FIN 614: Financial Management
Larry Schrenk, Instructor
1. What is Free Cash Flow (FCF)?
2. Calculating Free Cash Flow
3. Finding Firm, Equity and Share Prices
4. Market Multiple Analysis
Cash Flow Available for Distribution to All
Investors
Valuation of Firm or Equity
Application of Discounted Cash Flow
Contrast with Dividends
1. Firm may not be Paying Dividends
2. Dividends at Discretion of Board
3. Dividends Uncertain
4. Cannot be Used for Internal Divisions
Value of Firm = PV(FCF)
r = Weighted Average Cost of Capital
(WACC)
FCF
= NOPAT – Net Investment in Operating Capital
NOPAT = EBIT(1 – tc)
• NOPAT = Net Operating Profit after Taxes (but
without Interest being Deducted)
• EBIT = Earnings before Interest and Taxes
• tc = Corporate Tax Rate
• Net Investment in Operating Capital includes
changes on Long Term assets and Working
Capital
A firm has an EBIT of 50 and its marginal
tax rate is 40%. Its working capital was 10
last year and 12 this year, while its long
term operating assets were 100 last year
and 105 this year. What is its FCF?
NOPAT = 50(1 – 0.40) = 30
Net Investment in Operating Capital
= (105 + 12) - (100 + 10) = 8
FCF = 30 – 8 = 22
A firm has the following FCF’s and its
WACC is 8%. What is its value of
operations?
1
2
3
4+
100
200
250
300
NOTE: Same methodology as mixed model for
equity.
100
200
250
300
1
Vop 



 3439.39
3
2
3
(1.08) (1.08) (1.08)
0.08 1.08 
The firm’s value of operations is $3,439.39, it has
$500 in financial (non-operating) assets, $1,000 in
debt, no preferred shares and has issued 300
shares of common stock.
What is the value of the firm?
= value of operations + value of non-operating assets
= $3,439.39 + 500 = $3,939.39
What is the value of the firm’s equity?
= Firm Value – (debt + preferred shares)
= $3,939.39 - $1,000 = $2,939.39
What is the price per share?
= Equity Value/Shares Outstanding
= $2,939.39/300 = $9.80
Approach
Similar Assets, Similar Prices
Ratios Similar for Similar Firms
Value as a Multiple of a Market Metric
Comparison with Similar Firms
Relative Valuation
Most common valuation measure used
on Wall Street
Almost 85% of equity research reports are
based on multiples and comparables
Nearly 50% of all acquisition valuations are
based on multiples
Different companies can be compared
through common metrics or ratios
Ratios can often be abused or
manipulated
1. Select a company to value.
2. Create a set of comparable companies.
3. For each comparable company, calculate
ratios to compare to the selected company
1. Price/ Earnings
2. Price/ Sales
4. Use the multiples for the comparable
companies to create a price.
1. Dell: P/E ratio = 21.63, price = $29.40,
1. P/E = Price per Share/Earnings per Share
2. Earnings per Share = Price per Share/(P/E)
3. Therefore E/S = $1.36 = 29.40/21.63
2. Find the average P/E ratio for comparable
companies: 24.46
3. Multiple the Dell’s EPS by the industry
average P/E ratio for a ‘relative’ price of
$33.27
• 1.36 x 24.46 = 33.27
4. Implication: Dell’s price could be about
$33.27
• if it kept the same E/S of $1.36, and
• it’s P/E ratio increased to match its competition
5. Dell is slightly underpriced on a P/E basis
when compared to its competition
FIN 614: Financial Management
Larry Schrenk, Instructor