Forecasting and Valuation of
Free Cash Flows
Arzac, Chapter 2
Firm Valuation
historical financial statements
forecast period
opportunity costs of capital
market value weight
make assumptions for
continuation value
use formula to get
value
check different
scenarios
Firm Valuation
• DCF valuation - incorporates estimates
of FCF for set number of years with
calculation of continuation value at end
• multiples approach – comparable
companies or comparable transactions
FCF Calculation
• start with NI
• add net interest expense after tax to get
unlevered NI
• (1-T)(Int. Exp. – Int. Inc.) = Unlevered NI
• add back changes in deferred taxes and
depreciation
• noncash
• ↑ def taxes is source of cash
• depreciation can include all noncash charges deducted
from EBIT except for goodwill
FCF Valuation
• deferred taxes + unlevered NI = NOPAT
• depreciation to NOPAT = Gross CF
• total CF given off by firm
• Gross CF – Gross Inv. = FCF (operations)
• Gross Investment =
•
•
•
•
increase in WC
+ capital expenditures
+ investment in goodwill
+ increase in net other assets
Exhibit 2.1. AdvPak Technologies. Historical Data and Forecasting Assumptions
($000)
Historical
Forecast for Fiscal Years Ending 12/31
2006
2007
2008
2009
2010
Operations:
Unit Sales Growth
5.4%
6.0%
6.0%
5.6%
5.6%
Price Growth
2.0%
2.3%
2.3%
2.3%
2.3%
Growth Rate of Sales
7.5%
8.4%
8.4%
8.0%
8.0%
Cost of Sales (Excl. Dep. & Amort.) as % of Sales
Selling, General & Administrative as % of Sales
Research & Development as % of Sales
EBITDA as % of Sales
Growth Rate
2011
5.1%
2.3%
7.5%
81.8%
7.4%
0.9%
9.8%
8.5%
79.0%
7.0%
1.0%
13.0%
44.2%
77.5%
7.0%
1.0%
14.5%
21.0%
77.5%
7.5%
1.0%
14.0%
4.3%
77.5%
7.5%
1.0%
14.0%
8.0%
77.5%
7.5%
1.0%
14.0%
7.5%
16,100
80,414
39.50%
10,695
13.3%
11,740
14.6%
11,380
81,018
36.70%
10,775
13.3%
11,829
14.6%
17,771
86,658
36.20%
12,132
14.0%
12,999
15.0%
19,437
91,857
35.52%
14,238
15.5%
14,973
16.3%
22,046
98,617
35.30%
15,286
15.5%
16,075
16.3%
22,807
105,129
35.00%
16,295
15.5%
17,136
16.3%
Working Capital:
Cash balance as % of Sales
Accounts Receivable as % of Sales
Days Receivable
Inventories as % of Cost of Sales
Inventory Days on hand
Other Current Assets as % of Sales
1.7%
8.9%
32
15.1%
55
0.35%
1.6%
8.9%
32
15.1%
55
0.35%
1.6%
8.9%
32
15.1%
55
0.35%
1.6%
8.9%
32
15.1%
55
0.35%
1.6%
8.9%
32
15.1%
55
0.35%
1.6%
8.9%
32
15.1%
55
0.35%
Accounts Payable as % of Cost of Sales
Days Payable
Accrued Expenses as % of Sales
Tax Payable as % of Current Income Tax
Other Current Liabilities as % of Sales
10.6%
39
1.15%
0.37%
0.41%
10.8%
39
1.15%
0.37%
0.41%
10.8%
39
1.15%
0.37%
0.41%
10.8%
39
1.15%
0.37%
0.41%
10.8%
39
1.15%
0.37%
0.41%
10.8%
39
1.15%
0.37%
0.41%
16.67%
16.67%
16.67%
16.67%
2.49
2.56
2.52
2.56
8.35%
8.35%
8.35%
8.35%
4.61%
4.61%
4.61%
4.61%
100% of excess cash and marketable securities
38.25%
38.25%
38.25%
38.25%
16.67%
2.38
8.35%
4.61%
Capital Expenditures and Depreciation:
Capital Expenditures (net of Disposals)
Net Property, Plant & Equipment (PP&E)
% of Sales
Book Depreciation
% of Net PP&E
Tax Depreciation
% of Net PP&E
Debt, Interest, Dividends and Taxes:
Short-term Debt & Curr. Portion of LTD as % of Total Debt
Total Debt as a multiple of next year EBITDA
Interest rate on debt
Interest rate on cash and marketable securities
Dividends paid
Tax rate on income
16.67%
2.85
38.25%
38.25%
