Background & Highlights
Since the stock market crash of 1929, Discounting Cash Flow (DCF) has become
one of the prevalent model of valuing firms that has employed by many US
institutional investors including Warren Buffett, a prominent investor and
philanthropist. The method, however, shows its limitations in forecasting the
intrinsic value of Companies in South Korea and their intrinsic value of a stock
price. Using the same figures of US firms simply does not apply to Korean firms.
Through Researching and Running Multiple times of a designed FCF model by
Tong Yao, Associate Professor of Finance at the Tippie College of Business,
there seem to be reasonable inputs that could reduce the dispersion between
the market value of firms and the intrinsic value of firms. These variables are
Beta, Risk Premium rate, Risk Free rate, Cost of Debt, Tax Rate, and Debt to
Value of Operations. Each company is exposed to different risk levels, thereby,
estimating and adjusting the variables based on what kinds of industry are
crucial to lessen the dispersion and forecast the fundamental value of firms.
Assumptions & Methods
1. Collect financial statements from FactSet.
2. Gather the current stock beta and the current stock price from Yahoo!
Finance for US companies and from Naver Finance for Korean companies.
3. Assume that expected market risk premium remains constant by 6% for US
companies and is 7.45% for Korean companies
4. Assume that risk-free rate for US companies remains constant by 4% and is
2.55% for Korean companies.
5. Assume that the cost of debt will remains constant by 6% for US companies
and is 6.44% for Korean companies.
6. Use analysts’ consensus revenue forecasts to drive the growth rate.
7. Assume that sales growth rate decreases at constant and converge to 3.5%
by the terminal year (2029).
8. Use the ratio of EBITDA, non-operating assets, fixed assets, and
depreciation from analysts, and assume the ratios stay same at the CV year
9. Assume that Operating Working Capitals are constant at the CV year.
10. Assume that the terminal growth rate is 3.5%.
11. Calculate the Debt/ Enterprise Value using # shares outstanding, stock price,
normal cash, and non-current liabilities including short-term debt.
12. Calculate the WACC and the corresponding cumulative discount rates.
13. Discount the total free cash flow to bring it to PV and discount the terminal
value by the same discount rate.
14. Sum the value of operations and that of non-operating assets to calculate
for the intrinsic value of the firms.
15. Divide the intrinsic firm value by the number of outstanding shares is the
intrinsic stock price of the firm.
16. Compare the intrinsic stock price with the market stock price to see the
difference between two prices.
17. Conduct the sensitivity analysis to see what variable is causing the most
deviation in each US and Korean firm.
Limitations
Data:
 Risk Free Rate
- This model assumes the risk-free rate of US to be constantly 4%,
which is the historical average over a long horizon. Valuing equity,
however, can be based on the yield on 30-year Treasury Bond,
which is 2.47% as of April 2nd, 2015. For some companies,
changing risk-free rates from 4% to 2.47% makes the intrinsic
price closer to the market price. But, this may not be the case for
other companies.
 Market Risk Premium
- Market risk premium used for this model is 6%, which is the
reasonable estimate derived from the U.S. historical average risk
premiums. As of 2014, the historical average of risk premium is
4.62%. On April, the forward-looking MRP has released by NYU
Finance Professor. This rate is 5.24%. The average of these two
percentages give 5.24%, which is slightly deviated from 6%.
 Beta
- Each Financial website uses different ways to figure out the Beta.
Therefore, Beta may not be consistent industry-specific wise or
firm-specific wise.
 Cost of Debt
- Cost of Debt for Korea is not publicly released. The borrowing
rates for firms may not be the accurate estimates.
