Midterm: G3: Cash Flow Valuation Techniques Flashcards
The way to determine the value of an investment opportunity is by
Determining the actual cash generated by a particular asset
can be done by determining the present value of the net cash flows of the investment opportunity.
Discounted Cash Flows Analysis
refers to the amount of cash available for distribution to both debt and equity claims of the business or asset. This is calculated from the net cash generated from operations and for investment over time.
Net Cash Flows
NCF is used as basis of valuation if any of the following conditions are present:
● Company does not pay dividends
● Company pays dividends but the amount paid out significantly differs from its capacity to pay dividends
● Net Cash Flows and profits are aligned within a reasonable forecast period
● Investor has a control perspective. If an investor can exert control over a company, dividends can be adjusted based on the decision of the controlling investor.
Analysts find analyzing cash flows and its sources helpful in understanding the following:
- Source of financing for needed investment - The best case for firms is to fund its investments wholly or partly
through cash from operations. - Reliance on debt financing - Debt financing is an excellent financing strategy especially for expanding companies.
- Quality of earnings - Significant disparities between cash flows and income may indicate earnings does not get converted to cash easily, suggesting low quality.
The best case for firms is to find its investments, wholy or partly through cash from operations
Source of financing for needed investments
Debt financing is an excellent financing strategy especially for expanding companies
Reliance on debt financing
Significant disparities between cash flows and income may indicate earnings does not get converted to cash easily, suggesting low quality
Quality of earnings
Two levels of Net cash flows
Net cash flow to the firm
Net cash flows to equity
Is the amount made available to both debt and equity claims against the company
Net cash flows to the firm
Refers to the cash flow available to the parties who supplied capital after paying all operating expenses, including taxes and investing in capital expenditures and working capital as required by business needs
Net cash flows to the firm
Cash flows generated from operating activities which is intended to pay required return of fund providers. It only capture items that are directly related to the operating and investing activities of the business.
Net cash flows to the firm
Basic measure of a firms profitability which refers to the bottom line figure in an income statement. This is the amount left for the common shareholders after deducting all costs, expenses, depreciation, amortization interest, taxes, and dividends to preferred shareholders.
Net income available to common shareholders
Pertains to non-cash items that are included in the computation of net income
Non-cash charges (net)
Common noncash items
Depreciation and amortization
Restructuring charges
Provisions for doubtful accounts
This interest expense is a cash flow intended for the debt providers. It is added back to net income, since the objective of NCF is the measure of the cash flow’s associated with operating activities of the business.
After-tax interest expense
Net investment in current assets, such as receivables and inventory, is reduced by current liabilities like liable. The amount captured is based on the movements in these accounts from prior periods
Working capital adjustments
Pertains to cash outflows made to purchase or pay for capital expenditures that are required to support existing and future operating needs.
Investment in fixed capital
Assumes that the price financed is acceptable, and has positive net present value
Investment in fixed capital
Represents how much cash is a company generated from its operations. This shows how much cash is received from customers, and how much cash outflows are paid to vendors
Cash flow from operating activities
Represents how much cash is disbursed (received) for investments in (sale of) long-term assets, like property plant and equipment and strategic investments in other companies
Cash flow from investing activities
Represents how much cash was raised (or paid) to finance the company. This is not considered when computing NCFF.
Cash flow from financing activities
Pertains to income before deducting interest, taxes, depreciation, and amortization expenses, net of taxes
EBITDA earnings before interest, taxes, depreciation, and amortization
Non-cash charges are not typically adjusted if NCF starts with EBITDA. However, it is important that analysts should check whether non-cost charges were already deducted in computing for EBITDA or not.
Tax savings on non-cash charges
Represents the amount of cash flows made available to the equity stockholders after deducting, the net debt, or the outstanding liabilities to the creditors less available cash balance of the company
Net cash flows to equity
Refers to cash available for common equity, participants or shareholders, only after being expenses, satisfying operating and fixed capital requirements and settling cash flow transactions involving debt providers and preferred shareholders
Net cash flows to equity
This refers to the amount of cash, received by the company as a result of borrowing of long-term debt
Proceeds from borrowing
This is the total amount used to service the loans or debt financing. This is the total amount of loan repayment and the interest expenses, net of income tax benefit.
Debt service
Same with the debt, preferred shares as another form of financing, other than the issuance of ordinary, equity, must also be factored in the calculation of the net cash flows available to equity
Proceeds from issuance of preferred shares
Since payments made to preferential shareholders in the form of dividends are outflows
Dividends on preferred shares
Discounted cash flow analysis is most applicable to use when the following are available
Validated operational and financial information
Reasonable appropriated cost of capital or required rate of return
New quantifiable information
It’s a financial method of valuation, and it is widely used to assess any investment value or estimate the valuation of a company or project
DCF model formula
This calculation is done based on the cash flow’s projected for the future
DCF model formula
The value of the cash flows in the future will be less than it is today, because of the effect of the —
Time value of money
Steps
- Projections of the financial statements
- Calculating free cash flow to firm
- Calculating the discount rate
- Calculating the terminal value
- Present value calculations
- Adjustments
- Sensitivity analysis
If the value reached through discounted cash flow analysis is higher than the current cost of the investment opportunity would be —
Attractive
Entails thinking through factors that affect a firm, like future revenue growth and profit margins, cost of equity and debt, and a discount rate that largely depends on the risk free rate
DCF model
