The Final Assignment
1. Find and download financial statements for 5-7 years. put the data in excel file. Put Income statement data (for different years in one sheet, the balance sheet data in another, the same for the cash flow data… make sure that data are consistent through year (so that you can do horizontal analysis)
2. In addition download market data for the target (P/E, MV/BV, stock prices) + multiples for similar firms (peers)
The idea is
• Value your company by two methods
1) Discounted CF method
2) Relative valuation (using multiples)
• Compare your results with the market price
For discounted cash flow approach
• What model you would like to use stable growth, two periods or three period growths??? To decide you need to check if company is mature or growing.
• In case you see that the company’s current growth (EPS, sales) above 2%-3% (above the industry average, fluctuate a lot) you have to use either two or 3 stage growth model
• Project cash flow for the period of unstable growth (use percentage of sale method to project financials)
• Estimate the terminal value at the end of the period of unstable growth ( using formula for growing perpetuity)
• Think of the discount rate you would like to use to compute PV of cash flow. Different rate for different stage of growth? Or the same???
• Remember discount rate will depends on the capital structure of the firm, (If country significantly changed its D/E ratio in recent period you have to use industry average as a target structure and use it for calculation of discount rate for stable growth period) You may ned to adjust cash flow as well to reflect this changes
• Do not forget to make assumptions about growth rate of capex, depreciation in different periods of growth (you might look at industry peers data). They should align with your projections of sales.
• What you would like to value 1) entire firm (FCFF) or only equity part (FCFE or Dividend)
• Use WACC for firm valuation, required rate of return for equity for equity valuation
For equity valuation
• Dividend discount model or) Free cash flow to the equity.
• This depends on if company pays dividends, whether they are stable and some other factors ( imagine you purchase a big stake of the equity and you can influence the firm decision on dividends, in this case you should use FCFE)
• How to estimate the growth rate of dividend and growth rate of FCFE (ratios using historical average, industry average)
• What is your assumption about financing of capex and change in working capital??
• After computing value of equity you will add MV of debt to get your own estimate of the value of the firm. Remember you will compute enterprise value (PV (Future CF to the equity)+Debt)).
Valuation of FCFF will give you the enterprise value.
• If your company change its capital structure one way to avoid mistakes is to use FCFF, (at least you do not need to adjust FCFE)
• Still if you think that the current capital structure will not sustain in the future you should adjust WACC.
• To compare your results with market value
• Market price of the stock x Nmb of stocks outstanding + MV(Debt) – Cash =Enterprise value
For relative valuation, you need to do is to decide which multiple is more relevant in your case.
Questions to keep in mind
• Equity multiples versus Firm multiples
Rem: Firm value multiples allow for direct comparison of different firms, regardless of capital structure.
• EBITDA (both equity of firm)multiple is one of the most commonly used valuation metrics, as EBITDA is commonly used as a proxy for cash flow available to the firm.
• When a company has negative EBITDA, the EBITDA and EBIT multiples will not be material. In such cases, Sales multiple may be the most appropriate multiple to use.
• When depreciation and amortization expenses are small, as in the case of a non-capital-intensive company such as a consulting firm, EBIT and EBITDA will be similar.
• For the sake of consistency (because you want to compare both DCF and relative valuation results), if you value FCFF, use the multiples that estimate the value of the firm, if you estimate the value of equity FCFE, use the equity multiples.
