Corporate valuation
- 2. TABLE OF CONTENTS 2 I OVERVIEW OF VALUATION II INTRODUCTION TO VALUATION III VALUATION ANALYSIS IV HISTORICAL ANALYSIS V FORECASTING OF FUTURE PROJECTIONS VI POST PROJECTION CASH FLOW MAPPING VII DISCOUNTING CASH FLOWS METHOD VIII DISCOUNTING FACTOR IX TERMINAL VALUE X FCFF AND FCFE XI LIMITATIONS OF DCF XII CLOSING THOUGHTS
- 3. I. OVERVIEW OF VALUATION Business Valuationdepends upon Purpose of valuation Stage of business Past f inancials Expected f inancial results Industry scenario Business Valuationis the process of determining the "EconomicWorth" of a Company based on its Business Model and External Environmentand supported with reasons and empirical evidence. 3
- 4. VALUATION IS HYBRID OF ART & SCIENCE PRICE IS NOT THE SAME AS VALUE VALUEVARIESWITH PERSON, PURPOSEAND TIME TRANSACTION CONCLUDES ATNEGOTIATED PRICES 4 II. INTRODUCTION TO VALUATION
- 5. Mergers & Acquisitions Regulations DisputeResolution Succession Planning VoluntaryAssessment ESOPs 5 II. INTRODUCTION TO VALUATION THE NEED
- 6. Determine Purpose of Valuation Establish Valuation Date Collate Data IndustryAnalysis Historical Analysis of Company Adjustments& Recasts Evaluate Future Projections Implement Selected Valuation Methodologies Assign Weightages to Methodologies & Report 6 II. INTRODUCTION TO VALUATION THE PROCESS
- 7. III. VALUATION ANALYSIS ❖ Compare the valuation of one security to another security ❖ Compare the valuation of one security to a group of securities ❖ Compare the valuation of security in historical context 7
- 8. AnalyseRelevant EconomicData- Global& Domestic Analyse Competition & MarketPosition Comprehend Regulations Determine FutureGrowth Rates 8 IV. HISTORICAL ANALYSIS INDUSTRY
- 9. IV. HISTORICAL ANALYSIS COMPANY Analyse Historical Financial Statements AnalyseCapital Structure & Cost of Capital SWOT Analysis Determine FutureGrowth Rates & Correlatewith Industry 9
- 10. TrendAnalysis Revenue TrendAnalysis Expenditure Ratio Analysis Profitability & Efficiency Capital Expenditure Notes to Accounts 10 IV. HISTORICAL ANALYSIS FINANCIAL STATEMENTS
- 11. IV. HISTORICAL ANALYSIS ADJUSTMENTS & RECASTS Adjustments& Recasts Excludegains or losses from businessoperations that havebeen discontinued Eliminate any one- time gains or losses from the disposition of assets Factor outthe effectof any business interruptions Factor outamounts of non-operating nature Adjustoff-balance sheetitems Removeabnormally high or low profits 11
- 12. Determine Y-o-Y RevenueGrowth VariableExpenditure As a % of Revenue FixedExpenditure Historical Data Depreciation Historical Data+ Additional Capex Interest As a % of AverageDebt 12 Taxation EffectiveTax Rateas on Valuation Date V. FORECASTING OF FUTURE PROJECTIONS
- 13. Determine ReceivablesCycle DetermineInventory Cycle DeterminePayables Cycle Evaluatethe Capex Requirement 13 Evaluatethe Sources of Funds V. FORECASTING OF FUTURE PROJECTIONS
- 14. VI. POST PROJECTION CASH FLOW MAPPING TerminalGrowthRate < Growth Rate of Economy Evaluatethe TerminalGrowthRate Determine the Yearof StableCash Flows 14
- 15. • Expresses the present valueof the business attributableto all claimants(likeequity shareholders,debt holders,preference shareholdersetc.) as a function of its future cash earning capacity • Cash flows are discountedusing WACC Free Cash Flows to the Firm (FCFF) • Expresses the present valueof the business attributableto equity shareholdersas a function of its future cash earning capacity • Cash flows are discountedusing Ke Free Cash Flows to Equity (FCFE) 15 VII. DISCOUNTED CASH FLOWS METHOD
- 16. T erminal Value FreeCash Flows Cost of Equity(Ke) Cost of Capital (WACC) Beta, Market Risk Premium, Company Specific Risk Premium 16 VII. DISCOUNTED CASH FLOWS METHOD CONSTITUENTS
- 17. VII. DISCOUNTED CASH FLOW METHOD PROCESS Understandthe Business Model/Plan Identify Business Cycle AnalyzeHistoricalFinancial Performance ReviewIndustry and RegulatoryTrends UnderstandFuture Growth Plans (including Capex needs) 17
