valuation methods

Question 1

discounted cash flow (DCF)

Answer 1

-value of business is determined by its capacity to generate future cash flows discounted to the present moment
-difficult to predict future
-extremly senstive to assumptions
-highly time consuming and time is scarcest mean

3 elements:
-FCF estimate over 5-10 years
-estimate of residual value of the assets at the end of previous period
-estimae of appropriate discount factor to translate FCF to present value

formula for waac
cost of debt (Kd)*(1-tax rate)+ debt/(debt+equity) + cost of equity *(equity/equity+debt)

cost of equity = risk free+beta*market premium
–> beta usually 1, risk free is 10 year sovereign bond, market premium=market rate of return of this asset /stock-risk free rate

formula for DFC:
summe von
FC/(1+i)^n+VR/(1+i)^t+1
–>VR is residual value discounted to present

when use it
-when CF predicted with high level of certainty like regulated sectory or infrastructures or real estate rental companies –> when CF determined contractually

Question 2

three main valuation methods

Answer 2

from most reliable to least
1.net asset value
2.earnings power value
3.value of growth

Question 3

net asset value

Answer 3

-to discover if the eocnomic value of the assets is accurately reflected in the price of the securities
-net asset value=value of assets-value of liabilities
-no discount factor –>less margin of error
-rarely used

Question 4

earnings power value

Answer 4

-prone to fewer assumptions and estimates about the future than the DCF so less subject to error

some assumptions about:
1.FCF correctly adjusted correspond to a sustainable level of distributable CF and reflect real earnings power of the firm
2.if current FCF is momentarily depressed we calculate what we deem to be normalized earnings power of the biz based on history and where they are going
3.calculated normlaized FCF can be sustained at const lvl for the indefinite future

Question 5

earnings power value formula

Answer 5

CF normalized/k
–>normalize with adjustments
–>k is cost of capital –> use wacc formula but cost of equity comes from CAPM

Question 6

earnings power value, adjusted earnings

Answer 6

adjustments for normalized earnings
▪extraordinary costs and gains
▪imparments
▪inconsistencies between accounting
depreciation and amortization and real maintence capex
▪financial costs related to debt, cleaning FX and pension costs stock options and other share awards
▪ Effective taxratevs reportedtaxrate.
▪ Minorities.
▪ Associates.

calculate adjusted earnings
▪ Start with OPERATING PROFIT (EBIT)
▪ Less cyclical adj if industry/business is atPeak.Plus cyclical adj if industry/business is at Trough.
▪ Plus/minus anyotherone time adjustments (seeprevious slide)
▪ = ADJUSTED EBIT
▪ Minus effective taxratex Adj EBIT (effective tax)
▪ = Adjusted NOPLAT (Net OperatingProfit Less Adj Tax)
▪ Plus amortizationofgoodwill
▪ Plus D&A (depreciationandamortization)
▪ Less maintenance capex(total capex minus growthcapex,or zerogrowthcapex)