Company valuation Flashcards
What are the two methods to value a company?
Multiples and DCF
What are the two main multiples? How do you calculate them? How do you use them to estimate the value per share? What is included in “D”?
P/E-ratio=stock price/EPS=stock price/(net income/shares)
*Use comparables to calculate average P/E
Value per share_firm = EPS_firmP/E_average
Note: P should be most recent
EV/EBITDA=Enterprise value/Earnings before interest taxes depreciation and amortization
*Assets=liabilities –> EV + Cash = E + D –> EV = E + net debt (D=long + short term debt=accounting value)
*Use comparables to calculate average EV/EBITDA-ratio
EV_firm=EBITDA_firmEV/EBITDA_average
*E_firm = EV - net debt
*Divide with number of shares to get value per share_firm.
What are the four steps in the DCF-method? What is included in each step?
Step 1: Forecasting FCF
FCF=(1-t)*EBIT+Depreciation-CAPX-change in NWC
Step 2: Calculate terminal value
Terminal value=value of cash flows beyond forecasting period.
Using either growing perpetuity or exit multiple (EV/EBITDA):
TV=(1+g)*FCF_T/(WACC-g)
TV=EV/EBITDA_average*EBITDA_firm_T
Step 3: Calculate enterprise value
Discount factor: DF_1=1/(1+WACC)^1 …
PV(FCF)=FCF_1DF_1 + …
PV(TV)=TVDF_T
EV=PV(FCF)+PV(TV)
Step 4: From EV to E
E = EV - Net debt
Value per share = E/#shares
Step 5: Sensitivity analysis
What are advantages of using EV/EBITDA compared to P/E?
P/E more sensitive to capital structure, dividend policy decisions and non-operating items such as cash
What are issues with calculated TV using growing perpetuity?
*Sensitive to growth rate
*Growth rate cannot be too high (growth rate < economy growth rate)
How do you calculate FCF?
FCF=(1-t)*EBIT+Dep.-CAPX-change in NWC
How do you calculate r_WACC=weighted average cost of capital?
r_WACC=D/(E+D)(1-t)r_d+E/(D+E)*r_e
How do you estimate r_e?
r_e=r_f+beta_e*market risk premium
When can we use WACC and when not?
We can use WACC when we have a public company, the company has a fairly focused business or leverage level is currently close to target leverage
Thus, we cannot use WACC when we have a private firm, the company has multiple businesses or has a future different D/(D+E).
What is the method to compute WACC for alternative leverage? (=leverage is currently far from target leverage). Note: Write down formula for beta_u & beta_e
To do: Change ratio in formula, calculate new r_d and adjust r_e to new leverage ratio
r_e:
To adjust r_e (assuming beta_d=0 –> debt is risk free):
Step 1: Unlevering:
beta_u=beta_e/[1+D/E_old]
*asset beta (unlettered beta)=removes impact of company’s capital structure (use of debt financing)/removes effect of financial leverage=independent on financial decisions
Step 2: Relevering
beta_e=beta_u*[1+D/E_new]
Step 3:
Use beta_e to calculate r_e
Step 4:
Calculate/or obtain cost of debt, r_d
Step 5: Calculate WACC
What is the method to calculate WACC for a private company? Why can’t we just calculate WACC?
Since it is a private company, there are no stock prices (=no stock returns) –> we cannot estimate beta_e. Further, we do not know the leverage ratio as E is unknown due to no stock prices.
How do we get the information necessary to calculate a WACC?
*Leverage: Think of a reasonable target leverage given the business (we look at other firms in same situation)
*Cost of equity: From public traded industry peers (“comparables”) = same business as the firm (“pure plays”
Estimating beta_e from peers:
Step 1: Find comps
Comps are in the same industry but may differ in financial risk (β_E-β_U) due to different leverage –> we cannot average them
Step 2: Unlever each comparables beta_e using its own leverage
beta_u_comp1=beta_e/[1+D/E_comp1]
Step 3: Take average of comparables unlettered betas=firm’s unlevered beta
Step 4: Estimate firm’s equity beta
beta_e=beta_u*[1+D/E]
Step 5: Estimate firm’s cost of equity using CAPM
Step 6: Estimate WACC
What is the method to calculate WACC for a business unit? What happens if the group WACC is used and the divisional WACC is higher?
Problem: WACC for whole firm may not be representative –> Not right opportunity cost of capital –> Need for divisional WACC
Same approach as for private WACC.
Acquire might end up overpaying –> currently discounting with too low of a WACC.
What does the assumption that debt is risk free imply?
Asset beta may be underestimated because debt is risky
