Va lua t io n
Ca sh Fl o w An a lysis
Cr edit
Risk Assessmen t
Corporate Valuation
¦Corporate valuation involves
estimating the worth or price of a
company, one of its operating
units, or its ownership shares.
¦Fundamental analysis refers to
the process of using basic
accounting numbers in corporate
valuation.
Corporate Valuation
Steps
¦Forecasting future values of some
financial attributes
– Free cash flow
– Accounting earnings
– Balance sheet book values
¦Determining risk
¦Determining the discounted
present value
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Free Cash Flow
¦Free cash flow is defined as the
company’s operating cash flows
minus cash outlays for the
replacement of existing operating
capacity.
¦To value the company’s common
stock subtract cash interest
payments, debt repayments and
preferred dividends.
Free Cash Flow
∞
Po =
∑
t=1
∼
E o (CFt )
(1 + r)
t
The role of earnings
Research supports the proposition
that current accrual accounting
earnings are more useful than
measures of current cash flows in
predicting future cash flows.
2
The Role of Earnings
∞
Po =
∑
t=1
∼
E o (CFt )
(1 + r)
t
Simplifies to
Po =
Xo
r
Po
or
1
=
Xo
r
Sources of Variation in
P/E Multiples
¦ Risk differences
¦ Growth opportunities
¦ Permanent, transitory and valueirrelevant components
– Permanent q Income from continuing operations
– Transitory q Discontinued operations and extraordinary items
– Value-irrelevant q Change in accounting principle
¦ The concept of earnings quality
Abnormal Earnings
Approach
¦ Investors willingly pay a premium only for
those firms that earn more that the cost of
capital, positive abnormal earnings.
¦ Where earnings are normal, investors pay
only for the underlying book value of the
assets.
¦ Investors will pay less than the underlying
book value of the assets when there are
negative abnormal earnings.
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Abnormal Earnings
Approach
∞
P o = BVo +
∑
t=1
E o (Abnormal Earnings)
t
(1 + r)
Abnormal Earnings
Approach
Abnormal Earnings = X - (r * BVt - 1)
t
Earnings Surprises
“Earnings
surprises are
like
cockroaches,
you will
never see
only one.”
4
Cash Flow Analysis
and Credit Risk
¦ Lenders are primarily interested in the
ability of the borrower to repay from
future operating cash flows.
¦ Credit Analysis
–
–
–
–
Pro forma financial statements
Assessment of financial flexibility
Due diligence
Comprehensive risk assessment.
Cash Flow Components
¦Cash flow from operating
activities
¦Cash flow from investing
activities
¦Cash flow from financing
activities
Va lua t io n
Ca sh Fl o w An a lysis
Cr edit
Risk Assessmen t
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