share vauation

8/8/2019 Share Vauation

http://slidepdf.com/reader/full/share-vauation 1/21

©2001 M. P. Narayanan University of Michigan

FINValuation methodsValuation methods

An overview



©2001 M. P. Narayanan

University of Michigan 2

FIN MethodologiesMethodologies

3 Comparable multipless P/E multiples Market to Book multiples Price to Revenue multiples Enterprise value to EBIT multiple

3 Discounted Cash Flow (DCF)s NPV, IRR, or EVA based Methods

x WACC methodx APV methodx CF to Equity method





FIN Valuation: P/E multipleValuation: P/E multiple

3 If valuation is being done for an IPO or a takeover,s Value of firm = Average Transaction P/E multiple × EPS of firms Average Transaction multiple is the average multiple of recent

transactions (IPO or takeover as the case may be)3 If valuation is being done to estimate firm value

s Value of firm = Average P/E multiple in industry × EPS of firm3 This method can be used when

s firms in the industry are profitable (have positive earnings)s

firms in the industry have similar growth (more likely for “mature”industries)s firms in the industry have similar capital structure





FIN Valuation: Price to book multipleValuation: Price to book multiple

3 The application of this method is similar to that of theP/E multiple method.

3 Since the book value of equity is essentially the

amount of equity capital invested in the firm, thismethod measures the market value of each dollar of equity invested.

3 This method can be used for s companies in the manufacturing sector which have significant

capital requirements.s companies which are not in technical default (negative book

value of equity)





FIN Valuation: Value to EBITDAValuation: Value to EBITDAmultiplemultiple

3 This multiple measures the enterprise value , that isthe value of the business operations (as opposed tothe value of the equity).

3

In calculating enterprise value, only the operationalvalue of the business is included.3 Value from investment activities, such as investment in

treasury bills or bonds, or investment in stocks of other companies, is excluded.

3 The following economic value balance sheet clarifiesthe notion of enterprise value.





FIN Enterprise ValueEnterprise Value

Economic Value Balance Sheet

PV of future cash from businessoperations

$1500

Cash $200 Debt $650

Marketable securities $150 Equity $1200

$1850 $1850

Enterprise Value





FIN Value to EBITDA multiple:Value to EBITDA multiple:ExampleExample

3 Suppose you wish to value a target company using thefollowing data:

s Enterprise Value to EBITDA (business operations only)multiple of 5 recent transactions in this industry: 10.1, 9.8, 9.2,10.5, 10.3.

s Recent EBITDA of target company = $20 millions Cash in hand of target company = $5 millions Marketable securities held by target company = $45 millions

Interest rate received on marketable securities = 6%.s Sum of long-term and short-term debt held by target = $75

million





FIN Value to EBITDA multiple:Value to EBITDA multiple:ExampleExample

3 Average (Value/ EBITDA) of recent transactionss (10.1+9.8+9.2+10.5+10.3)/5 = 9.98

3 Interest income from marketable securitiess 0.06 × 45 = $2.7 million

3 EBITDA – Interest income from marketable securitiess 20 – 2.7 = $17.3 million

3 Estimated enterprise value of the targets 9.98 × 17.3 = $172.65 million

3 Add cash plus marketable securitiess 172.65 + 5 + 45 = $222.65 million

3 Subtract debt to find equity value: 222.65 – 75 = $147.65 million.





FIN Valuation: Value to EBITDAValuation: Value to EBITDAmultiplemultiple

3 Since this method measures enterprise value itaccounts for different

s capital structuress cash and security holdings

3 By evaluating cash flows prior to discretionary capitalinvestments, this method provides a better estimate of value.

3 Appropriate for valuing companies with large debtburden: while earnings might be negative, EBIT is likelyto be positive.

3 Gives a measure of cash flows that can be used tosupport debt payments in leveraged companies.





FIN Heuristic methods: drawbacksHeuristic methods: drawbacks

3 While heuristic methods are simple, all of them shareseveral common disadvantages:

s they do not accurately reflect the synergies that may begenerated in a takeover.

s they assume that the market valuations are accurate. For example, in an overvalued market, we might overvalue thefirm under consideration.

s They assume that the firm being valued is similar to themedian or average firm in the industry.

s They require that firms use uniform accounting practices.





