# 1

Corporate Valuation
• DCF valuation methods
• FCF-WACC method
• APV (adjusted present value) method
• FTE (flow-to-equity) method
• Industry comparables method
2
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.
3
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.
4
Value of Operations
¿
·
=
+
=
1 t
t
t
Op
) WACC 1 (
FCF
V
5
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)
6
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.
7
Total Corporate Value
• Total corporate value is sum of:
• Value of operations
• Value of nonoperating assets
8
Claims on Corporate Value
• Debtholders have first claim.
• Preferred stockholders have the next
claim.
• Any remaining value belongs to
stockholders.
9
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.
10
Data for Valuation
• FCF
0
= \$20 million
• WACC = 10%
• g = 5%
• Marketable securities = \$100 million
• Debt = \$200 million
• Preferred stock = \$50 million
• Book value of equity = \$210 million
11
Value of Operations:
Constant Growth
Suppose FCF grows at constant rate g.
( )
( )
¿
¿
·
=
·
=
+
+
=
+
=
1 t
t
t
0
1 t
t
t
Op
WACC 1
) g 1 ( FCF
WACC 1
FCF
V
12
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 t
t
0 Op
WACC 1
g 1
FCF V
13
Constant Growth Formula (Cont.)
• The summation can be replaced by a
single formula:
( )
( ) g WACC
) g 1 ( FCF
g WACC
FCF
V
0
1
Op
÷
+
=
÷
=
14
Find Value of Operations
( )
( )
420
05 . 0 10 . 0
) 05 . 0 1 ( 20
V
g WACC
) g 1 ( FCF
V
Op
0
Op
=
÷
+
=
÷
+
=
15
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 = ?
16
Value of Equity
Total corporate value = V
Op
+ Mkt. Sec.
= \$420 + \$100
= \$520 million

Value of equity = Total - Debt - Pref.
= \$520 - \$200 - \$50
= \$270 million
17
• 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
18
Breakdown of Corporate Value
0
100
200
300
400
500
600
Sources
of Value
Claims
on Value
Market
vs. Book
MVA
Book equity
Equity (Market)
Preferred stock
Debt
Marketable
securities
Value of operations
19
Example of non-constant growth
• Debt= \$40 million
• The company has 10 million shares
of stock.
• The weighted average cost of
capital=10%.

(More…)
20
• 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.

21
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.
22
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.
23
Horizon Value Formula

• Horizon value is also called terminal
value, going-concern value or
continuing value.
( ) g WACC
) g 1 ( FCF
V HV
t
t time at Op
÷
+
= =
24
V
op
at 3
Find the value of operations by discounting
the free cash flows at the cost of capital.
0
-4.545
8.264
15.026
398.197
1 2 3 4
k
c
=10%
416.942 = V
op
g = 6%
FCF= -5.00 10.00 20.00 21.2
\$21.2
. .
\$530.
10 0 06
=
÷
=
0
25
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.
26
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…)
27
• 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.

28
(a) Estimate the horizon value.
(b) Estimate the value of operation.
(c) Estimate the enterprise value.
(d) Estimate the per share price.

29
Horizon Value Formula

( ) g WACC
) g 1 ( FCF
V HV
t
t time at Op
÷
+
= =
30
V
op
at 3
Find the value of operations by discounting
the free cash flows at the cost of capital.
0
-17.70
23.49
27.72
494.37
1 2 3 4
k
c
=13%
527.88 = V
op
g = 7%
FCF= -20 30 40 42.8
\$42.8
. .
\$713.33
13 0 07
=
÷
=
0

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.
2

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.
3

Value of Operations VOp   t 1  FCFt t (1  WACC) 4 .

Measurement of FCF • FCF=After-tax net operating profitrequired investment • FCF=(EBIT)(1-T)+DEP-(ΔNFA+ ΔNWC+DEP) • FCF=(EBIT)(1-T)-(ΔNFA+ ΔNWC) • FCF=NOPAT-(ΔOperating Asset) 5 .

6 .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.

Total Corporate Value • Total corporate value is sum of: • Value of operations • Value of nonoperating assets 7 .

• Preferred stockholders have the next claim. 8 .Claims on Corporate Value • Debtholders have first claim. • Any remaining value belongs to stockholders.

• Model can be applied to a company that does not pay dividends. or a division of a company.Applying the Corporate Valuation Model • Forecast the financial statements. • Calculate the projected free cash flows. 9 . since FCF can be calculated for each of these situations. a privately held company.

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 10 .

FCFt VOp   t 1 t 1   WACC  FCF0 (1  g)  t 1 t 1   WACC   t 11  .Value of Operations: Constant Growth Suppose FCF grows at constant rate g.

As t gets very large.Constant Growth Formula • Notice that the term in parentheses is less than one and gets smaller as t gets larger. term approaches zero.  1 g  VOp   FCF0    1  WACC  t 1  t 12 .

Constant Growth Formula (Cont.) • The summation can be replaced by a single formula: FCF 1 VOp  WACC  g  FCF0 (1  g)  WACC  g  13 .

Find Value of Operations FCF0 (1  g) VOp  WACC  g  20 (1  0.05 14 .10  0.05) VOp   420 0.

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 = ? 15 .

Debt .\$200 .Value of Equity Total corporate value = VOp + Mkt. = \$420 + \$100 = \$520 million Value of equity = Total .\$50 = \$270 million 16 . = \$520 . Sec.Pref.

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 17 .

Book Preferred stock Debt Marketable securities Value of operations 18 MVA Book equity Equity (Market) .Breakdown of Corporate Value 600 500 400 300 200 100 0 Sources Claims Market of Value on Value vs.

(More…) 19 . • The weighted average cost of capital=10%.Example of non-constant growth • Debt= \$40 million • The company has 10 million shares of stock.

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

• Growth in free cash flows is not constant during the forecast. 21 .Horizon Value • Free cash flows are forecast for three years in this example.so we can’t use the constant growth formula to find the value of operations at time 0. so the forecast horizon is three years.

) • 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.Horizon Value (Cont. 22 .

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. 23 .

264 15.00 10.545 8.10  0.Find the value of operations by discounting the free cash flows at the cost of capital.2 Vop at 3 Vop \$21.942 = -5. 0 .06 24 .00 20.00 21.026 398. 0 k =10% c 1 2 3 g = 6% 4 FCF= -4.2   \$530.197 416.

Find the price per share of common stock.94 /10 = \$37. Price per share = \$376. Value of equity = Value of operations .\$40 = \$376.94 million.94 . 25 .69.Value of debt = \$416.

(More…) 26 .Practice problem • Marketable securities=\$10 million • Debt= \$100 million • The company has 10 million shares of stock. • The weighted average cost of capital=13%.

• Year 3 FCF = \$40 million • FCF grows at constant rate of 7% after year 3. • Year 2 FCF = \$30 million.• Projected free cash flows (FCF): • Year 1 FCF = -\$20 million. 27 .

89. (c) Estimate the enterprise value.S=437. Answers: V=537.(a) Estimate the horizon value. (d) Estimate the per share price. (b) Estimate the value of operation.p=\$43.79 28 .89.

Horizon Value Formula FCFt (1  g) HV  VOp at tim e t  WACC  g  29 .

8   \$713.33 0 . 0 k =13% c 1 2 3 g = 7% 4 FCF= -17.88 = -20 30 40 42.8 Vop at 3 Vop \$42.70 23.72 494.Find the value of operations by discounting the free cash flows at the cost of capital.37 527.13  0.07 30 .49 27.

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