Corporate Valuation – Study Guide
Autumn 2010
Corporate Valuation
Study Guide: Autumn 2010
Industrial and Financial Management
Department of Business Studies
Göteborg University
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Corporate Valuation – Study Guide
Autumn 2010
Learning objectives (from the course syllabus)
The course is divided into several important topics in company valuation
i) Understanding the financial statement
Financial statements provide the fundamental information describing historic events and
constitute the origin of company valuation. The students will learn the accounting principles
behind valuing assets, as well as breaking down the balance sheet into operating non-operating
items, and, the income statement into ordinary and unordinary items.
ii) Foundations of valuation
In this case, the student will learn techniques and models for estimating a firm’s free cash flow.
Important aspects are tax effects, adjusting for R&D as well as estimating the net investment for
growth calculations. The case will also discuss the correct information to be used for estimating
the cost of capital.
iii) Valuation from a portfolio management perspective
The objective is to understand the investment philosophy of the investor. Active and passive
portfolio management has different valuation purposes adopting different techniques. In this part
the importance of barriers to entry is analyzed, discussing the effect on volatility, distribution and
growth in earnings.
iv) Valuation from a M&A perspective and Value enhancement
The different classification of mergers and acquisitions will be discussed together with processes
and steps in M&A activities. Motives behind, and synergy effects of M&A will be viewed both
from theory and from empirical evidence. In the last case the students may also discuss valuation
from the view of a manager. From a broad perspective, the value based management literature
has brought new insight into the role of the managers, in the narrow perspective this section
focus on the importance of correct depreciation schedules.
The aim of the course is to give the participants a thorough knowledge in evaluating companies
using DCF, Value based management models and multiples.
Learning outcomes
After completing the course the student will understand and be able to
1. Analyse a company’s financial performance and extract information from the
financial statements.
2. Apply different valuation techniques such as FCFF, FCFE, Dividend-models and relative
valuation.
3. Analyse and describe a company’s value driving factors
4. In corporation with other students, and with limited information conduct a practical valuation
of a chosen company. This will be carried out from different perspective.
Lectures
Lectures are used to highlight theory and guide you through the difficulties of valuation theory.
This is a Masters level course and therefore lecturers do not directly explain what is in the
textbook. Instead the focus is on topics that are discussed in the text and try to put the text in a
perspective. The lecture is structured by the teacher, but we try to have open discussions. Before
the lecture make sure you have prepared yourself and if there are specific preparation questions
(written in this Study Guide) you can work with them as well.
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Seminars
At the seminars it is the course participants who present their work. The teacher’s role is to
provide a structure which enables everyone to get the most benefit out of group discussions. The
first two seminars are practically oriented and build on each other. The third seminar concerns
some more advanced valuation topics. It is very important that all students come to the seminars
ready to participate in the discussions. This does not just mean that you present your own
material, but also that you ask questions to others. I deduction of the score received on the case
will be given to each individual not present (compare course syllabus)
Signing up for a seminar
A team consists of 4 students (sometimes 3, but never 5!) that work together in terms of making
an analysis and presenting it at the seminar. All students sign up for the seminar in the
beginning of the course. As long as you attend the lectures you will have plenty of opportunities to
find other students to work with. You sign up by writing down your name and e-mail address on
the seminar list which is available on the notice board at the D6 building and brought to the first
lectures by the teachers. We prefer if all seminar groups consist of at least one Swedish national
and one exchange student. The reason for this is that (1) this forces everyone to work in the
English language, and (2) it creates an integration of exchange students in the student body. If
you do not know whom to work with, just talk to one of the teachers and we will make sure that
you do find a group.
After you have found a few friends to work with, you have to decide what company to analyze. In
the end of this Study Guide you will find a list of companies. Two groups cannot analyze the same
company and they are allocated on a ‘first come, first serve’ basis. The scheduled times for your
team’s presentations can be found in the tentative schedule.
The first seminar deals with the historical analysis of your company. Your team is asked to write
a paper that describes the company’s past performance. You do this in a reasonably structured
manner (remember that we do have a system making valuation analyses) but there is room for
you to highlight particularities in your company. You find all the details in Appendix B. At the
seminar all groups are given some time to present their company.
The second seminar follows directly on the first seminar. The task is now to move the analysis
from the past to the future. The team will then use the information of the company’s historical
performance relative to competitors, and discuss what the future is likely to be. You will then
come up with estimates of value drivers and use them to find the appropriate value of your
company. You find more information in Appendix C.
The third seminar is not directly linked to the previous seminars. Information on this seminar
will be handed out later during this course.
