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FINC361 Fall2016
ProfessorMahdiMohseni
Stock valuation
Goal:
Determine fair market value for a stock (equity)
How?
Fair value= PV(Expected future cash flows)
Discounted Cash Flow (DCF) approach
Cash flows of stock: Dividends usually
Time 1
Time 2
Timeline
Div1
P0 =
rE g
CN+1=[C(1+g)(N-1)]*(1+f)
C(1+g)
C(1+g)
C
Time 0
Time 1
Time 2
Time N
Time N+1
Timeline
Time 0
Time 1
Time N
Time 2
1
= C
rg
1+ g N
1
1 + r
Timeline
CN+2=CN+1 (1+f)
CN+3=CN+1 (1+f)2
Time 0
Time N
Time N+1
Time N+2
Time N+3
Timeline
C N +1
=
r f
1
= PVN , Stage 2 *
N
(1
r)
+
PV0 = C
rg
1 + g N C
1
+ N +1
1 + r r f
(1 + r) N
Firm valuation
Goal: Find fair value of firms underlying business
Fundamental value = Intrinsic value = (Total) Enterprise value
More basically:
Shareholders
Debtholders
(Preferred stockholders)
For simplicity we will assume no preferred stock on the balance sheet for now
M&A
Fairness opinions
Research
Steps
1. Need to determine the appropriate cash flows
Free cash flows
Corresponds to:
Free cash generated by the business: Cash that can
be freely distributed between debtholders and
shareholders (your capital providers!)
Start with:
1.
EBIT x (1-)
Necessary adjustments:
1.
2.
Depreciation
3.
Non-cash expense
Add back
Recall, an increase in net working capital (e.g. increase in inventories) represents a cash
outflow not reflected in the income statement
Subtract
Capital expenditures
After-tax
Operating
Income
+ Depreciation
Increases in Net Working Capital
Capital Expenditures
Total Investments
Debtholders
Shareholders
FCF1
FCF2
FCFN
FCFN+1=FCFN(1+ gFCF)
FCF3
Time 1
Time 2
Time N
Timeline
The math
Define: VN = Terminal value at time N
Hence:
=
V0
(1 + g FCF ) FCFN
FCFN +1
VN =
=
rwacc g FCF
rwacc g FCF
FCFN
VN
FCF1
FCF2
+
+ +
+
N
2
1 + rwacc
(1 + rwacc )
(1 + rwacc )
(1 + rwacc ) N
N first FCFs discounted back individually to time zero
Growing
perpetuity
discounted back
to time zero
First example:
Free Cash Flows given
Free cash flows of Heavy Metal Corp over next five years:
Year
FCF ($MM)
1
51.1
2
67.6
3
77.1
4
74.8
5
83.6
Solution
Formula:
FCFt
FCF6
1
+
V0 =
5
t
(1 + rwacc ) rwacc g
t =1 (1 + rwacc )
FCF6 = FCF5 (1 + g )
V0 = $650.25MM
2011
800
2012
1,000
500
120
80
300
90
210
80
40
100
150
Assumptions:
Assume 25% sales growth
50% of sales
12% of sales
8% of sales
After some number crunching, suppose you get the table below
You also assume:
Why the different modeling of Incr. in NWC relative to the other items?
Alternative modeling: Forecast NWC each year (as % sales) then compute changes in NWC over time
Sales
Sales Growth
Operating Margin
Depr
Income Tax
Incr in NWC
Capex
2012
14526
2013
2014
2015
2016
2017
4.0%
10.7%
3.9%
35.0%
8.0%
5.0%
3.0%
10.7%
3.9%
40.0%
8.0%
5.0%
3.0%
10.7%
3.9%
40.0%
8.0%
5.0%
3.0%
10.7%
3.9%
40.0%
8.0%
5.0%
3.0%
10.7%
3.9%
40.0%
8.0%
5.0%
Solution
First five years:
Years
Sales
EBIT
Less Tax
EBIT(1-t)
Add Depr
Less NWC
Less Capex
FCF
2012
14,526.0
2013
15,107.0
1,616.5
(565.8)
1,050.7
589.2
(46.5)
(755.4)
838.0
2014
15,560.3
1,664.9
(666.0)
999.0
606.8
(36.3)
(778.0)
791.5
2015
16,027.1
1,714.9
(686.0)
1,028.9
625.1
(37.3)
(801.4)
815.3
2016
16,507.9
1,766.3
(706.5)
1,059.8
643.8
(38.5)
(825.4)
839.8
2017
17,003.1
1,819.3
(727.7)
1,091.6
663.1
(39.6)
(850.2)
864.9
We just computed:
We know:
%y definition:
So:
Stock Price =
FCFN
VN
FCF1
FCF2
1 rwacc
(1 rwacc ) 2
(1 rwacc ) N
(1 rwacc ) N
VN
FCFN 1
rwacc g FCF
(1 g FCF ) FCFN
rwacc g FCF
Relative valuation
Goal: Firm valuation
Approach
1.
2.
B. In practice
Think of the car analogy
No two firms are identicalneed dimensions along which to
compare them
1. Industry
2. Size
Valuation Multiples
Definition of a multiple: It is simply a Ratio:
1. Numerator
Value: Enterprise value or stock/equity value
2. Denominator
Value driver: Size (Sales, etc.) or profitability (EPS, EBITDA, etc.)
Equity or enterprise value
(Value)
Financial statistic
(Value driver (profitability))
Multiple
(Value relationship)
Examples
1. P/E multiple: Stock price relative to EPS
2. EBIT multiple: Enterprise value relative to EBIT
Approach is straightforward
Step 1: Select group of peer firms
Typically firms in same industry
Hence the term Industry multiples
In Practice
Two big issues:
1. Wide dispersion within a given industry
2. Only relative valuation, what if entire industry is
sinking or overheating?
Solution
1. Use several valuation multiples
Get a range
Sensitivity analysis