Exhibit 2.2. AdvPak Technologies. Pro-Forma Income Statements
($000)
Historical
2006
Sales
203,580
Cost of Sales
166,592
Gross Profit
36,988
Sales, General & Administrative Expenses
15,164
Research & Development
1,922
EBITDA
19,901
Depreciation
10,695
EBIT
9,206
Interest Expense
Interest Income
Pretax Income
Current Income Tax
Deferred Tax
Net Income
2007
220,758
174,399
46,359
15,453
2,208
28,699
10,775
17,923
6,831
157
11,250
3,900
403
6,947
Forecast for Fiscal Years Ending 12/31
2008
2009
2010
239,386
258,605
279,368
185,524
200,419
216,510
53,862
58,186
62,858
16,757
19,395
20,953
2,394
2,586
2,794
34,711
36,205
39,112
12,132
14,238
15,286
22,579
21,967
23,826
7,218
7,741
8,237
163
176
191
15,524
14,403
15,780
5,606
5,228
5,734
331
281
302
9,586
8,894
9,744
2011
300,369
232,786
67,583
22,528
3,004
42,052
16,295
25,757
8,974
206
16,989
6,177
322
10,491
Exhibit 2.3. AdvPak Technologies. Pro-Forma Balance Sheets
($000)
Historical
2006
Assets
Current:
Cash and Marketable Securities
3,417
Accounts Receivable
18,119
Inventories
25,158
Other Current Assets
717
Total Current Assets
47,411
2007
Forecast for Fiscal Years Ending 12/31
2008
2009
2010
2011
3,532
19,647
26,337
777
50,294
3,830
21,305
28,017
843
53,996
4,138
23,016
30,267
911
58,331
4,470
24,864
32,697
984
63,015
4,806
26,733
35,155
1,058
67,752
Property, Plant & Equipment
Less: Depreciation
Net Property, Plant & Equipment
117,667
37,253
80,414
129,047
48,028
81,018
146,818
60,160
86,658
166,255
74,398
91,857
188,301
89,684
98,617
211,108
105,979
105,129
Other Noncurrent Assets:
Total Assets
9,352
137,177
9,352
140,665
9,352
150,006
9,352
159,540
9,352
170,984
9,352
182,233
Liabilities
Current:
Short-term Debt & Current Portion of LTD
Accounts Payable
Accrued Expenses
Taxes Payable
Other Current Liabilities
Total Current Liabilities
Long-term Debt
Deferred Income Taxes
Total Liabilities
Common Stock and Retained Earnings
Total Liabilities and Net Worth
13,632
17,659
2,341
20
835
34,487
68,162
1,209
103,859
33,319
137,177
14,405
18,835
2,539
14
905
36,699
72,027
1,612
110,338
30,327
140,665
15,449
16,439
20,037
21,645
2,753
2,974
21
19
981
1,060
39,241
42,138
77,246
82,194
1,943
2,224
118,430 126,556.48
31,576
32,983
150,006
159,540
17,910
23,383
3,213
21
1,145
45,672
89,548
2,526
137,746
33,237
170,984
17,910
25,141
3,454
23
1,232
47,759
97,626
2,848
148,233
34,000
182,233
Exhibit 2.4. AdvPak Technologies. Pro-Forma Cash Flow Statements
($000)
Historical
2006
Funds from Operating Activities
Net Income
Depreciation
Deferred Tax
Decrease (Increase) in Current Assets
Increase (Decrease) in Current Liabilities except debt
Decrease (Increase) in Net Working Capital
Funds From Operations
6,947
10,775
403
(2,768)
1,439
(1,330)
16,796
9,586
12,132
331
(3,404)
1,498
(1,905)
20,144
8,894
14,238
281
(4,028)
1,907
(2,121)
21,292
9,744
15,286
302
(4,351)
2,064
(2,287)
23,044
10,491
16,295
322
(4,401)
2,087
(2,314)
24,793
Funds for Investment
Capital Expenditures
11,380
17,771
19,437
22,046
22,807
Funds to (from) Financing
Decrease (Increase) in Debt
Dividends
Total Funds to (from) Financing
Increase (Decrease) in Cash
End-of-Year Cash & Marketable Securities
(4,638)
9,939
5,301
115
3,532
(6,262)
8,337
2,075
298
3,830
(5,939)
7,486
1,547
308
4,138
(8,824)
9,490
666
332
4,470
(8,078)
9,728
1,650
336
4,806
Required cash balance ………………...……
Excess cash …………………………………..