Data:
FCF Worksheet
2014 (last)
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
178542
184552
170988
179330
187855
196549
205399
214390
223506
232729
242042
251423
260853
270310
279771
9602
10723
12424
13030
13649
14281
14924
15577
16239
16910
17586
18268
18953
19640
20328
-24835
-16734
1140
-21372
-22173
-22975
-23774
-24568
-25355
-26133
-26899
-27649
-28383
-29097
-29788
-50287
-52695
-55331
-58031
-60789
-63603
-66467
-69376
-72326
-75311
-78324
-81360
-84412
-87472
-90533
36601
2408
2637
2699
2758
2813
2864
2909
2950
2985
3013
3036
3052
3060
3062
66477
68761
76097
79809
83603
87472
91411
95412
99469
103574
107718
111893
116090
120299
124509
TAX
17368
17965
19881
20851
21842
22853
23882
24927
25987
27060
28142
29233
30330
31429
32529
Operating Cash Flow
58711
61520
68639
71988
75410
78900
82452
86062
89721
93424
97162
100928
104713
108509
112307
70477
47194
72416
53316
55995
58738
61542
64403
67316
70275
73277
76314
79382
82473
85580
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
Investment Cash Flow
163308
Long-term Assets
Depreciation & Amortization
Investment Cash Flow
Cash Flow Due to change in Net Working Capital
-13686
NWC
Cash Flow due to change in NWC
Operating Cash Flow
EBIT
52349
Free Cash Flow
Cost of capital Worksheet
2014 (last)
Stock beta
0.99
0.99
0.99
1.00
1.00
1.00
1.00
1.00
1.00
1.00
1.00
1.00
1.00
1.00
1.00
1.00
Cost of equity
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
Cost of debt
0.06
0.06
0.06
0.06
0.06
0.06
0.06
0.06
0.06
0.06
0.06
0.06
0.06
0.06
0.06
0.06
Debt / Value of Operations
0.08
0.08
0.08
0.08
0.08
0.08
0.08
0.08
0.08
0.08
0.08
0.08
0.08
0.08
0.08
0.08
WACC
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
0.10
cumulative discount rate
1.00
1.10
1.20
1.31
1.44
1.58
1.73
1.89
2.07
2.27
2.48
2.72
2.98
3.26
3.57
3.91
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
64357
39354
55141
37070
35549
34050
32574
31124
29702
28311
26952
25626
24336
23083
21867
Valuation Worksheet
2014 (last)
Discounted FCF
PV of FCF up to terminal year
509096.56
Terminal Value (TV, evaluated
1466856.25
at terminal year)
PV of Terminal Value
374795.41
Value of operations
883891.97
Value of non-opearting assets25077.00
(cash & ST investments)
Intrinsic firm value
908968.97
Value of debt (approximated 63152.00
by book value of debt)
Intrinsic equity value
Shares outstanding
845816.97
5825.00 million
Intrinsic stock price (intrinsic stock
$145.20
price)
Current market price
2-Apr
$124.25 as of:
INDUSTRY
02-Apr-15
FIRM
MARKET
THEORITICAL
OVER/UNDER
BETA
RPM
Rf
Rd
D/V
Tc
KOR
ENERGY
SK INNOVATION INC.
$
91.38
$
39.60
OVERVALUED
1.80
7.45% 2.55% 6.44%
62%
31%
USA
ENERGY
EXXON M OBIL CORP.
$
84.46
$
36.60
OVERVALUED
1.09
6.00% 4.00% 6.00%
26%
35%
KOR
CONSTRUCTION
DOOSAN INFRACORE
$
10.05
$
-5.42
OVERVALUED
1.73
7.45% 2.55% 6.44%
82%
32%
USA
CONSTRUCTION
CATERPILLAR INC.
$
79.64
$
49.88
OVERVALUED
1.12
6.00% 4.00% 6.00%
56%
27%
KOR
AUTOM OBILE
HYUNDAI M OTORS
$
149.85
$
246.59
UNDERVALUED
1.73
7.45% 2.55% 6.44%
86%
24%
USA
AUTOM OBILE
GENERAL M OTORS
$
36.74
$
47.07
UNDERVALUED
1.07
6.00% 4.00% 6.00%
75%
29%
KOR
TECHNOLOGY
SAM SUNG ELECTRONICS
$ 1,310.43
$ 1,194.80
OVERVALUED
1.51
7.45% 2.55% 6.44%
10%
21%
USA
TECHNOLOGY
APPLE INC.
$
124.25
$
145.20
UNDERVALUED
0.96
6.00% 4.00% 6.00%
8%
26%
KOR
ONLINE DATABASE NAVER CORP.
$
586.72
$
515.95
OVERVALUED
0.58
7.45% 2.55% 6.44%
3%
28%
USA
ONLINE DATABASE GOOGLE INC.
