DCF Valuation
The discounted cash flow (DCF) model involves valuing the company using the
present value of expected cash flows and its terminal value. The five main steps of doing a
DCF valuation are forecasting free cash flow, calculating the weighted average cost of
capital, calculating the terminal value, discounting the cashflows and terminal value, and
finally calculating the implied share price.
Free cash flows
For this analysis, we first need to determine the time frame. As the case provides
estimated data for five years starting from 2015 to 2019, the valuation will consider the free
cash flows of the entity for that period and the terminal value of the firm in 2020. For this
analysis, the following formula will be used to calculate the free cash flows of Ferrari.
FCFF= EBITDA(1-tax rate) + Depreciation (tax rate)- investment in working capitalinvestments in Fixed capital.
Therefore, we can calculate the free cash flows as follows (all figures are in Euro millions).
The assumptions used to calculate the revenue and operating profit are provided in the case
and they are shown in annexures 1.
Table
It should be noted that the same calculation of free cash flows to the firm can also be
done by the formula of FCFF= NOPAT+ Depreciation and amortization – Capital expenditure
– change in net working capital. To make our analysis more sound, FCCF calculated using
this formula is highlighted in the following table.
Table
Note that the corporate tax rate is given in the case as 38%. As we can see under both
formulas, we will get the same free cash flows. When calculating free cash flows, capital
expenditure and change in net working capital play a major role. The calculation of those
have been shown in the following table.
Table
Having calculated free cash flows to the firm, the next step is to determine the
weighted average cost of capital. In the case study, it has been mentioned that the cost of
capital had been estimated to be 5.0% in euros. Therefore, we can directly use this rate to
discount free cashflows and the terminal value.
The next step is to calculate the terminal value. The perpetuity growth method can be
used to calculate the terminal value. For this, we have to determine the growth rate of the
company as it is not mentioned in the case.
Growth rate (g)
Ferrari is a super luxury car brand, therefore, it is more associated with the growth of
luxury brands rather than normal premium car brands such as BMW and Audi. Also, when
considering the growth rate after 2019, it should be noted that the financial impact and
regulatory impact of IPO will be mitigated by then. Therefore, although we can expect high
growth in earnings in the short run, in the long run, the company will most probably grow
with the luxury goods industry as it reflects the buying power and consumer preference of
wealthy customers who consume luxury brands. Therefore, we will use 2.88% as the long-
term growth rate of the company which is closely associated with the average growth rate of
the luxury goods industry. The calculation of the growth rate is shown below.
Table
Having calculated the growth rate, the terminal value of the Ferrari can be calculated using
the following formula.
TV= (FCFn(1+g)/ (WACC- g)
Since the growth rate is estimated to be 2.88%, WACC to be 5% and the free cash flow of
2019 to be Euro Mn 240, the terminal value will be (240(1+0.0288)/ (0.05-0.0288) which is
11,636.11 and the the summary of calcuation is provided in the following table.
Table
Having calculate all of these values, we can finally build the discounted cashflow model as
follows. FCFFs are discounted using the cost of capital of 5% to calculate the present value
of free cash flows and the sum of all are known as sum of PV of FCF. Terminal value is also
discounted. The sum of terminal value and the sum of PV of FCF are known as the enterprise
value. The enterprise value is then converted into the equity value by adding cash and
deducting the debt amount. The number of shares after the IPO issue is 189 millions.
Table
Annexures
Annexures 1
Annexures 2