USTS WEEK 8 DISCOUNTED CASH FLOW VALUATION
Announcements This is the last meeting of the quarter Next quarter, Melanie Gin, the co-president, will join me.
She has been studying abroad this quarter. I’d like to resume member presentation on week 3 of next
quarter. If you’d like to present, please come talk to me. Enjoy Thanks Giving, Good Luck on the Finals, and Have
a great Winter Break!
Discounted Cash Flow Valuation What is it? Intrinsic valuation Why use this? Not susceptible to market error Flexible to future changes – just apply different inputs. No need for a peer group What’s the limitation? The accuracy (rather, inaccuracy) of assumptions of future. Very
sensitive to changes in those assumptions
A Subjective process
Process of DCF 1. Calculate weighted average cost of capital (WACC)
Find out cost of debt Find out cost of equity using CAPM
2. Select forecast period & period of steady state
condition
3. Calculate/project the firms’ Unlevered Free Cash Flow
(UFCF) from EBIDTA (just look up Morning star)
4. Discount each UFCF by WACC to the present value
and add them up.
Process of DCF 5. Calculate the firm’s terminal value (TV) & Discount to
present value
Exit Multiple Method Perpetuity Growth Rate Method (or both) (personal choice)
6. Derive Total Enterprise Value
Tot. EV = Net present value of Future FCF + present value of TV
7. Derive the firms Total Equity Value from Enterprise
Value
Equity Val.=Enterprise Val. – debt – preferred stock – minority interest + cash & cash equivalents
Process of DCF 8. Create a range of values by running different
inputs & assumptions 9. Compare it to other valuation methods & see if the
DCF value is reasonable. If there’s a wild difference, figure out why.
1. Calculate WACC WACC = Ke * (E/D+E) + Kd * (1-T) * (D/D+E) Ke = Cost of equity (using Capital Asset Pricing Model) Ke
= Rf + (β * (Rm – Rf) Rf = Risk free rate (T-bill 10 yr. most commonly used) Β = Volatility of the stock compared to the market (can be found in Yahoo! Finance, etc.) Rm = Rate of Return in the market. This is SUBJECTIVE. May use S&P 500 average return.
E = market value of equity = share price * diluted shares outstanding D = Market value of Debt = May use book value (caution!) or if debt is publicly traded, that price may be used. T = marginal tax rate
Calculate WACC WACC = Ke * (E/D+E) + Kd * (1-T) * (D/D+E) Kd = Cost of Debt The
company’s debt footnote in its 10-k or annual report. If there was a recent debt issuance, use that rate If the debt is publicly traded, get a quote from there All else fail, look for a comparable company with a similar risk/ credit profile
WACC will be your discount rate
Calculate & predict FCF Unlevered Free Cash Flow: Cash Flow independent of capital
structure (i.e. cash flow after covering cap ex, working cap, investment needs but before interest and dividends)
No need to calculate this. Just look up in the internet
Growth projections: may use the firm’s own projections or use
analysts’ consensus.
What life cycle is it in? steady state, growth, or demise? Use the rate to calculate each future years’ FCF Discount it to present Value: PV = CF1/(1+r)^1 + CF2/(1+r)^2 + …
Calculate Terminal Value Exit Multiple method: Sell off concept Terminal Value = Multiple * Financial Metric n Multiple
= total enterprise value / EBIDTA Financial Metric n = EBIDTA of year of ending forecast period
Will the same multiple hold in the future?
Perpetuity Growth Rate method: goes on forever TV = (FCF n * (1+g)) / (r-g) FCFn
= predicted UFCF of future year n g = steady growth rate (SUBJECTIVE!) r = WACC
Finally PV or FCF + PV of TV = Enterprise Value Equity Value = Enterprise Val. – debt, PFD, minority
int. + cash & equivalents Equity Value per share = Equity Value / Diluted
Shares