$
549.49
$
795.09
UNDERVALUED
0.87
6.00% 4.00% 6.00%
4%
19%
Preliminary Conclusion
Assumptions and Inputs
2014 (last)
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
Sales Growth Rate
-6.23%
0.33%
3.19%
-1.20%
-0.80%
-0.41%
-0.02%
0.37%
0.76%
1.15%
1.54%
1.93%
2.33%
2.72%
3.11%
3.50%
EBITDA margin (EBITDA/Sales)
19.99%
20.92%
21.52%
23.59%
23.59%
23.59%
23.59%
23.59%
23.59%
23.59%
23.59%
23.59%
23.59%
23.59%
23.59%
23.59%
Long-term Assets / Sales
53.54%
55.92%
57.29%
59.90%
59.90%
59.90%
59.90%
59.90%
59.90%
59.90%
59.90%
59.90%
59.90%
59.90%
59.90%
59.90%
Depreciation/Long-term Assets
15.09%
15.89%
15.49%
17.00%
17.00%
17.00%
17.00%
17.00%
17.00%
17.00%
17.00%
17.00%
17.00%
17.00%
17.00%
17.00%
Operating Current Assets / Sales
24.77%
24.77%
24.77%
24.77%
24.77%
24.77%
24.77%
24.77%
24.77%
24.77%
24.77%
24.77%
24.77%
24.77%
24.77%
24.77%
Operating Current Liabilities / Sales
19.60%
19.60%
19.60%
19.60%
19.60%
19.60%
19.60%
19.60%
19.60%
19.60%
19.60%
19.60%
19.60%
19.60%
19.60%
19.60%
2.02
2.02
1.95
1.87
1.80
1.73
1.66
1.58
1.51
1.44
1.36
1.29
1.22
1.15
1.07
1
Stock Beta
FCF Worksheet
2014 (last)
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
109896
116187
Depreciation & Amortization
17463
17997
Investment Cash Flow
-22481
-24288
Cash Flow Due to change in Net Working Capital
NWC
10119
10153
10477
Cash Flow due to change in NWC
-33
-324
Operating Cash Flow
EBIT
23645
25642
TAX
4927
5343
Operating Cash Flow
36180
38296
120022
20403
-24239
119057
20239
-19274
118565
20155
-19664
118539
20151
-20125
118977
20225
-20663
119882
20379
-21285
121263
20614
-21995
123135
20932
-22804
125517
21337
-23720
128437
21834
-24753
131927
22427
-25917
136028
23124
-27225
140789
23933
-28694
10351
125
10268
83
10226
42
10223
2
10261
-38
10339
-78
10458
-119
10620
-161
10825
-205
11077
-252
11378
-301
11732
-354
12142
-411
26857
5597
41664
26641
5552
41328
26531
5529
41158
26525
5527
41149
26623
5548
41301
26826
5590
41615
27135
5655
42094
27554
5742
42744
28087
5853
43571
28740
5989
44585
29521
6152
45796
30439
6343
47220
31504
6565
48873
17550
22138
21537
21026
20600
20252
19980
19779
19646
19580
19578
19641
19767
Investment Cash Flow
Long-term Assets
104878
Free Cash Flow
13667
13684
Cost of capital Worksheet
2014 (last)
Stock beta
Cost of equity
Cost of debt
Debt / Value of Operations
WACC
cumulative discount rate
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2.02
0.18
0.06
0.10
0.16
1.16
1.95
0.17
0.06
0.10
0.16
1.35
1.87
0.17
0.06
0.10
0.15
1.56
1.80
0.16
0.06
0.10
0.15
1.79
1.73
0.15
0.06
0.10
0.14
2.04
1.66
0.15
0.06
0.10
0.14
2.33
1.58
0.14
0.06
0.10
0.13
2.64
1.51
0.14
0.06
0.10
0.13
2.98
1.44
0.13
0.06
0.10
0.12
3.36
1.36
0.13
0.06
0.10
0.12
3.76
1.29
0.12
0.06
0.10
0.11
4.19
1.22
0.12
0.06
0.10
0.11
4.65
1.15
0.11
0.06
0.10
0.10
5.13
1.07
0.11
0.06
0.10
0.10
5.65
1.00
0.10
0.06
0.10
0.10
6.19
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
11745
10149
11282
12386
10532
9027
7797
6787
5955
5265
4692
4213
3813
3477
3196
2.02
0.18
0.06
0.10
0.16
1.00
Valuation Worksheet
2014 (last)
Discounted FCF
PV of FCF up to terminal year
110315.26
Terminal Value (TV, evaluated
340178.67
at terminal year)
PV of Terminal Value
Value of operations
54992.04
165307.29
Value of non-opearting assets
56241.04
(cash & ST investments)
221548.33
Value of debt (approximated by
18313.08
book value of debt)
Intrinsic equity value
203235.25
Shares outstanding
170.10 million
Intrinsic firm value
While the price of technology firms moves in the opposite
direction, that of energy firms are positively correlated. The
price of internet companies also move in the opposite direction,
whereas that of construction firms move in the same way. The
debt to enterprise values of an automobile industry are also
larger than that of other industry. Both of these companies are
undervalued.
The question is what variables are causing these deviations.
Are the differences arising from market factors or are they
coming from firm-specific factors, such as capital structures?
How similar industry firms can have different movements?
These questions are going to be analyzed throughout the rest
of the semester. The conclusion should reduce the abnormal
gap between the market price of the stock and the intrinsic
price of the firm and further give the better estimates of riskfree rates, market risk premium rates, and cost of debt.
Intrinsic stock price (intrinsic stock
$1,194.80
price)
Current market price
$1,310.43 as of:
02-Apr-15
References: Yahoo! Finance, FACTSET, NAVER