Chapter 13
The Valuation of an Actual
Company: Home Depot
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Steps to estimate value using the
Corporate Valuation Spreadsheet
The valuation spreadsheet has seven interrelated
worksheets, each of which performs an essential
function:
(1) Proj & Val
(2) Inputs
(3) WACC
(4) Hist Analys
(5) Condensed
(6) Comprehensive
(7) Actual
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Horizon Value Methods
Recall what the “Proj & Val” sheet does:
This sheet automatically forecasts the future Pro
Forma financial statements, based on data in the
Inputs Sheet.
It automatically calculates future expected Free
Cash Flows (FCF) from the Pro Formas.
It then calculates Present Value (PV) of future
expected FCF and finds estimated price per share.
(continued)
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Horizon Value Methods (continued)
The value of a company is the present
value of all future free cash flows
A realistic approach to valuation involves:
analysts only forecast a finite number of years (20
years is more than adequate)
the last year in the forecast is called the horizon
(i.e., it begins the steady state, period of constant
growth)
(continued)
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Horizon Value Methods (continued)
The discounting of the future free cash
flows involves three steps:
find the value of all free cash flows beyond the
horizon, discounted back to the horizon.
find the present value of the firm’s horizon value
and all of its forecasted free cash flows for the
years up to the horizon.
add the two components of value together
(continued)
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Horizon Value Methods (continued)
There are four ways to calculate the
horizon value:
1) continuing value method
2) book value method
3) convergence value method
4) general value method
(continued)
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Horizon Value Methods (continued)
1) The Continuing Value Horizon Formula:
Suppose the WACC=10%, and ROIC for the last
year in the forecast is 15%.
Q: can the company earn a return in excess of its
cost of capital indefinitely?


Are barriers protecting this company from the forces of
competition?
Will future competition in the period after our last
forecasted year fail to drive down the company’s
ROIC?
(continued)
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Horizon Value Methods (continued)
If you think the answers to these questions are
“Yes”, then use the Continuing Value Horizon
Formula:
FCFT (1  g)
HVT 
WACC  g
Where HVT is the horizon value at year T.
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(continued)
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Horizon Value Methods (continued)
2) The Book Value Horizon Formula:
Suppose that immediately after the horizon year,
competition will force the ROIC on existing capital
and on new investment to the WACC. As of that
time, the NPV of all the firm’s assets and future
investment is zero, and the horizon value equals
book value of capital as of the beginning of the
horizon:
HVT  Capital T
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(continued)
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Horizon Value Methods (continued)
3) The Convergence Value Horizon Formula:
Suppose ROIC on existing capital can be maintained,
but competition will force ROIC on new capital (after
the horizon) to equal the WACC. Then horizon value is
just the value of the free cash flows from existing
capital.*
NOPATT 1  g 
HVT 
WACC  g
*Eventually the ROIC of the firm converges the WACC.
(continued)
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Horizon Value Methods (continued)
4) The General Value Horizon Formula
Competition will result in a gradual reduction of the
return on new capital, forcing the ROIC on new
capital to fall from ROICT to some long-term
sustainable ROICL, which may be greater than the
WACC.




 ROIC  g Capital   ROIC  ROIC Capital 
L
T  
T
L
T 
HVT 

 

WACCg
WACC

 