Increase in Net Debt
Net debt
3,417
Actual
3,417
0.000
78,378
2007
3,532
0.000
4,523
4,523
82,901
Forecast for Fiscal Years Ending 12/31
2008
2009
2010
3,830
0.000
5,964
5,964
88,865
4,138
0.000
5,631
5,631
94,496
4,470
0.000
8,492
8,492
102,988
2011
4,806
0.000
7,742
7,742
110,730
Financial Flows
• includes all interest-earning or interest-paying
financial securities and equity
• independent estimate from FCF
• must be equal to FCF (good check!)
∆ excess marketable securities
- AT interest income
+ ↓ debt
+ AT interest expense
+ dividends
+ share repurchases
−−−−−−−−−−−−−−−−−−−−−−−−−−−−−
Total Financial Flow = Total FCF
Estimating FCF
• forecast financial statements
• consistency
• compare with analysts ?
• common forecasting error
• “plugs” for building balance sheet
• calculate FCF for set number of years
• how long?
Estimating FCF
• Continuation Value
• idea is that over time most firms regress to
industry norm
• estimate FCFs over period of “competitive
advantage” relative to industry and then make
growth assumptions with firm converging to
industry norm – i.e., constant growth
NOPATT (1  g )[1  ( g / r )]
VCV 0 
WACC  g
Estimating FCF
NOPATN  1
VN 
WACC
• assumption that competition drives return on
invested capital in LR to equal WACC
• perpetuity model
• growth rate in CF not relevant because no value
creation
• discount VN back to time 0 (discount using?)
Estimating FCF
• value driver model
• dominant firm in industry – Microsoft, Coca-Cola
• potential to earn high returns on invested capital for very
long time
• discount to get value at T=0
NOPATN  1(1  g / r )
VN 
WACC  g
Exhibit 2.5. AdvPak Technologies. Enterprise Valuation as of 12/31/2006
($000)
Year-end
2006
Net Income
Net Interest after Tax
Unlevered net income
Change in deferred taxes
NOPAT
Depreciation
Change in Net Working Capital
Capital Expenditures
Free cash flow
Valuation
WACC
PV{FCF} @
Continuation growth rate
Continuation value
PV{Continuation value} @
Enterprise value
10.03%
WACC
7.52%
2007
2008
2009
2010
2011
6,947
4,121
11,068
403
11,470
10,775
(1,330)
(11,380)
9,537
9,586
4,357
13,942
331
14,274
12,132
(1,905)
(17,771)
6,729
8,894
4,671
13,565
281
13,846
14,238
(2,121)
(19,437)
6,526
9,744
4,969
14,713
302
15,014
15,286
(2,287)
(22,046)
5,966
10,491
5,414
15,905
322
16,226
16,295
(2,314)
(22,807)
7,400.3
27,783
316,370
WACC
196,153
223,936
AdvPak Technologies, Inc.