Make sure that the paper is handed in well before the deadline. Also make sure you e-mail the
presentation (it must be a PowerPoint file) prior to the seminar. Please put the name of the
company you analyze in the title of the e-mail.
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Teachers:
Stefan Sjögren (Associate Professor ph.d. – finance) earned his doctoral degree at the Department
of Business Studies, University of Gothenburg in 1996. He teaches a wide variety of courses in
the area of corporate finance and investments. In 2005 he co-edited a book on investment
decisions, relating theory to practice. Currently Stefan’s research interests involve corporate
finance decisions, and investment practices in particular.
Telephone: 031-786 1499.
E-mail: stefan.sjogren@handels.gu.se
Jan Marton (Assistant Professor). Teaches in the area of financial accounting, accounting theory,
financical statement analysis and group accounting. His research interests are 1) IFRS both from
a producer and a user perspective. 2) Voluntary disclosures in accounting, especially disclosures
about human resources and management control in the companies. 3) Accounting and trust,
which involves a comprehensive study of how the concept of trust has been used in the accounting
literature, and the result obtained to date in research on accounting and trust.
Ted Lindblom is a full professor specialized in industrial and financial management. He has long
experience of education and research in corporate finance related topics. His most recent research
concern capital budgeting and financial decision-making, incentive pay, the cost of trade credit,
and risk management in banks.
Telephone: 031-786 1497.
E-mail: ted.lindblom@handels.gu.se
Hans Jeppsson is a PhD student in Finance at the University of Gothenburg, School of Business,
Economics and Law. His primary research interest lies within empirical corporate finance with
an application on biotech companies. In the first research paper, he is analyzing news
announcements of European biotech firms and stock market reactions. In the second research
paper, he examines how biotech firms source equity capital to finance investments in R&D and
how they are able to time these equity issues with respect to theories of market mispricing and
adverse selection costs.
E-mail: hans.jeppsson@handels.gu.se
Emmeli Runesson is a PhD student in Accounting. Her research is in the area of accounting and
capital market, with a main focus on the effects of international accounting standards (IFRS) on
the financial reporting. The research issue is how international standards affects the reporting
quality from an investors perspective and how professional investors take use of the financial
reporting.
E-mail: Emmeli.runesson@handels.gu.se
You can find all material that has been handed out as well as other useful information on the
course web site (GUL). The course coordinator is Stefan Sjögren.
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Wiviann Hall takes care of most administrative matters.
telephone 031-786 1507, E-mail: wiviann.hall@handels.gu.se
For master students administration is handled by Tina Alderin (tina.alderin@handels.gu.se).
Detailed lecture information
LECTURE 1: INTRODUCTION, AND VALUATION MODELS AND
PERSPECTIVES
Content
This lecture provides an overview of different valuation perspectives. Valuation is useful from a wide range of tasks. Fund
managers and outside investors are valuing companies using public information. Valuation plays an important role also in
acquisition analysis. In the case of M&A the information available are often more detailed, and not only public. A third
role is to value a company from a manager’s point of view in order to take value enhancement decisions. Analysts use a
wide range of methods. We will introduce these methods briefly and discuss their pros and cons.
Things to think of
1. What is the value of an investment?
2. From which perspective is the valuation undertaken?
3. What are the building stones of the DCF method?
Preparation
Read chapters 1 and 2 in Damodaran.
LECTURE 2: ACCOUNTING AND VALUATION
Content
This lecture provides a background to accounting information which is used as the key input in all valuation models. We
discuss the role of accounting and how it can help and hurt the investor when evaluating the performance and financial
position of a company. This lecture also focuses on the company’s income statement. We make it useful for forecasts of
future performance by learning how to remove/adjust for unsustainable elements. We distinguish between operating and
financial activities. The objective is to identify and understand the operating activities in which the company has/wishes
to have a competitive advantage.
Things to think of
1. Have you understood everything in the Study Guide?
2. Do you know any good examples of when companies deliberately have fooled investors with the help of
accounting information?
3. What conflicts can arise between different users of accounting information (e.g. investors and creditors)?
Preparation
Read chapters 1, 2 and 9 in Damodaran.
LECTURE 3: ESTIMATING RISK AND THE COST OF CAPITAL
Content
This lecture focuses on the discount rate that is used in the valuation model. We will discuss how to practically estimate
all risk factors, and finally a proxy for an overall firm discount rate (WACC or return on equity). This includes repeating
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the CAPM model in order to estimate the cost of equity, and how to practically estimate a firms cost of debt. Using these
estimates also requires an assumption on the market efficiency.
Things to think of
1. Are financial markets efficient? Name the classifications of market efficiency.
2. What is risk? To whom?
3. Should we use the WACC or the cost of equity in the valuation model?
Preparation
Read chapters 4,6, 7 and 8 in Damodaran.
