1. Fin 4201/8001 1 Value of firm = PV of all future cash flows 1) Discount explicit forecast period CF 2) Capitalize continuing value = Add 1 + 2 for value of firm Valuation - The Numbers

2. Fin 4201/8001 2 Start with value of operations (8.4) Next consider financing flows (8.4) After tax interest expense Δ debt Dividends or share repurchase Determine WACC (8.5) Continuing value (8.6) Put it all together (8.3) Exhibits 8.3 – 8.6

3. Fin 4201/8001 3 ROIC = NOPLAT/Invested Capital NOPLAT = net operating profit less adjusted taxes Invested Capital = Working capital + Net PPE + other assets ROIC is a rate of return Also need “economic profit” to reveal dollar amount What Drives Cash Flow and Value

4. Fin 4201/8001 4 Reorganize the financials to estimate ROIC Make sure you account for everything in statements (lines 1-29 Income and 36-70 BS) Invested capital (denominator) lines 71-98 NOPLAT (numerator) lines 106-138 ROIC 140-155 couple of calculation methods Economic profit (175-195) reflects spread (ROIC-WACC) FCF (210-240) Put it all together for firm value (249-271) What’s the process? Look at spread sheet

5. Fin 4201/8001 5 Economic profit = Inv.capital * (ROIC –WACC) = NOPLAT – capital charge = NOPLAT – (invested capital*WACC) EP does not have to translate into ↑ market value FCF shows how firm generates or uses cash Once you have done all of this have the elements to do ratio analysis Implications of the numbers

6. Fin 4201/8001 6 You can build your own Look at in a minute Can just look it up Discounts FCF to PV for all investors Is after tax since FCF is after tax and is nominal Need to use market value (not BV) Can be subject to change due to changes in inflation, risk, or capital structure Estimating Cost of Capital – WACC

7. Fin 4201/8001 7 WACC = kb(1-T)(B/V) + kp(P/V) + ks(S/V) where kb = pretax YTM on non-callable, nonconvertible debt T= marginal tax rate B= mkt value of debt V=market value of enterprise (B+P+S) kp=after tax cost of preferred stock P=mkt value of preferred ks=opportunity cost of equity capital S = mkt vlue of equit Estimating Cost of Capital – WACC

8. Fin 4201/8001 8 capital structure may be complicated Convertibles or callables Warrants Executive stock options How to do it = 3 Steps 1) Develop market weights - discover trends 2) Estimate cost of non-equity financing 3) Estimate cost of equity financing Complications

9. Fin 4201/8001 9 Detailed forecast near term + summary forecast long term. Take strategic perspective and account for competitive advantage You could say: Demand is increasing rapidly because of changing demographics, yet prices will remain stable because of the competitive structure of the industry. Given the company’s competitive position, it should be able to increase market share somewhat, although profitability will remain constant. Franchise, commodity, efficient use of capital, bargaining power Forecasting Performance

10. Fin 4201/8001 10 Incorporate opinions into FCF. Look at ratios = reality check Six steps 1) Revenue forecast – volume growth & price changes 2) Fore cast operational items 3) Project non-operating items (investments or interest exp) 4) Project equity accounts (old + NI – div&repurchases) 5) Balance cashflows and balance sheet 6) Calc ROIC, key ratios, and pull together Translate vision into numbers

11. Fin 4201/8001 11 Needs to be high quality since may be over half the valuation Plug into – Know assumptions Constant margins, returns on new investment, and capital turnover What about changes over time (horizon)? Sensitivity analysis Make sure reasonable Use the “continuing value”