Final Flashcards
Free Cash Flows Approximation
FCF= EBIT (1 – t) + Depreciation – Inv. in WC – Inv. in l.t.. assets
Two methods for valuation as an independant firm:
Discounted cash flows
Multiples
Valuation of independent firm
Liquidation value (LV) : Value of the firm in the case of liquidation (sale of all assets)
Operating value (OV) : Value of the firm if operations continue Note: usually, if LV > OV, firm is liquidated. But, sometimes, managers and important shareholders refuse to give up.
Market value (MV) : Price paid for company by rational investor, having all information. Max (LV, OV)
Determine the value of the firm as an independant entity:
Without considering the synergy effects if acquisition
Without considering the change of control
With present management and strategies
Value of ‘minority interests
Free Cash Flows = ?
CF available to shareholders and creditors after the investment in assets (current and l.t.) necessary to maintain production level.
To value the firm we….?
We determine the discount rate (WACC) We determine the ‘predictable period’ We determine the yearly FCF for the predictable period We determine the residual value We discount all CF to 0
The residual value:
Firm’s value at the end of predictable period
How to determine the residual Value
- Liquidation value
- Price / Earning multiple:
We determine EPS at end of predictable period
We multiply by relevant P/E ratio
We add debt to value firm - Discounting of a perpetuity
FCF at end of predictable period + 1
Divided by r or (r-g)
Ratios to use when analysing multiples
Price/Earnings ratio
Firm MV / EBITDA
Price / Sales
Equity MV/ Equity book value
Control premium
Increase of value after change in control
New firm’s value – value as independent firm
Empirically = 30 %
Maximum premium to pay to gain control:
If premium paid = maximum premium:
Like NPV= 0
Those who benefit = targeted firm’s shareholders
If premium paid < maximum premium:
Like NPV > 0
Those who benefit = targeted firm’s shareholders and buying firm’s shareholders
Valuation of liquidity premium
Value of a publically traded firm > Value of a private firm Liquidity premium: Penalty if private firm Discount: 25 – 30 % Necessary if: Firm valued is a private firm Discounted CF or Multiple methods
Do acquisitions create value ?
Do they create value for the targeted firm’s shareholders ?
Do acquisitions create value ?
The answer is yes.
Do they create value for the targeted firm’s shareholders ?
Prices are by 30-35% 5 days after acquisition.
Small businesses’ particularities
Managers: Limited financial knowledge
Unclear distinction between owner and company
No board of administrators
3 things needing special attention from the banker when analysin small companies:
Financial statements not audited
Debt towards a shareholder : Liabilities for company
Shareholder loans money to company
Excluded from liabilities, included in equity
Loan to a shareholder : Asset for the company
Company loans money to a shareholder
Excluded from assets, included in dividends
Financial Distress, Defenition and solution
Incapacity to meet financial obligations Insolvency Can we maintain such a state ? (((NNOOO)) Solutions: Liquidation Operational or financial restructuring
Ratios for financial distres:
Quick and current ratios CFO / Capital A/P days outstanding Other ratios (indirect indicators): Debt level Operating profit margin
Problems with ratios for financial distress:
Interpretation problems:
Negative CFO
Quick and current ratios
Contradictory information:
High debt level
CFO / capital > 1
Quick and current ratios too low
Past and not future:
Observation
Not forecast
Prediction models for financial distress
Definition:
Mathematical models predicting whether a firm will be in financial distress in the future (usually 1 or 2 years)
Examples: Z-Score (or Altman score)Den enda som kommer på fialen(?) CA-Score Recursive partitioning Neural network Genetic algorithm
Causes and solution for Financial Distress:
Cause 1: Operational problem: Insufficient sales Cost poorly managed Delays poorly managed Solution: Operational or organizational restructuring Managed by marketing or operations departments, not finance. Cause 2: Debt poorly managed: Debt level too high Bad mix between current and l.t. Solution: Financial restructuring Decrease of debt, increase of equity Decrease of current debt, increase of l.t. debt Viable only if. Kasst att man måste ta in folk utanför företaget för att få in nya peningar.
Guarantees for Long term loans and Credit line respectively.
Long term: Max 80% of the equipment Max 75% of the fixed assets Credit line: Max 75% of accounts receivable Max 50% of the inventories
What are the 5Cs?
Character Conditions Capital Capacity Collateral
Character:
Project analysis:
Extending the current activities (less risky)
Complimentary activities-pizzeria säljer frusen pizza
New activities (riskier)- pizzeria säljer tröjor
Management analysis:
Profiles
Seriousness
Management capacity
Points of judgment: Character
Points of judgement
Potential for the project
Management’s capacity at executing the project.
Profiles: Asking for resumes
Experience
Relevant education
Seriousness:
Wheter or not the managers owns stocks in the company. Makes the managers work harder as they lose money if the company does.
Conditions:
Exploitation risk high or low? Number of product Number of clients Competition Market shares Economic context All other elements already reviewed (diversification, importance of the company in its market, etc.) KEY: COMMERCIAL RISK SHOULD BE A SLOW AS POSSIBLE. IF ONE HAS HIGH COMMERCIAL RISK ONE SHOULDN'T HAVE HIGH FINANCIAL RISK AS WELL
Capital:
Debt level analysis:
Evolution Sector Short term vs. Long term
Items possibly needing adjustments in capital analysis:
Future tax liabilities
Definition
Liabilities or Equity ?
If firm growing…
Commitments:
Example: Operating leases
To be included in liabilities
Contingencies:
To be included if high probability
Capacity:
Ability to repay l.t. liabilities: CFO / capital > 1 Problem: CF plan does not provide CFO Solution ?? Debt / EBITDA Interpretation Make sure the company is able to repay its debt in the long term and in the short term. CFO / payment of capital on long term debt. EBIT /(int + (cap/1-t)) b) Ability for short term reimbursment Quick and current ratios CFO / Current liabilities(Slightly better according to prof)
(Capacity) Comments about Current and Quick ratios:
Current Ratio = Current Assets/Current Liabilities
Quick Ratio = (Current Assets-Inventories)/Current Liabilities
Caracteristics:
Static measure of the available resources at a specific time to honour the short term engagements.
If we didn’t have incoming funds, would sold short term assets be sufficiant to reimburse the short term liabilities.
The management policies on A/R and inventory are based on a efficient use and not on «covering» the short term liabilities.
Problems:
Ratios don’t take into account the future CF
The short term assets sales values vs. book value
Certain requirements on a short term basis are not considered ( lease payments, pension plan contributions, etc.)
Interpretation mistakes regarding Current and Quick Ratios!
Ex.1:In a recession period, the A/R and inventories might increase.
Ex. 2: For a company that experiences a lot of success, the «Income taxes to be paid» can substantially increase.
Possible manipulations:
At year end, a company can decide to shorten the collection period to pay more of its accounts payables.
Collateral:
Warranty analysis:
What are the available assets (not associated to other loans) ?
What are the assets linked to a new project to be used as warranty ?
Liquidation value (in %)
Calculs:
Identify the assets used for warranty.
Determine and justify the % of sale liquidation
Check if the assets taken under warranty are sufficient.