FIN Valuation: DCF methodValuation: DCF method

3 Here we follow the discounted cash flow (DCF)technique we used in capital budgeting:

s Estimate expected cash flows considering the synergy in atakeover

s Discount it at the appropriate cost of capital





FIN DCF methods: Starting dataDCF methods: Starting data

3 Free Cash Flow (FCF) of the firm3 Cost of debt of firm3 Cost of equity of firm3 Target debt ratio (debt to total value) of the firm.





FIN Template for Free Cash Flow Template for Free Cash Flow

“IncomeStatement”

Working capital

Year 0 1 2

RevenueCosts

Depreciation of equipment Noncash itemProfit/Loss from asset sales Noncash item

Taxable incomeTaxNet oper proft after tax (NOPAT)Depreciation Adjustment for

Profit/Loss from asset sales for non-cash

Operating cash flowChange in working capitalCapital Expenditure Capital items

Salvage of assetsFree cash flow






3 The goal of the template is to estimate cash flows, not profits.3 Template is made up of three parts .

s An “Income Statement”s Adjustments for non-cash items included in the “Income

statement” to calculate taxess Adjustments for Capital items, such as capital expenditures,

working capital, salvage, etc.3 The “Income Statement” portion differs from the usual income

statement because it ignores interest. This is because, interest, thecost of debt, is included in the cost of capital and including it in thecash flow would be double counting.

3 Sign convention: Inflows are positive, outflows are negative. Itemsare entered with the appropriate sign to avoid confusion.






3 There are four categories of items in our “Income Statement”.While the first three items occur most of the time, the last one islikely to be less frequent.

s Revenue itemss

Cost itemss Depreciation itemss Profit from asset sales

3 Adjustments for non-cash items is to simply add all non-cashitems subtracted earlier (e.g. depreciation) and subtract all non-

cash items added earlier (e.g. gain from salvage).3 There are two type of capital items

s Fixed capital (also called Capital Expenditure (Cap-Ex), or Property,Plant, and Equipment (PP&E))

s Working capital






3 It is important to recover both at the end of a finite-lived project.s Salvage the market value property plant and equipments Recover the working capital left in the project (assume full recovery)






Taxable incom e = Revenue - Costs - Depreciation + Profit from asset sales

NOPAT = Taxab le incom e - Tax

Operating cash flow = NOPAT + Depreciation - Profit from asset sales

Free cash flow = Operating cash flow - Change in working capital - Capital Expenditure +

Salvage of equipment - Opportunity cost of land + Salvage of land

Adjustment of noncash items:

Add the noncash items you sub tracted earlier and sub tract the noncash items you added earlier.





FIN Estimating HorizonEstimating Horizon

3 For a finite stream, it is usually either the life of theproduct or the life of the equipment used to manufactureit.

3 Since a company is assumed to have infinite life:s Estimate FCF on a yearly basis for about 5 − 10 years.s After that, calculate a “Terminal Value”, which is the ongoing value

of the firm.3 Terminal value is calculated one of two ways:

s

Estimate a long-term growth and use the constant growthperpetuity model.s Use a Enterprise value to EBIT multiple, or some such multiple





FIN Costs of debt and equityCosts of debt and equity

3 Cost of debt can be approximated by the yield tomaturity of the debt.

3 If it is not directly available, check the bond rating of

the company and find the YTM of similar rated bonds.3 Cost of equitys CAPM

x Find β e and calculate required r

e.s Use Gordon-growth model and find expected r

e. Under theassumption that market is efficient, this is the required r

e.





FIN Model of a FirmModel of a Firm

Value fromOperations

FIRM

DEBT andother

liabilitiesEQUITY

Value generated

Value to Equity

Equal if debtis fairly priced

Value frominvestments

Enterprise value

share vauation

Documents