Lectures 3-4 DCF

Question 1

What does leverage create?

Answer 1

Leverage magnifies the volatility of accounting profitability. If there are taxes, it provides tax shields

Question 2

ROE formula in a scenario with no taxes

Answer 2

ROE = ROI + D/E(ROI - i)

Question 3

What leverage effects? And what are the two scenarios?

Answer 3

Leverage affects asset (enteprise value). If there are taxes it adds to enterprise value if there are not it is unchanged.

Question 4

Calculation of FCFE?

Answer 4

EBIT
- Operating Tax (EBIT*tax)
+D&A
+- Change in NWC
- CAPEX
FCFO
- Interest payments
+ income from associates
+- exceptional items
+ value of tax shield
+- change in gross debt
+- change in surplus assets
FCFE

Question 5

Required return to equity holders(with no leverage)?

Answer 5

Keu = rf + beta unlevered*MRP

Question 6

Enterprise and Equity value in a no debt scenario?

Answer 6

EV = FCFO/Keu
EqV = EV

Question 7

What happens to the required returns when there is debt?

Answer 7

Now there are two separate returns required by shareholders and by debtholders

Question 8

Enterprise value in a company with debt scenario?

Answer 8

EV = FCFO/Keu + Debt*tax –> Adjusted Present Value

Question 9

What is the debt value in a no-growth opportunity?

Answer 9

D = Market Value

Question 10

What is the cost of levered equity?
What is EV?
What is EqV?

Answer 10

Kel = rf + Keu(D/E(keu-kd)*(1-t))

EqV = FCFE/Kel
EV = EqV + D

Question 11

What happens when debt increases?

Answer 11

Keu becomes Kel as shareholders require bigger returns for the risk involved from leverage

Question 12

What is the WACC formula?

Answer 12

WACC = Kel(E/E+D) + Kd(1-t)*[D/D+E]

Question 13

What is the EV in a scenario of a company with significant debt? - asset side?

Answer 13

EV = FCFO/WACC <– DCF model asset side
EqV = EV - Debt

Question 14

What is the EV in a scenario of a company with significant debt? - equity side?

Answer 14

EqV = FCFE/Kel
EV = Debt + EqV

Question 15

What is the EV in a scenario of a company with significant debt? - APV?

Answer 15

EV = FCFO/Keu+ tD - D

Question 16

What is the EV under a DCF - asset side model?

Answer 16

EV = Ξ(the sum) of FCFO/(1+WACC)^t+ TV/(1+WACC)^t
Discounting the different cash flows (usually 5 years) back to the present + the terminal value

Question 17

Terminal value under DCF?

Answer 17

(FCFO*(1+g))/ WACC - g

where g = fcfo growth

Question 18

What is the EqV under a DCF - equity side model?

Answer 18

EqV = Ξ(the sum) of FCFE/(1+Kel)^t + TV/(1+Kel)^t

TV = [FCFE*(1+g)]/(Kel - g)

EV = EqV + Debt

Question 19

What is the APV with a DCF model?

Answer 19

It splits into two

1. Ξ(the sum) of FCFO/(1+Keu)^t + TV/(1+Keu)^t
   TV = FCFO*(1+g)/(Keu - g)
   g = fcfo growth
2. Ξ(the sum) of Tax Shields/(1+Kts)^t + TV of tax shields/(1+Kts)^t
   TV = TS*(1+g)/(Kts - g)
   g = tax shield growth

Question 20

Capital reinvestment rate?

Answer 20

This is the capital that gets reinvested back into the business.
1 - FCFO/NOPAT

can also be
growthNOPAT/ROI

This is a fundamental relationship: under constant returns (which is reasonable in the long term) the growth rate in earnings (g) should be equal to the product of the reinvestments into the business (CRR) and the return on these investments (ROI)

Question 21

ROI?

Answer 21

NOPAT/Capital employed(t-1)

Question 22

Terminal Value if ROI converges to WACC?

Answer 22

NOPAT(t+1)/WACC

Question 23

Equity reinvestment rate?

Answer 23

1 - FCFE/Net Income

if ROE is constant
ERR = NetIncome/Equity t-1
ERR = G(err)/ROE