26 years x 2 periods/yr = 52
Rd = discount % = i = YTM = ? = 4.5% x 2 periods = 9%
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9. Calcuating the Yield to Maturity for a Bond
Year
Month
Day
2003 8 20
Input the bond's settlement date in these cells. Technically, bonds "settle" a couple of days after the "purchase" date, but that will have virtually no impact on the calculated yield. So entering today's date is fine for the purpose of calculating yield.
2029 15
Input the bond's maturity date in these cells.
8.000%
Input the coupon rate here. For a 5% coupon bond, enter 5%.
90.015
Input the bond's price. Most sources quote prices as a percent of par, so enter the percent here. For example, if the quoted price percent, enter If the price is quoted in dollars, enter it as a percent of par. For example, if the quoted price is $9,81.92 for a $1,000 bond, enter $9,81.92/$1,000 = = percent.
Input the bond's maturity value (also called face value or par value) here, based on 100 percent. For example, if a bond has a maturity value of $1,000, enter $1,000/$1,000 = 1.00 = 100 percent. Some callable bonds will have a higher "price" if called, usually expressed as a percent. For example, a callable bond might have a call price of $1,070. In this case, enter $1,070/$1,000 = 1.07 = 107 percent. 2
Input the number of times a year coupons are paid. This is usually 2.
Input the basis here. For US bonds, leave this blank or put 0. See the comment in the cell if the bond is not a US bond.
8.9999%
This is the bond's yield.
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10. Cost of long-term debt
Cost of debt when issued 4 years ago was 8%, but cost now is different because bond price declined from $1,000 to $900.15
Now the cost is 9%
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11. Cost of equity
Its required return: depends on how risky stock is to investors.
This risk is measured by “Beta” and the Capital Asset Pricing Model (CAPM) relates Beta to required return.
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12. ACME’s cost of equity CAPM: rS = rRF + Beta (RPM) Beta = 1.1
rRF = 5.4% = L/T rate on Treasuries
RPM = market risk premium = 6%
rS = 5.4% + 1.1(6%) = 12%
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13. Target weights and WACC
Target is 30% debt, 70% equity
Tax rate = 40%
WACC = 0.70(12%) (9%)(1-0.40)
= 10.0%
WACC used as discount rate on FCFs.
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14. Projections
Next chapter focuses on nuts and bolts of projections. For now, assume your financial analyst already made following projections.
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15. Income statement projections
Income Statements
Actual
Projected
2003
2004
2005
2006
2007
Sales
4,512.44
4,873.44
5,165.84
5,475.80
5,804.34
Costs of Goods Sold
2,797.71
3,021.53
3,202.82
3,394.99
3,598.69 S
ales, General and Administrative
902.49
974.69
1,033.17
1,095.16
1,160.87
Depreciation
225.62
243.67
258.29
273.80
290.22
Operating Profit
586.62
633.55
671.56
711.85
754.56
Interest on original debt
80.00
Interest Expense on ne
w debt
25.73
34.35
42.84
50.18
57.95
Interest expense
105.73
114.35
122.84
130.18
137.95
Earnings Before Taxes
480.89
519.19
548.72
581.67
616.61
Taxes
192.35
207.68
219.49
232.67
246.65
Net Income
288.53
311.52
329.23
349.00
369.97
Dividends
104.89
135.10
191.43
202.90
215.05
Additions to retained earnings
183.64
176.41
137.80
146.11
154.91
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16. Balance Sheet Projections
Balance Sheets
Actual
Projected
Projected
Projected
Projected
2003
2004
2005
2006
2007
Cash
45.12
48.73
51.66
54.76
58.04
Inventory
631.74 6
82.28
723.22
766.61
812.61
Accounts receivable
1,128.11
1,218.36
1,291.46
1,368.95
1,451.09
Total current assets
1,804.98
1,949.38
2,066.34
2,190.32
2,321.74
Gross PPE
3,443.32
3,867.49
4,271.98
4,700.75
5,155.24
Accumulated depreciation
1,187.09
1,430
.77
1,689.06
1,962.85
2,253.07
Net PPE
2,256.22
2,436.72
2,582.92
2,737.90
2,902.17
Total assets
4,061.20
4,386.09
4,649.26
4,928.22
5,223.91
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17. Balance Sheet Projections
Liabilities
Actual
Projected
Projected
Projected
Projected
2003
2004
2005
2006
2007
Accounts payable
451.24
487.34
516.58
547.58
580.43
Accrued expenses
225.62
243.67
258.29
273.79
290.22
Short -
term debt
381.71
476.04
557.55
643.90
735.40
Total current liabilities
1,058.57
1,207.05
1,332.42
1,465.27
1,606.05
Long -
term debt
1,000.00
1,000.00
1,000.00
1,000.00
1,000.00
Total liabilities
2,058.57
2,207.05
2,332.42
2,465.27
2,606.05
Commo
