Corporate Valuation

• DCF valuation methods

• FCF-WACC method
• APV (adjusted present value) method
• FTE (flow-to-equity) method

• Industry comparables method

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 Corporate Valuation:

• We introduce the FCF-WACC

method.
• Of the DCF valuation methods, the
FCF-WACC method is the most
widely used.
• We break up assets into operating
and non-operating assets for the
purpose of firm valuation.

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 Operating assets
• Operating assets are non-financial assets
including buildings, machines and
inventory.
• They generate operating incomes, which
are expected to grow.
• After-tax net operating profit (NOPAT) net
of required investment is called free cash
flow (FCF).
• The PV of the expected future free cash
flows, discounted at the WACC, is the
value of operations.
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 Value of Operations


FCFt
VOp  
t 1 (1  WACC) t

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 Measurement of FCF

• FCF=After-tax net operating profit-required investment

• FCF=(EBIT)(1-T)+DEP-(ΔNFA+ ΔNWC+DEP)

• FCF=(EBIT)(1-T)-(ΔNFA+ ΔNWC)

• FCF=NOPAT-(ΔOperating Asset)
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 Nonoperating Assets

• Marketable securities
• Ownership of non-controlling
interest in another company
• Value of nonoperating assets usually
is very close to figure that is reported
on balance sheets.

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 Total Corporate Value

• Total corporate value is sum of:

• Value of operations
• Value of nonoperating assets

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 Claims on Corporate Value

• Debtholders have first claim.

• Preferred stockholders have the next
claim.
• Any remaining value belongs to
stockholders.

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 Applying the Corporate Valuation
Model
• Forecast the financial statements.
• Calculate the projected free cash flows.
• Model can be applied to a company that
does not pay dividends, a privately held
company, or a division of a company,
since FCF can be calculated for each of
these situations.

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 Data for Valuation
• FCF0 = $20 million
• WACC = 10%
• g = 5%
• Marketable securities = $100 million
• Debt = $200 million
• Preferred stock = $50 million
• Book value of equity = $210 million
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 Value of Operations:
Constant Growth
Suppose FCF grows at constant rate g.

FCFt
VOp  
t 1 1  WACC 
t


FCF0 (1  g) t

t 1 1  WACC 
t

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 Constant Growth Formula

• Notice that the term in parentheses is

less than one and gets smaller as t
gets larger. As t gets very large,
term approaches zero.

 1 g 
 t

VOp   FCF0  
t 1  1  WACC 
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Constant Growth Formula (Cont.)

• The summation can be replaced by a

single formula:
FCF1
VOp 
WACC  g 
FCF0 (1  g)

WACC  g  13
 Find Value of Operations

FCF0 (1  g)
VOp 
WACC  g 
20 (1  0.05)
VOp   420
0.10  0.05
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 Value of Equity
• Sources of Corporate Value
• Value of operations = $420
• Value of non-operating assets = $100
• Claims on Corporate Value
• Value of Debt = $200
• Value of Preferred Stock = $50
• Value of Equity = ?
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 Value of Equity
Total corporate value = VOp + Mkt. Sec.
= $420 + $100
= $520 million

Value of equity = Total - Debt - Pref.

= $520 - $200 - $50
= $270 million
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 Market Value Added (MVA)

• MVA = Total corporate value of firm

minus total book value of firm
• Total book value of firm = book value
of equity + book value of debt + book
value of preferred stock
• MVA = $520 - ($210 + $200 + $50)
= $60 million
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 Breakdown of Corporate Value

600 MVA

500 Book equity

400
Equity (Market)
300
Preferred stock
200

100 Debt

0 Marketable
Sources Claims Market securities
of Value on Value vs. Book Value of operations

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Example of non-constant growth
• Debt= $40 million
• The company has 10 million shares
of stock.
• The weighted average cost of
capital=10%.

(More…)
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• Projected free cash flows (FCF):
• Year 1 FCF = -$5 million.
• Year 2 FCF = $10 million.
• Year 3 FCF = $20 million
• FCF grows at constant rate of 6%
after year 3.

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 Horizon Value

• Free cash flows are forecast for three

years in this example, so the forecast
horizon is three years.
• Growth in free cash flows is not
constant during the forecast,so we
can’t use the constant growth
formula to find the value of
operations at time 0.
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 Horizon Value (Cont.)

• Growth is constant after the horizon

(3 years), so we can modify the
constant growth formula to find the
value of all free cash flows beyond
the horizon, discounted back to the
horizon.

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 Horizon Value Formula

FCFt (1  g)
HV  VOp at tim e t 
WACC  g 
• Horizon value is also called terminal
value, going-concern value or
continuing value.

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Find the value of operations by discounting
the free cash flows at the cost of capital.
0 k =10% 1 2 3 4
c

g = 6%
FCF= -5.00 10.00 20.00 21.2
-4.545
8.264
15.026
$21.2
398.197 Vop at 3   $530.
0 .10  0.06
416.942 = Vop
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 Find the price per share of common
stock.
Value of equity = Value of operations
- Value of debt
= $416.94 - $40
= $376.94 million.

Price per share = $376.94 /10 = $37.69.

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 Practice problem
• Marketable securities=$10 million
• Debt= $100 million
• The company has 10 million shares
of stock.
• The weighted average cost of
capital=13%.

(More…)
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• Projected free cash flows (FCF):
• Year 1 FCF = -$20 million.
• Year 2 FCF = $30 million.
• Year 3 FCF = $40 million
• FCF grows at constant rate of 7%
after year 3.

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(a) Estimate the horizon value.
(b) Estimate the value of operation.
(c) Estimate the enterprise value.
(d) Estimate the per share price.
Answers: V=537.89;S=437.89;p=$43.79

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 Horizon Value Formula

FCFt (1  g)
HV  VOp at tim e t 
WACC  g 

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Find the value of operations by discounting
the free cash flows at the cost of capital.
0 k =13% 1 2 3 4
c

g = 7%
FCF= -20 30 40 42.8
-17.70
23.49
27.72
$42.8
494.37 Vop at 3   $713.33
0 .13  0.07
527.88 = Vop
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