1. Valuation FIN 449 Michael Dimond

2. Michael Dimond School of Business Administration Calculating Free Cash Flow to Equity FCFE = Net income – Net investment + Net debt issued

3. Michael Dimond School of Business Administration Net Investment Net investment = (Capital expenditures – Depreciation) + Increase in noncash working capital

4. Michael Dimond School of Business Administration CapEx Line item on Statement of Cash Flows? Calculate the changes (from year to year) of ALL long-term assets shown on the balance sheet. Find the total amount (for a given year) shown in the “Investing” section of the Statement of Cash Flows. Issues?

5. Michael Dimond School of Business Administration Depreciation “Basic definition” of net cash flow = net income + depreciation Non-cash expense In the “balance sheet” approach to define capital expenditures, depreciation is usually not incorporated explicitly. Why not? If the “Statement of Cash Flows” approach is used, one must explicitly subtract depreciation from capital expenditures (shown in the “Operating” section of the Statement of Cash Flows)

6. Michael Dimond School of Business Administration Non-cash Working Capital Noncash working capital = (current assets – cash) – current liabilities… what else? Noncash working capital = (current assets – cash) – (current liabilities – interest bearing debt included in current liabilities) Why? Why not include cash?

7. Michael Dimond School of Business Administration Net Debt Issued “Net” debt issued implies that one must take both debt issuances AND repayments into account Discussion: Constant Debt Ratio –Suppose a firm always finances new investment with a fixed debt ratio (say, 30% debt and 70% equity, for example). The general equation for FCFE could be expressed as follows: –FCFE = Net income – (1 – debt ratio)(Net investment) OR –FCFE = Net income – (equity ratio)(Net investment)

8. Michael Dimond School of Business Administration Free Cash Flow to Equity FCFE = Net income – Net investment + Net debt issued

9. Michael Dimond School of Business Administration Damodaran has resources online http://pages.stern.nyu.edu/~adamodar/ His spreadsheets are not always as helpful as you might want… An example of a valuation summary he did in 2008

10. Michael Dimond School of Business Administration What Damodaran’s valuation summary looks like: September 2008

11. Michael Dimond School of Business Administration What Damodaran’s valuation summary looks like: October 2008

12. Michael Dimond School of Business Administration Bear in mind, these were a summary. We will ultimately want something more detailed for a working document.

13. Michael Dimond School of Business Administration What does the DCF Model look like? What drives the figures? How sensitive are they to basic inputs?

14. Michael Dimond School of Business Administration To start, compute historic FCFF & FCFE for the past 5 years FCFF = NI + Int(1-t) + Depr - ΔFA - ΔNWC FCFE = NI + Depr - ΔFA - ΔNWC + ΔDebt - PfdDiv FCFF = FCFE + Int(1-t) - ΔDebt + PfdDiv FCFE = FCFF - Int(1-t) + ΔDebt - PfdDiv How accurate would it be to extrapolate the future cash flows from the past FCFE figures? In other words, can we simply assume FCFE will grow X% forever? Here are the historic FCFE for a company: Instead, we project the drivers of these figures for the future. Compute FCFF & FCFE based on the forecast figures

15. Michael Dimond School of Business Administration Relationships in financials drives FCFF & FCFE We will start with financial statements and forecast expected reportings, then adjust to find expected future cash flows

16. Michael Dimond School of Business Administration Relationships in financials drives FCFF & FCFE We will start with financial statements and forecast expected reportings, then adjust to find expected future cash flows

17. Michael Dimond School of Business Administration We need to assess sensitivity to assumptions What drives the figures? How sensitive are they to basic inputs?

18. Michael Dimond School of Business Administration We need to assess sensitivity to assumptions What drives the figures? How sensitive are they to basic inputs?

19. Michael Dimond School of Business Administration Building the sensitivity table

20. Michael Dimond School of Business Administration Building the sensitivity table What’s in the yellow cell in the middle of the table? (easier to click cells than type references) = ( NPV( $E223, $H$206, $I$206, $J$206, $K$206, $L$206+ ($L$206*(1+I$218)/($E223-I$218)) ) +$G$209) /$G$211 You should be able to paste the foumula into the remaining cells in the table and get the correct results. equals group everything together PV of cash flows Ke from the sensitivity table CF1 CF2 CF3 CF4 CF5 plus… terminal value, using %s in table close the NPV function add the cash divide by the number of shares

21. Michael Dimond School of Business Administration Coming up Strawman exercise –Template on the course webpage –Final version due via email by midnight Sunday 4/20 Mini-projects 1 & 2 Begin valuation #1