BU Finance & Investment ClubJoseph McNiff & Xun Yao Chen

Spring 2013

Introduction to Valuation

 

2

Meeting Schedule

Apple Trees & Valuation[Xun]

4 Valuation Methods[Joe]

Basic example of how to value an apple tree, basic concepts of valuation used for equity investments

Overview of the 4 valuation methods used to derive a projected share price

Valuation

Apple Tree

OR

Where is Your Apple?

Your APPLES

TIME

Your APPLES

NOT your APPLES

Opportunity Cost

• Lost of Apple Received = Opportunity Cost• Time is Money

• Discount on future cash = discount rate (interest rate / year)

How much cash can you make?• Free cash flow

– Free: something that is not tied up to any use

Revenues: Apples

Expenses or costs: Water, grooming, chemical to shoo the bugs away, land to plant your apple tree, labor fee,

Any capital expenditures to fund your business growth or maintain your business

FREE Cash Flows to the Firm (FCFF)

So much should you pay?

TIME

How much should you

pay?

Discount Discount Discount Discount Discount

How s

How do you measure opportunity cost?

• For now, just assume 10% because economic average ROE

• Next TOPIC

What Else is On Balance Sheet?

• Cash that are not used for main business• Investments that are not core of the

company’s business

 

12

Meeting Schedule

Apple Trees & Valuation[Xun]

4 Valuation Methods[Joe]

Basic example of how to value an apple tree, basic concepts of valuation used for equity investments

Overview of the 4 valuation methods used to derive a projected share price

 

13

4 Ways to Value a Company

1. Precedent Transactions2. Discounted Cash Flow (DCF)3. Trading Multiples4. LBO

In order of Highest Valuation to Lowest

 

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EBITDA

Earnings Before:InterestTaxesDepreciation (tangible assets)Amortization (intangible assets)

- EBITDA is a cash-adjusted (D&A) measurement of the income generated by a company before making distributions to debt holders,

the government and the remainder being left for equity holders.

EBITDA is widely used in precedent transaction and trading multiple valuation

 

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Precedent Transactions (Previous Purchases of Competitors)

Highest Valuation due to Premiums Companies make transactions due to Synergies

– Cost Synergies from transaction/operating costs– Revenue Synergies from sales and distribution

Willing to pay Control Premium to gain synergies

Pay X times for transaction related to EV/EBITDA or other multiple– Can use this metric from similar transactions to value a company

 

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Discounted Cash Flow Analysis 5-step process

1. Investment Horizon2. Forecast Financial Statements3. FCF4. WACC5. TV

 

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DCF – Investment Horizon Determine length of time you want to calculate cash flows (point of stabilization) Determine how long till terminal value

For BUFC– 5 year forecast, 1 year target price

 

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DCF – Forecast Financial Statements Input past data (10-K’s) Forecast future data (from trends & opportunities, Industry Analysis)

Historical Data gives benchmark for future data

 

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DCF – Calculating Free Cash Flow To calculate

1. EBIT x (1-tax rate) = NOPATTax adjustment

2. Net Operating Profit After Tax+ D/A – CAPEX– Net working capital [increases = – ]

= Free Cash Flow

Free Cash Flow represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base.

 

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DCF – Weighted Average Cost of Capital

(Cost of Debt x Weight of Debt) + (Cost of Equity x Weight of Equity) = WACC

Cost of Debt = After TaxCost of Equity = CAPM = Rf + B(Rm-Rf)

This represents the discount rate (time value of money) used to get the present value of the FCF’s calculated and forecasted.

SAMPLE FCF

 

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DCF – Terminal Value Time when cash flows stabilize Two Methods

1. Exit Multiple Method TV = EBITDA x PTm (precedent transaction multiple)

2. Perpetuity Growth Model FCF / (r-g)

R = Discount Rate [WACC] G = Anticipated Growth Rate of Company Forever

 

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Trading Multiples Comparable multiples

focus on how the company’s stock is currently trading in relation to a measurement of company earning ability

If a company’s multiple is value lower than industry, considered undervalued

Expected Value = EPS x Mean/Median Multiple

• A forward multiple uses the anticipate earnings for example (P/E) and uses that as the divisor for current price. Gives an idea of how much current investors are willing to pay for future earnings.

 

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Leveraged Buyout AnalysisThe acquisition of another company using a significant amount of borrowed money

(bonds or loans) to meet the cost of acquisition.

• Typical example is a private equity firm purchasing a company through raising large amounts of debt and uses the Cash Flow of the company to pay off the periodic payments; ultimately reselling the company in either a primary or secondary market.