- 18. VII. DISCOUNTED CASH FLOW METHOD PROCESS SegregateBusiness and Other Cash Generating Assets Identify Surplus Assets (assets not utilized forBusiness say Land/Investments) PrepareBusiness Projections DiscountBusiness Projections to Present (Explicit Periodand Perpetuity) Add Valueof Surplus Assetsand Subtract Valueof ContingentLiabilities 18
- 19. ❖ Cost of Capital: ▪"Cost of capital" means "the opportunity cost of all capital invested in an entity ”. Breaking down the above sentence: • “Opportunity cost” is the loss one incurs when one alternative investment is chosen over the other. • “All capital invested” is the total funds invested into a business. On an entity level, this refers to the fact that we are measuring the opportunity cost of all sources of capital which includes debt and equity both. ❖ Steps for calculating Cost of Capital VIII. DISCOUNTING FACTOR Deducethe costof capital components Ascertain the capitalstructure Weigh the components 19
- 20. CAPITALASSET PRICING MODEL (CAPM) Ke = Rf+Beta*(Rm-Rf)+ARP Ke = Costof Equity Rf = Risk free Rate of Return Beta = Beta Coefficient Rm = MarketReturn ARP = Additional Risk Premium 20 VIII. DISCOUNTING FACTOR COST OF EQUITY (Ke)
- 21. InterestRate after Adjusting for Tax Deductions Kd = I*(1-t) Kd = Costof Debt I = InterestRate t = Tax Rate 21 DISCOUNTING FACTOR COST OF DEBT (Kd)
- 22. CAPITALSTRUCTURE • We calculatethe contributionof each sourceof capital as follows: • Equity= E / (E+D) • Debt= D / (E+D) Where, • E = Equity • D = Debt WEIGHTAGE 22 • The WACCequationis the aggregateof cost of each capital component which is multipliedby its proportional weight: • Formula: • WACC= Ke*E/(E+D) + Kd *D/(E+D) VIII. DISCOUNTING FACTOR CAPITAL STRUCTURE & WEIGHTAGE
- 23. IX. TERMINAL VALUE 23 Terminal Value Liquidation Value Multiple Approach Stable Growth Model
- 24. IX. TERMINAL VALUE STABLE GROWTH MODEL Capitalizes FCF after definiteforecastperiod as agrowing perpetuity EstimateTerminalValueusing TerminalValueMultiplier applied on terminalyear cash flows Gordon Formula is often used to derivethe Terminal Cash Flows by applying thelastyear cash flows as a multiple of the growth rate and discounting factor (1+g)/(WACC-g) Estimated Terminal Value is then discounted to present day at company’s cost of capital based on the discounting factor of terminal year projected cash flows Usually comprises a Largepartof TotalValueand is sensitiveto small changes 25 Note: “g” refers to terminal growth rate
- 25. X. FREE CASH FLOWS TO FIRM PROCEDURE Step1:Arrive at EBIT Earning before interestandtaxes Step2:Multiply with(1-tax rate) EBIT * (1-tax rate) * Step3:Arrive at Operatingprofitafter tax Operating profit after tax = Step4:Addback non cashcost (already subtractedearlier) NonCash Cost + Step5:Subtract Capital Expenditures Capital expenditures - Step6:Add/Subtract Changes inNCWC Increase/Decrease inNCWC +/- Step 7:AddTerminalValue TerminalValue + Step8:Arrive at FreeCashFlowstoFirm Free cashflow tofirm = Step9:Discount the FCFF for each yearwiththe costof capital DiscountedFree CashFlow toFirm = 26 Note: “NCWC” refers to Non-cash Working Capital
- 26. X. FREE CASH FLOWS TO EQUITY 26 PROCEDURE Step1:Arrive at PBT Profit BeforeTax Step2:Multiply with(1-tax rate) PBT*(1-tax rate) * Step 3:Arrive at PAT Profit After Tax = Step4:Addback non cashcost (already subtractedearlier) NonCash Cost + Step5:Subtract Capital Expenditures Capital expenditures - Step6:Add/Subtract Changes inNCWC Increase/Decrease inNCWC +/- Step 7:Take into account the effectof changes indebt Changes inDebt +/- Step8:AddTerminalValue TerminalValue + Step9:Arrive at FreeCashFlowstoEquity Free cashflow toEquity = Step10:Discount theFCFEfor eachyear withthe cost of equity DiscountedFree CashFlow to Equity =
- 27. Requires lotsof inputs & informationcomparedto other methods 27 Inputs are difficult to estimate and can be manipulated Discountedcash flow modelsmay very well find every stockin a sector or even a marketto be over valued, if marketperceptions have run ahead of fundamentals XI. LIMITATIONS OF DCF
- 28. SOME GOOD READS ON VALUATION Books on Valuationby Aswath Damodaran Books on Valuationby Shannon P.Pratt 28
- 29. Let’s Discuss More on Valuation Questions/Comments 29 THANK YOU