LECTURE 4: UNDERSTADNING THE VALUE OF A FIRM’S RESOURCES
Content
At this lecture we focus on the company’s resources (assets) as measured in the balance sheet, and its obligations
(liabilities). We look at different valuation techniques (e.g. historical cost and fair value), differences between different
kinds of assets and potential problems when comparing different companies.
Things to think of
1. At the last lecture we discussed the measurement of the core operation’s performance. There are three
conceptually different ways of manipulating this performance. Assume you are the manager of a company, your
stock options will soon expire and you want to boost your company’s operating profit margin. What can you do?
2. A part of Electrolux corporate strategy is to acquire and integrate small local competitors. These integrations
(and the continuous moving of production to low-cost countries) give rise to restructuring costs. How should such
costs be handled in an analysis of past performance?
3. Nokia receives about 80% of its sales revenue from the mobile phone division, and the rest from its network
system division (now a joint venture with Siemens and a direct competitor of Ericsson). What alternatives exist
for an analyst in terms of identifying its core business and judging performance?
Preparation
see chapters 2 and 9 in Damodaran.
LECTURE 5: ADJUSTING EARNINGS AND DCF METHODS
Content
This lecture will use the financial statement, especially the income statement, as a starting point. The items on the
income statement must be normalized and corrected with the purpose of trying to give a true picture of a firm’s
performance. Thereafter, this lecture focuses on how to estimate the free cash flow of a firm by adjusting some cost and
income items.
Things to think of
1. What (if any) is the difference between “correcting” and “adjusting” accounting items?
2. How do you adjust leasing, R&D and marketing expenses?
3. What is the main difference between FCFF and FCFE?
Preparation
Read chapters 9 and 10 in Damodaran.
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LECTURE 6: ANALYZING HISTORICAL PERFORMANCE
Content
Most of this lecture is not going to be devoted to financial ratios, but actually to finishing lecture 5 (on financial position)
and a regrouping of the financial statements. It is only when we have regrouped the financial statements that internally
consistent and valuation-relevant financial ratios can be constructed. We introduce these ratios in the end of the lecture.
Things to think of
1. If you are going to analyze a company’s profitability which is the best measure to use: (1) the return on equity,
(2) the return on net operating assets, or (3) the return on total assets?
2. What do you think is a normal return on financial assets and return on (net) operating assets? Why is there a
difference in these two returns?
3. In corporate finance you have probably have learnt that in reality there is an optimal debt ratio (mainly because
of taxes and agency costs). But is it common that companies have a negative debt ratio (i.e., more financial
assets than interest bearing debt)? Give examples (besides Nokia) of such companies/industries and provide
theoretical arguments as to why they might keep such (negative) debt ratios.
Preparation
LECTURE 7: ESTIMATING GROWTH AND CLOSURE
Content
This lecture provides tools and techniques on how to estimate the future. The value of a firm is equal to the present value
of all future cash flows. The most critical input in valuation is to foresee these cash flows. The valuation depends critically
on two things: the size of the growth rate, and for how long the estimated growth rates will persist. We will also discuss
the accuracy of financial analysts’ forecasts and introduce some relative comparisons.
Things to think of
1. How do you create expectations concerning the growth rate? What alternatives exist?
2. What is the terminal value of a firm? Do you think most value is created before or beyond the forecast horizon?
3. How is growth created?
Preparation
Read chapters 11-16 in Damodaran.
LECTURE 8: FORECASTING A FIRM’S FUTURE PERFORMANCE
Content
This lecture is about forecasting the future in a structured way. We use the framework we have introduced and learnt in
the past and now we discuss it in the light of strategic considerations (performance relative to competitors in the past and
in the future). The financial ratios from lecture 7 are now connected to the modeling of the future performance.
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Things to think of
1. Many companies have in recent years performed considerably better than their long-term historical average.
Can there be shifts over time in the overall level of performance (say for example the level of the sustainable
operating profit margin)? There are arguments both for and against so think carefully!
2. What would you as an investor be most happy about: (1) a company that has a constant operating margin and
market share in a growing market, (2) a company that has a constant operating margin, but gains market
shares in a market that is not growing, or (3) a company that increases its operating margin in a market that is
not growing?
Preparation
This chapter is more of a summary of what we have done so far. It provides a link between the valuation chapters in
Damodaran (i.e., chapter 13-16) and the financial analysis in the compendium. Hand-out distributed at the lecture.
LECTURE 9: PEER VALUATION AND MULTIPLES
Content
This lecture discusses the use of multiples and key ratios, and discuss their usefulness as valuation tools. We also show a
buttom up valuation using multiples.
