Corporate Valuation, 2002-4, p. 1
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“Valuation depends mainly on understanding the
business, its industry, and the general economic
environment, and then doing a prudent job of
forecasting. Correct methodology is only a
small, but necessary, part of the valuation
process” p.292
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 2
CMK 8 Framework for valuation
Models
• DCF enterprice
• Economic Profit (EP)
• APV (changing cap.structure)
• DCF equity (fin.institutions)
add on’s
• options
• nominal vs. real
• pre-post tax
• formulae instead of explicit forecast
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 3
Framework for valuation
DCF enterpricemodel
• value of operations based on free cash
flow forecast
• discounted back with risk adjusted rate
• less value of debt
• regulated for non-operating assets /
liabilities
The discount rate reflects the opportunity cost of
all capital (WACC, tax shield), eg. exhibit 8.5.
Forecast for 100 years OR utilize a formula for
the last 90 years - giving the continuing
value, whose
formula is composed of NOPLAT, growth,
ROIC - and WACC p.136
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 4
Framework for valuation
Growth rate = ROnewIC * investment rate, p.
138.
Investment rate =
Net Investments / NOPLAT =
(Gross Investments - depreciation) / NOPLAT
Key drivers of value are ROIC (relative to
WACC) and growth, exhibit 8.8.
ECONOMIC PROFIT MODEL
V = capital invested + PV-value created in the
future - debt +/- non-operating assets/liabilities
• economic profit = invested capital*(ROICWACC) or NOPLAT-(inv.cap.*WACC)
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 5
Framework for valuation
ADJUSTED PV MODEL (APV)
• values based only on cost of equity and
then adds value of tax benefit of debt (tax
shield)
DCF-equity MODEL
• values the equity DIRECTLY based on cost
of equity
• BUT get the leverage right !
5 STEP “how to do” in ch.9-13
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 6
Step 1
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(ch.9) Analyzing Historical Performance
Reorganize accounting statements to be
able to calculate NOPLAT, free cash flow &
operating capital
Focus on key value drivers i.e. ROIC and
growth
Break them down into their component
drivers i.e. ROIC into cap.turnover and
profit margin, cf. exhibit 9.8
Distinguish operating from non-operating
Ending with consistency between
NOPLAT and operating invested capital
How is the liquidity balance, p. 173-176
(Donaldson)
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 7
Analyzing Historical Performance
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NOPLAT: Convert tax to cash basis as tax expensed on
operating profit (eg. exhibit 9.4)
Add quasi-equity (reserves, provisions, deferred income
tax) to invested capital, adjust NOPLAT if necessary to
secure consistency (eg. exhibit 9.10 & p. 179)
Extraordinary items should not be included in NOPLAT
calculations
Goodwill amortization is not deducted in NOPLAT
(operating capital should be calculated both inclusive
and exclusive goodwill resulting in two ROIC-measures)
ROIC = NOPLAT / Invested capital
FCF = NOPLAT - Net investments
= (NOPLAT + depreciation) - Gross Investments
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 8
Analyzing Historical Performance
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Do not correct for inflation unless in a high
inflation environment
IF lumpy investments - spread it out or utilize
CFROI Valuation, cf. p. 181-183
Expensed investments (R&D, marketing)
could be capitalized and depreciated, p.
181.
Foreign exchange translation effects are
treated as non-operating cash flow
Operating leases should be capitalized if
material, p. 177.
Minority interest: earnings = financing
cost; cash flow (dividend) = financing
flow, p. 180.
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 9
Analyzing Historical Performance: Output
•NOPLAT & Free Cash Flow-statements
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Cash flow available to investors = Total financing flow,
Exhibit 9.7
•Operating invested capital (ex. & incl. Goodwill)
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Total investor funds (assets) = Total investor funds
(liabilities), Exhibit 9.3
•Debt, equity, non-operating liabilities and assets.
•ROIC, ROIC-tree, and growth (in revenues and
NOPLAT) + Economic Profit
•Credit health and liquidity
•Look for trends and compare with industry
•Linking economic measures (ROIC & growth) to
historic development in:
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Industry
Competitors
Stock markets
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 10
Step 2
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(ch.10)
Cost of Capital
WACC
Market weights should be used
Use target capital structure
Look out for changes in inflation, systematic
risk, capital structure, and market weights over
the time horizon
CAPM for cost of equity
Market risk premium 4 - 5% in US
Risk free rate: use a 10-year Treasury bond
Check your beta ! And leverage it correct
(p.307-311)
Debt in foreign exchange is valued with foreign
exchange interest rates and converted at spot
rate
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 11
Step 3
(ch.11)
Forecast performance
How the company may develop
•Length and level of detail
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the explicit forecast should cover a full cycle
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one or two explicit periods + terminal period
(see ch. 12)
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the forecast should be explicit until steady
state
•Have a strategic perspective considering the
industry (Ghemawat) and competitive position (e.g.
2*Porter)
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 12
Forecast performance
Historical performance
•ROIC, growth in
revenues, EBITA,
NOPLAT, investments,
free cash flow, etc.
Strategic context
Cause
Continuity,
consistency
Future performance
•SWOT, competitive
advantages, competitors,
industry structure (Porter),
value chain, PEST (politics,
economics, social &
technology), etc.
Cause •Changes
•ROIC, growth in revenues,
EBITA, NOPLAT, investments,
free cash flow, etc.
•Value
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 13
Forecast performance
•Good idea to develop a strategic perspective about the
company’s future performance, eg:
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”Demand is increasing rapidly because of changing
demographics, yet prices will remain stable …”, p.
235. (or Heineken, p. 252)
•Should be formulated with basis in the strategic context
•Should be consistent with the historical performance
•Future performance should be derivable from the strategic
perspective
•Follow the advise on p. 241 in establishing exh. 11.1611.27 & p. 292-293.
•Alternative scenarios, e.g. exhibit 11.7
•Check for consistencies, e.g. exhibit 11,25, 11.27, 9.19
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 14
Step 4
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(ch.12)
Continuing Value
PV of cash flow after the explicit forecast
period
Simplified assumptions make formulas do the
impossible job
Different formulas for different approaches
For DCFenterprise the value-driver formula =
NOPLATt+1 (1-g/ROIC)/ WACC-g
Also non-cash flow based approaches in special
situations (Price to earnings, Market to book,
liquidation value, replacement cost)
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 15
Step 5 (ch.13) Calculating and
interpreting the results
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Discount FCF using WACC
Discount continuing value using WACC
Add value of non operating assets
Subtract value of non operating liabilities
Mid-year adjustment.
Subtract value of debt
Compare with present market value
Evaluate debt-equity forecast / balance
sheet
Compare the scenarios and assess the
likelihood
Define your margin of error / test
sensitivity
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 16
Aggarwal 16
Justifying strategic investments
Has the manufacturing setup an impact on value ?
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Different types of man.systems - fig.16-1
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Optimality of manufacturing setup - fig.16-2
Institut for Regnskab, Tom Hansen
Corporate Valuation, 2002-4, p. 17
NEXT - 21. October
Workshop
•Dialogue and coaching
•Exercise 12.4
Lectures:
•Options (chap. 20, Kasanen, 2* Luehrman)
Remember mid stage report on 21 October
• One pager (1 A4) per group
• Email to me
• How is things going
· information gathering, work plan,
outline of report, model building,
valuation method, etc.
Institut for Regnskab, Tom Hansen