Valuation Flashcards
Valuation (2)
- more of an art than science
- mispricing by financial market, target not traded, change of target operations and/or realize synergies
Comparable approach (1)
- calculate key ratios or multiples for groups of similar companies or transaction as a basis for valuing target
DCF approach (1)
- projects cash flow based on current financial statements and historical performance and considering strategy as well as environment
Four kinds of valuation (4)
- multiple/comparable
- DCF
- value assets
- strategize/transformational
Why do we need valuation (1)
- firm (A+B) > firm (A) + firm (B)
How to calculate comparable approaches (4)
- key ratios calculate each company
- key ratios average for group
- average ratio apply to absolute data for company of interest
- applying ratio yield indicates market value
Average ratio (2)
- industry ratio: 1.2
- total MV equity/ BV equity
Company comparable formulas (6)
- MV equity / sales
- MV equity / BV equity
- MV equity/ net income (PE ratio)
- price/ cash flow
- price/ earnings growth
- EV/ EBITDA
What is comparison sample (3)
- industry comparison
- companies
- size/growth option/technological
Advantage and Disadvantage of comparable approach (7)
Advantage
- easy to communicate
- marketplace transaction are used
- widely use for legal cases, fairness evaluation
- allow for valuation of private firm
Disadvantage
- easy to manipulate
- too simple
- difficult to find company comparable
NPV (1)
- present value of all future cash flow discounted on cost of capital, minus cost of investment made over time compounded by opportunity cost of funds
Accounting vs financing objectives (2)
- accounting: use stability stage profitability (buy: depreciate, sell: increase receivables)
- financing: what should I pay/get? (buy: pay now, sell: do not receive cash)
Procedure of DCF (6)
- presented in 5 to 10 years
- financial analysis is performed to determined ratio and patterns
- analysis of business economic of industry
- based on analysis, cash flow is forecast
- determined cost of capital
- cash flow is discounted to obtain NPV
Cash flow consideration (8)
- forecast earning
- opportunity cost
- sunk cost and overhead
- externalities
- taxes
- book and tax depreciation
- interest expense
- capital expenditure
Forecasting earning (2)
- all numbers come from accountants (different perspectives)
- earning is use to compute tax
Depreciation (5)
- book and tax depreciation is different
- tax authorities do not allow us to write off investment immediately
- downside: keep table of book value of all asset
- book value assets is I minus accumulated depreciation
- subtract adjusted profit after tax, then add it back
Capital cost allowance (4)
- item are pooled together
- new investment = underappreciated cost capital
- each year fraction is depreciated
- never reach zero until items are all sold
Interest expense and actual taxes (2)
- annual report: tax on EBIT- interest expense
- interest expense are tax deductible
Capital budgeting (4)
- separate investing decision from financing decision
- tax deductibility of interest expense is discounted rate
- calculate cash flow as if expense is not deductible
- calculate tax is EBIT only
Tax (1)
- marginal rate from earning another dollar
Opportunity cost (2)
- project might use resources that the company already owns
- reduce cash flow by the opportunity cost even if asset is idle
Project externalities - cannibalization (1)
- new projects might change cash flow of existing projects
Sunk cost and overhead (2)
- irrelevant decision to go forward
- overhead: irrelevant to capital budgeting and use accounting purposes
Calculate free cash flow (1)
- adjusted item that are non cash, subtract depreciation on tax (add back later), subtract CAPEX
What happens at end of planning horizon (2)
- project ends and equipment sold
- project continues: PV of future cash flow
New working capital (4)
- cash received + inventory + receivables - payables
- accounting: sign of sales contract increase earnings
- finance: cash not received until paid
- increase EBIT and tax, does not increase cash flow,
reduce unlevered net income by change in receivables
Free cash flow things to consider (3)
- do not ignore bad outcome
- includes synergies
- includes cost of restructuring, severance payment, retention, and advisory fee
Cash and marketable securities (2)
- interest earned is not part of FCF
- add cash to discounted FCF or subtract from debt
Why do balance sheet ratio matter (4)
- maintain target credit rating
- financing constraints
- loan convenant
- EPS accretion vs dilutive
WACC (4)
- debt/ total capital * cost of debt + equity/total capital * cost of equity
- cost of capital is determined by systematic risk of project
- target WACC is relevant
- financing proportion of total capital, cost of equity, after tax cost of debt
Cost of debt (1)
- after tax: deductible interest payment
cost of equity (2)
- equity > 1 riskiers
- RF - beta (RM-RF)
beta (equity risk premium) (2)
- regression analysis of historical price vs market
- measure of how much a stock moves when index moves
Equity beta varies with leverage (1)
- Be = BU * 1 + B(1-T) / S
Asset beta measures risk which is constant (1)
- Bu = Be + S / S + B(1-T)
Beta calculation (4)
- cannot use equity beta because firm has different capital structure
- take comparative equity beta unlevered to get asset beta
- relever average asset beta to get target equity beta
- compute target cost of equity
Leveraging and unleveraging beta (4)
- levered beta = equity beta (regress stock price)
- reflect industry risk and capital structure
- unlevered beta = asset beta (unlevered equity beta)
- reflect industry risk
Capital structure (3)
- use market value ratio for weights than book value of equity
- optimal capital structure might change post M & A
- intended financing proportion should reflect best judgement of firm’s financial structure in the future
Changing leverage affect WACC (3)
- weight
- cost of debt
- cost of equity
Shouldn’t WACC work only when we finance the deal with debt vs equity (3)
- No, WACC work only for projects not carbon copies
- levered up, cost of debt increases
- overall risk is important not the source of funds
Where do inputs come from (2)
- asset of beta
- capital structure weights
Four basic model of terminal value (5)
- no growth
- constant growth
- supernormal growth, then no growth
- supernormal growth, then constant growth
- growth perpetuity
growth perpetuity (2)
- C / r-g
- growth rate should at least be the inflation rate
Other valuation techniques (6)
- precedent acquisition
- contribution analysis
- real option
- business metric analysis
- liquidation/break up
- leverage buyout model
Real option valuation (8)
- growth
- expand scale
- abandon
- contract scale
- timing
- replace
- switch
- strategy
real option analysis should be used in conjunction with DCF (3)
- project that has negative NPV can be positive
- DCF has downside/upsides
- real option estimate upsides, minimize risk, recapture loss of DCF