Things to think of
3. Both P/E ratios and other key ratios, such as Ebitda/sales, are very common in describing a firm’s performance.
What are the drawbacks using key ratios for valuation purpose
4. A ratio must be theoretically consistent. The P/E ratio measures the price for a share in relation to the earnings
you receive owning the share, the measure and the purpose of the valuation are therefore aligned as the
numerator and the denominator are both eqiuty value. This is not so if we look at the price to EBITDA ratios.
Preparation
Read chapters 17 and 18 in Damodaran
LECTURE 10: MERGERS & ACQUISITIONS (SYNERGIES)
Content
This lecture examines M&A activities with special emphasis on the acquisition process and the various motives that
different parties concerned may have for initiating and carrying though an M&A. The importance and use of different
forms of payment for the target firm is also elaborated upon.
Things to think of
1. What are the relevant cash flow effects to consider when evaluating the performance of an M&A?
2. What time horizon is relevant in such an evaluation?
3. How does M&As impact on the acquiring company’s overall risk?
Preparation
Read chapter 25 in Damodaran.
LECTURE 11: VALUE ENHANCEMENT
Content
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This lecture examines actions to increase firm value and the impact of different financial performance measurements on
managerial incentives. We compare two widely used value enhancement and performance measurements; Economic Value
Added (EVA) and Return on Investment (ROI), and show when these measures are consistent with traditional Net
Present Value (NPV) calculations and when they are not.
Preparation
Read chapters 31 and 32 in Damodaran.
Literature
General comments
There are, quite obviously, a number of standard textbooks on the topic of valuation. We have
selected one of them; Investment Valuation by Aswath Damodaran. The strength of this book is
that the on-line support for student and researchers are very useful, and that the book cover a
wide area from a financial perspective. You can buy the book in paperback or hardback and we
certainly suggest that you get the paperback.
There are several alternatives that are worth mentioning. Stephen Penman has written a much
appreciated textbook that has a clear-cut accounting orientation. Its title is “Financial Statement
Analysis and Security Valuation”. Another book that is often used in valuation classes is
“Valuation: Measuring and managing the value of companies” by Koller, Goedheart and Wessels.
It is now out in its fifth edition (2005) and focuses on free cash flow models.
Investment Valuation (Aswath Damodaran (2002). John Wiley & Sons, 2 nd ed.)
The book by Damodaran is nearly 1000 pages long and contains 35 chapters. We require course
participants to read 16 chapters intensively and suggest that you read another 6 chapters
extensively. The following chapters are part of the required readings:
No
2
3
4
7
8
9
10
11
12
13
14
15
16
17
Title
Approaches to valuation
Understanding financial statements
The basics of risk
Riskless rates and risk premiums
Estimating risk parameters and cost of financing
Measuring earnings
From earnings to cash flows
Estimating growth
Closure in valuation: Estimating terminal value
Dividend discount models
Free cash flow to equity models
Firm valuation: Cost of capital and adjusted present value approaches
Estimating equity value per share
Fundamental principles of relative valuation
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25
31
32
Earnings multiples
Acquisition and takeovers
Value enhancement: A discounted cash flow valuation framework
Value enhancement: EVA, CFROI and other tools
Extensive reading:
1
5
6
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Appendix A
All teams have to sign up for a company that they want to analyze (by writing your names next to
the company on the seminar list). The companies are allocated on a ‘first come, first serve’ basis.
Seminar Group 1: Heavy manufacturing, large cap
Atlas Copco
Sandvik
SKF
Alfa Laval
Alternatives: Volvo, Scania, Assa Abloy, Saab
Seminar Group 2: Heavy manufacturing, mid cap
VBG
Haldex
Beijer Alma
Trelleborg
Alternatives: Nederman, Seco Tools
Seminar Group 3: Construction
Skanska
NCC
JM Bygg
Peab
Alternatives: Lindab, Systemair
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Seminar Group 4: Forestry & Paper
SCA
Holmen
StoraEnso
UPM Kymmene
Alternatives: Billerud, Norske Skog, Rottneros
Seminar One – Historical analysis of the company
Date: Friday the 9th of October
Structure and organization of seminar one
There will be four 2-hour seminars and at a seminar there will be 4 teams presenting. Each team
attends one 2-hour seminar. Appendix A contains a list of companies your team may choose
among. You choose a company by signing up on the seminar list. The intention is to have all
teams within a seminar to analyze a company in the same industry.
