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Corporate Finance

by: Katherine Spencer

Corporate Finance MGT 541

Katherine Spencer
GPA 3.64


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Class Notes
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This 24 page Class Notes was uploaded by Katherine Spencer on Thursday October 29, 2015. The Class Notes belongs to MGT 541 at Yale University taught by Staff in Fall. Since its upload, it has received 23 views. For similar materials see /class/231016/mgt-541-yale-university in Business, management at Yale University.


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Date Created: 10/29/15
Corporate Finance 11 Session II 090601 Werner Stanzl Yale School of Management Company Valuation Methods Book Value Comparable Companies or Earnings Multiple Method Liquidation Value Diseounted Cash Flow Method APV Model Equity DCF Model Eoonomio Pro t Method Option Valuation Method 111 Book Value rm value book value of all assets One of the most Widely used methods Based on historical numbers lgnores future Aeeounting numbers are awed and can be easily manipulated lgnores intangibles lgnores risk Prioe paid for an asset may have no relation to its value in operation or if it had to be sold or replaced 112 Comparable Companies Method Most common multiple used VEBIT Market Value of Company Earnings Before Interest and Tax Debt Equity Earnings Before Interest and Tax Estimate of the market value of an asset V com Market Value of Asset p x EBIT EBIT Where LYN is the value to earnings ratio of a EBIT comparable traded company or average of a group of companies Pros amp Cons Easy to use method VEBIT is accounting gure and probably not a meaningful economic quantity earnings are subject to shortterm uctuations but important are stationary earnings gures adjust for temporary shocks if possible VEBIT assumes that all companies can generate the same growth Other multiples used PriceNet Earnings PriceSales Market ValueBook Value Asset Value EBIT 113 Discounted Cash Flow Method Procedure 1 Forecast free cash ows during forecast horizon 2 Estimate the cost of capital weighted average cost of capital WACC 3 Estimate continuing value value after forecast horizon 4 Discount to the present 5 Add the value of excess cash and other nonoperating assets 6 Deduct nancial debt to get market value of equity Example horizon 5 years WACC 10 Time 1 2 3 4 5 FCF 300 250 270 210 260 Continuing Value 57 O ValueofAsset 2 ag E E a 11 112 113 114 115 134099 Adi usted Present Value Method APV model separates the value of operations into two components the value of operations as if the company were entirely equity nanced the value of taX bene t arising from debt nancing Value of FCFs Value of taX shield Nonoperating assets Total enterprise value Value of Debt Equity Value To compute value of FCF and taX shield use k WACCkbiT BS Where k unlevered cost of equity kb 2 cost of debt T marginal tax rate on interest expense B 2 market value of debt S 2 market value of equity APV yields same result as standard DCF method IF the WACC is adjusted for changing capital structure Equity DCF Method Equity cash ow rather than FCF is used Discount rate WACC Disadvantage of Equity DCF Method Discounting equity cash ow provides less information about the sources of values creation The Equity DCF Method is primarily applied for nancial institutions II4 Economic Pro t Method Economic Value Added EVA Invested Capital X ROIC WACC Where ROIC Rate of Return On Invested Capital Invested Capital LongTerm Assets Working Capital wNi t Four Questions What are Free Cash Flows How is ROIC de ned HOW to estimate the Continuing Value What is WACC 115 Free Cash Flow Operating Pro t EBIT Taxes on EBIT Increase in deferred taxes Net Operating Pro t Less Adjusted taxes NOLPAT Depreciation Increase in Working Capital Capital Expenditures Free Cash Flow Where Operating Cash Accounts Receivable Inventories Accounts Payable Net Accruals Working Capital L Forecasting Free Cash Flows Forecast sales Examine historical relationship between sales and other components of FCF Check Whether forecasts are reasonable Consistency II6 Return On Invested Capital ROIC NOPLAT Invested Capital ROIC Growth Rate ROIC X Investment Rate Net Investment NOPLAT where Investment Rate The key factors for economic growth of an enterprise are the ROIC and the growth rate Examples Case 12 Investment Rate 25 ROIC 10 Growth Rate 25 WACC 10 Year 0 1 2 3 4 5 NOPLAT 100 10250 10506 10769 11038 11314 Net Investment 25 2563 2627 2692 2760 2829 Free Cash Flow 75 7688 7880 8077 8279 8486 PV of Free Cash Flow 37992 Case 22 Investment Rate 0 ROIC 20 Growth Rate 0 WACC 10 Year 0 1 2 3 4 5 NOPLAT 100 10000 10000 10000 10000 10000 Net Investment 0 000 000 000 000 000 Free Cash Flow 100 10000 10000 10000 10000 10000 PV of Free Cash Flow 47908 Examples Cont d Case 3 Investment Rate 25 ROIC 000001 Growth Rate 0 WACC 10 Year 0 1 2 3 4 5 NOPLAT 100 10000 10000 10000 10000 10000 Net Investment 25 2500 2500 2500 2500 2500 Free Cash Flow 75 7500 7500 7500 7500 7500 PV of Free Cash Flow 35931 Crucial Comparison ROIC gt WACC rm is pro table has competitive advantage ROIC WACC perfect competition ROIC lt WACC value destruction Estimating Growth in Earnings Look at the historical growth in earnings per share Look at estimates of comparable rms Look at fundamentals 117 Estimating Continuing Value Three approaches 1 FCF growth is constant after the forecast horizon 2 Convergence Approach 3 Terminal Value 1171 FCF growth is constant after the forecast horizon Typically additional assumption in nite life of the rm Free Cash Flow grows at rate g FCFT1 WACC g T where T is the end of the forecast horizon Better NOPLATT1 1 gROIC WACC g where ROIC is long term ROIC CVT Advantage You don t need to estimate the Capital Expenditures 1172 Convergence Approach Assumption ROIC WACC In this case NOPLATT1 CVT WACC Hence if growth doesn t create economic value then the growth rate g does not matter 1173 Terminal Value Terminal Value Book value of Invested Capital Backwardlooking method but easy to use Readings CKM chapters 8911 and 12 RWJ chapters 7 and 8 Ross Uses Abuses and Alternatives to the NPVRule Course Packet


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