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Valuing Operations: Home Depot
Recursive Calculation of Value:
The Val & Proj worksheet starts (in cell W97) with
the horizon value as the value at year T (2023) of
free cash flow beyond year T. This is
V2023 = HV2023
The value at T-1 (2022) is the free cash flow during
year T and subsequent years:
V2022=(FCF2022+V2023)/(1+WACC)
And so on, back to year 2003.
(continued)
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Valuing Operations: Home Depot, 2021 and beyond
Note hidden
columns
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This is the
horizon year
13
The Half-Year Adjustment
Cash flows occur throughout the year and
not just on the last day of the year.
The estimate of the value of operations based upon
year-end cash collection understates the true value
of operations. The half-year adjustment treats the
total yearly cash flow as if it occurs at mid-year:
VAfter Adjustment=VBefore Adjustment(1+WACC)0.5.
(continued)
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The Half-Year Adjustment for Home Depot
Note hidden
columns
DES Chapter 13
This is the
horizon year
15
Target Valuation Date
Cells in the “Calculating Value” section of
the worksheet give the valuation
calculations as of the end of the most
recent fiscal year.
It’s usually desirable to calculate value
as of the current date, or some other
“target date”, usually the date on which
the valuation estimate is completed.
(continued)
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Target Valuation Date (continued)
Cells in the “Price per share on target date”
section adjust value of operations for the
elapsed time from last FYR date to the target
date by compounding at the WACC:
Vtarget date = VFYR date (1 + WACC)#days/365
(continued)
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Target Valuation Date (continued)
Target date adjustments for Investments and
nonequity claims use linear interpolation
between FYR ends:
Xtarget date = XFYR date + Adj,
Where:
Adj= [XFYR date+ 1 year - XFYR date](#days/365)].
(X stands for either investments or nonequity claims.)
(continued)
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Target Valuation Date Adjustments for Home Depot
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Valuation of Home Depot
Once satisfied that the projected
financials are plausible, look closely at
the projected ROIC:
actual ROIC for 2003 was 19.2%
declines gradually to 16.2% by 2023
assumed long-term ROIC is 10%,
compared to WACC of 8.51%
(continued)
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Valuation of Home Depot (continued)
Summary of valuation (worksheet row
numbers in parentheses):
(Row 97) the present value of all
forecasted future free cash flows as of
2/2/2003 is about $75.0 billion
(Row 98) the half-year adjustment give
the value of operations on the target date
of 5/21/03 at about $78.2 billion
(continued)
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Valuation of Home Depot (continued)
Summary of valuation (continued):
(Row 99) add nonoperating investments,
which are less than $0.1 billion
(Row 101) subtracting nonequity claims of
$1.8 billion
(continued)
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Valuation of Home Depot (continued)
Summary of valuation (continued):
(Row 102) total value of equity of $76.4
billion
(Row 104) dividing by shares outstanding
gives intrinsic value for the most recent
fiscal year-end, 2/02/2003, of $32.71 per
share
(continued)
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Valuation of Home Depot (continued)
Summary of valuation (continued):
(Row 117) Finally, making the adjustments
for target date valuation results in a target
dated estimated share value of $33.45.
(continued)
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Valuation of Home Depot (continued)
Perspective on value:
To gain some perspective on the valuation
result, put the intrinsic value estimate in the
context of recent stock prices for Home
Depot. As of this writing, there are almost
five months of hindsight on the 5/21/2003
value estimate:
(continued)
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Home Depot stock prices: October 2002-October 2003
Intrinsic value estimate
for 5/21/2003: $33.45
Actual HD stock prices
Source: marketguide.com (http://www.multexinvestor.com/Home.aspx)
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Other Financial Measures
(Row 120) Economic profit - “profit” that
the company generated during the year in
excess of the “profit” that investors
required at the beginning of the year:
EP = NOPAT – Capital charges
= NOPAT – WACC(Op. capital at the beg. of the year).
(continued)
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Other Financial Measures (continued)
(Row 121) Market value added (MVA) - the
estimated value of operations minus the
total operating capital (at current book
value):
MVA = Value of operations – Operating capital
(continued)
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Other Financial Measures (continued)
(Rows 122-125) Comparative valuation
approaches:
P/E (or just PE) ratio
market to book ratio
Value/Sales ratio

Value/EBITDA ratio
(EBITDA is earnings before interest, taxes,
depreciation,and amortization.)
(continued)
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Other Financial Measures (continued)
(Rows 126-127) Capital structure:
market-based percent of the firm that is financed
with debt
times-interest-earned ratio
(continued)
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Other Financial Measures (continued)
(Rows 149-157) Net cash flow from
financing activities:
short-term borrowing/ short-term investments
long-term borrowing
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Reverse Engineering
What if intrinsic value estimates are
substantially different from current
market price?
Reverse engineering is the process of
discovering what changes in the analyst’s
input choices would give an intrinsic value
estimate that equals the market’s price.
(continued)
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Reverse Engineering (continued)
Is the market price reasonable?
If you only have to make small
changes in the inputs that reflected
your best judgment to get the model’s
price equal to the market’s price, then
the stock is probably fairly priced.
(continued)
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Reverse Engineering (continued)
Is the market price reasonable? (continued)
If not, then the market may be wrong.
Perform sensitivity analysis to identify
critical inputs, and determine how your
valuation “holds up” under plausible
variation in those inputs.
(continued)
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Scenario Analysis: Assessing the
Impact of Managerial Decisions
The FCF model is very useful in
assessing the impact that operating
decisions or external events have on
the firm’s value.
Change sales growth
 Change profitability (margin)
 Change working capital requirements
 Change fixed asset requirements

(continued)
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Scenario Analysis (continued)
The financial projections from the free
cash flow model may be used to
facilitate long-term financial planning.
Change in dividend policy
 Change in financial structure
 Stock repurchases

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