One team analyses one of the companies in the industry and to do this they need at least the
latest three annual reports of their company. You need to get a copy of these from the company’s
webpage (or order them from the company!). It is also highly beneficial if you search the Internet
for analyses of your company, and particularly analyses where its performance is compared to
other companies. Remember to make a reference to such analyses that you find and use.
Overall purpose
The overall purpose with seminar one is to get a good understanding of the company’s current
financial position and its development over the last years. We focus primarily on the financial
analysis, but do not forget that when extrapolating past performance into the future (i.e., the task
for seminar two) one needs to understand the competitive environment of the past relative to the
future. This means doing a strategic analysis. We divide the task into three components.
Task One: Creating common-size financial statements
You only need to perform this task for the latest year (=2008). Rearrange the assets and liabilities
so that it is possible to identify risk bearing capital, interest bearing debt, non-interest bearing
debt, capital employed and financial/operating assets. Create common-size financial statements
for your company. All balance sheet items that make up more than 10% of total assets/liabilities
should be separately noted.
Do the same thing with the income statement. (Sales revenue is then equal to 100%)
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Task Two: Measuring financial performance
Calculate the following financial ratios for your company and for the years 2006-08:
Sustainable operating profit margin
Net profit margin
Return on net operating assets
Return on capital employed
Return on risk bearing capital
Debt ratio
Interest cover margin
Operating cash flow to sales
Specify the definitions that you use. If you have problems with interpreting certain accounting
items this should be specified in notes.
Task Three: Analysis of the financial performance
Make a brief analysis of your company. This analysis should comprise 3-4 pages. You may bring
up anything you want but the following questions are interesting (Do NOT attempt to answer all
of them!). Remember: this seminar paper must comprise an analysis. This is of course the most
important part of the paper, but it builds on solid work in the previous parts.
* Have there been any changes over time (2005 to 2008)? -Comment on observable trends.
* Does your company state any financial goals in the annual report? -How does the company
perform in relation to these goals?
* Have there been any substantial gains/losses in the years you analyzed? -How have they
affected the measures?
* Decompose the RNOA into asset turnover and profit margin. -Which factor affects RNOA the
most?
* Try to find any financial analyses on the Internet of the industry your company is in. How does
your company perform in comparison to other companies?
Hand-in of material
The seminar paper shall be handed in (using e-mail) to Mattias Hamberg no later than 18.00 the
day before the presentation. It shall be in a Word-format or pdf-format. We do not want any
attached Excel-files (=create tables of the important information). All team members must
participate in the work. The length of the paper shall be no longer than nine (9) well-written
pages (excluding the front page)! Because half of the teams have one day more to prepare for the
presentation it is not possible to make any changes to the paper after the due date. This is only to
ensure reasonable fairness between teams!
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Presentation
A presentation of your company has to be prepared. This presentation has to be short however
and you do not have to present details of the financial situation. Maximum 15 minutes and 10
slides. After this we will continue to analyze the companies. Send a PowerPoint file with your
presentation no later than 18.00 the day before the presentation..
All seminar participants need their own copies of the annual reports. It is not good enough with a
pdf-file on the laptop.
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Seminar Two – Valuation of the company
Date: The 21th of October
Background and tasks
The second seminar is a direct continuation of seminar one. Your task is to conduct a company
valuation of the same company as before. This involves particularly the creation of pro forma
financial statements for a foreseeable time period. Each team will therefore base their analysis on
the financial statement analysis from the first seminar. It is encouraged that students use the
analyses from the other teams (at their seminar) when determining how well their own firm
performs.
1. Make a comment on the financial statements from the past years. Make them usable for a
forecast of the future (Income statements, Balance sheets and Net investments)
2. State the assumptions on which your valuation is based.
3. Make forecasts of financial statements for a foreseeable time-period (pro forma statements)
4. Estimation cost of capital, continuing value, etc.
5. Determine the company value, applying discounted cash flow methods.
and discuss it briefly (scenarios and sensitivity)
Presentation
The presentation shall be 20 minutes per group including 8 minutes seminar discussion. You are
asked to present the background for your analysis, assumptions and the actual results. After the
presentations there will be time to discuss the questions listed below. All students should have
considered these and be prepared to discuss them (you should not address them in your paper
though).
1. What are the main difficulties when creating pro forma statements for your company?
2. What portion of your company’s current value is, according to your estimates, created during
the foreseeable future?
Send a PowerPoint file with your presentation before 18.00 the day before the presentation.
Hand-in of material
The analysis has to be handed in to Stefan Sjögren before 18.00 the day before the presentation.
It shall be in a Word-format or pdf-format. We do not want any attached Excel-files (=make tables
of the important information). The length of the paper shall be no longer than nine (9) wellwritten pages (excluding the front page)!
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