Cost of Capital Calculation
Levered
Long-term government bond yield
Market equity premium
Beta coefficient
Cost of equity before small cap premium
Small capitalization premium
AdvPak Technologies cost of equity
Cost of debt
Corporate tax rate
Debt ratio
WACC
4.62%
4.36%
0.9361
8.70%
3.90%
12.60%
8.52%
38.25%
35.00%
10.03%
Unlevered
4.62%
4.36%
0.6085
7.27%
3.90%
11.17%
WACC
WACC
Exhibit 2.6. AdvPak Technologies
Value Table ($000)
Growth Rate
7.0%
7.5%
8.0%
9.50% 229,340
283,060
366,605
10.03% 189,690
223,936
271,616
10.50% 164,798
189,394
221,525
10.00% 191,692
226,797
275,933
12.00% 116,376
127,231
139,891
8.0%
366,605
271,616
221,525
275,933
139,891
Exhibit 2.7. AdvPak Technologies
Implied EBITDA Multiples from
Continuation Value Estimates
Growth Rate
7.0%
7.5%
8.0%
9.50%
7.0
8.9
11.7
10.03%
5.8
7.0
8.7
10.50%
5.0
5.9
7.0
10.0%
5.87
7.09
8.80
12.0%
3.52
3.93
4.40
8.0%
11.73
8.66
7.04
8.80
4.40
Exhibit 2.8. AdvPak Technologies. Free Cash Flow Decomposition
($000)
Net Income
Depreciation
Deferred Tax
Decrease in Net Working Capital
Capital Expenditures
Increase in Net debt
Cash flow to equity holders
Net Interest after Tax
Increase in Net Debt
Cash flow paid to debtholders, after tax
Free cash flow to all security holders
2007
6,947
10,775
403
(1,330)
(11,380)
4,523
9,939
2008
9,586
12,132
331
(1,905)
(17,771)
5,964
8,337
2009
8,894
14,238
281
(2,121)
(19,437)
5,631
7,486
2010
9,744
15,286
302
(2,287)
(22,046)
8,492
9,490
2011
10,491
16,295
322
(2,314)
(22,807)
7,742
9,728
4,121
(4,523)
(402)
9,537
4,357
(5,964)
(1,607)
6,729
4,671
(5,631)
(960)
6,526
4,969
(8,492)
(3,524)
5,966
5,414
(7,742)
(2,328)
7,400
Exhibit 2.9. AdvPak Technologies. Equity Valuation as of 12/31/2006
($000)
2002
2003
2004
Free cash flow to equity
Cost of equity
Continuation value growth rate
Continuation value
PV of equity cash flows
PV of continuation value
Equity value
9,939
8,337
2006
2007
7,486
9,490
9,728
12.60%
7.5%
205,729
31,923
113,652
145,575
Exhibit 2.10. AdvPak Technologies. Net Debt Valuation as of 12/31/2006
($000)
2002
2003
2004
Free cash flow to net debt
Cost of net debt after taxes
Net debt balance in 2007
PV of net debt cash flows
PV of net debt balance
Net debt value
2005
(402)
(1,607)
2005
2006
2007
(960)
(3,524)
(2,328)
5.26%
110,730
(7,327)
85,689
78,361
Exhibit 2.11. AdvPak Technologies. Enterprise Valuation under No-Real Growth as of 12/31/2006
($000)
Year-end
2006
Net sales
EBITDA
Depreciation
EBIT
Taxes
Unlevered net income
Change in deferred taxes
NOPAT
Depreciation
Change in Net Working Capital
Capital Expenditures
Free cash flow
Valuation
WACC
PV{FCF} @
Continuation value growth
Continuation value
PV{Continuation value} @
Enterprise value
10.03%
WACC
2.3%
2007
2008
2009
2010
2011
208,262
27,074
10,165
16,909
6,468
10,441
380
10,821
10,165
64
(6,184)
14,867
213,052
30,893
10,797
20,095
7,686
12,409
295
12,704
10,797
(389)
(11,490)
11,622
217,953
30,513
12,000
18,514
7,082
11,432
237
11,669
12,000
(543)
(12,291)
10,835
222,965
31,215
12,200
19,016
7,273
11,742
241
11,983
12,200
(552)
(13,490)
10,141
228,094
31,933
12,374
19,559
7,481
12,078
244
12,322
12,374
(565)
(13,500)
10,631
44,754
140,651
WACC
87,206
131,960