n stock
600.00
600.00
600.00
600.00
600.00
Retained earnings
1,402.63
1,579.04
1,716.84
1,862.95
2,017.86
Total common equity
2,002.63
2,179.04
2,316.84
2,462.95
2,617.86
Total liabilities and equity
4,061.20
4,386.09
4,649.26
4,928.22
5,223.91
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18. FCF Projections Actual Projected 2003 2004 2005 2006 2007
Operating profit
586.62
633.55
671.56
711.85
754.56
Tax on operati
ng profit
234.65
253.42
268.62
284.74
301.83
NOPAT a
351.97
380.13
402.94
427.11
452.74
Operating current assets
1,804.97
1,949.37
2,066.34
2,190.32
2,321.74
Operating current liabilities
676.86
731.01
774.87
821.37
870.65
NOWC b
1,128.11
1,218.36
1,291. 47
1,368.95
1,451.09
Total operating capital c
3,384.34
3,655.08
3,874.39
4,106.85
4,353.26
Investment in total net
operating capital d
279.45
270.74
219.31
232.46
246.41
FCF e
72.52
109.39
183.63
194.65
206.33
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19. ROIC Projections Long term projected growth is 6% Actual Projected
2003
2004
2005
2006
2007
ROIC =
(NOPAT/Beginning capital)
11.3%
11.2%
11.0%
11.0%
11.0%
Growth in Sales
9.0%
8.0%
6.0%
6.0%
6.0%
Growth in NOPAT
9.0%
8.0%
6.0%
6.0%
6.0%
Growth in total net op. cap.
9.0%
8.0%
6.0%
6.0%
6.0%
Growth in FCF
376.6%
50.8%
67.9%
6.0%
6.0%
Growth in dividends
-34.5%
28.8%
41.7%
6.0%
6.0%
Long term projected growth is 6%
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20. Horizon Value
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21. Value of operations
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22. Value of operations Excel Fin Calculator: Use NPV Function Cf0 = 0
NPV = Vop = $
Excel
Use NPV Function
=NPV(Rate,Value1,Value2, Value3,. . .)
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23. Value of equity Vequity = VOPS + non-operating assets – debt
Debt: $ million short term + 1 million long-term bonds at $ each
= = $1, million
Vequity = $4, ,281.86
= $2, million
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24. Per share equity 100 million shares outstanding
Value per share = $29.91
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25. Per share equity
To find stock price, subtract co’s debt from estimate of firm value, then divide by number of c.s. shares o/s.
Simple method, but doesn’t provide much discrimination among firms.
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26. Alternate valuation method
Method of multiples
Not as reliable as Discounted FCF model
But is frequently used by less-sophisticated analysts
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27. Method of Multiples P/E Price / EBITDA Price / Sales Price / Book
Price / CF
Price / FCF
Use current value, ave historic, ave projected
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28. Method of Multiples
Idea is to find some representative measure that should capture what makes firm valuable, like sales, or net income, or earnings before interest, taxes, depreciation and amortization (EBITDA).
Need to determine comparable multiples for firms of same size and same line of business.
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29. Method of Multiples: EBITDA
Calculate the ratio of Value/EBITDA for a representative sample of firms. Value is defined as the total value of the firm (the value of debt plus the value of equity), because EBITDA is available for all of the firm’s investors- - both debt and stock holders. Suppose, it’s determined the value of similar firms to ACME equals times EBITDA
To find estimated value of firm being analyzed, multiply its EBITDA by this representative ratio.
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30. Method of Multiples: EBITDA
To find estimated value of firm being analyzed, multiply its EBITDA by this representative ratio of 5.261x.
So, need EBITDA (using actual ’03)
Sales $4,512.44
-CGS 2,797.71
-SGA
=EBITDA
x comparable EBITDA multiple
=Firm Value 4, Acme
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31. Method of Multiples: EBITDA
From Multiples,
$4, ACME Firm Value
- 1, ACME Debt
=2, Vequity for ACME
Price per share = $2, / 100 mm shs
Value per share = $29.91
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32. Variations is multiples ratios
Average for industry may be 5.26x, but range from 2x to 18x. Why?
i.e. Co.’s in same industry with identical EBITDA’s have variety of different prices due to:
Diff FCFs
Higher sales and FCF growth rate than others
Ignores potential differences in risk.
BOTTOM LINE: Multiples easy to use, but not nearly best gauge.
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