2. New & High Growth Companies – Key Value Drivers
• Revenue growth
• Forecast the potential revenue in the terminal year – usually industry size potential x
target market share
• Assume a revenue growth path to the terminal year potential – initially high & similar
to recent trends, declining as the revenue base increases
• Path to stable operating margin
• Forecast the stable EBIT margin based on most established peers by the terminal year
• Gradually increase the initial EBIT margin to the forecasted stable EBIT margin
• Estimate cumulative net operating losses (NOL), since tax will be 0 or less than marginal
tax rate till cumulative NOL are absorbed completely (subject to loss carry forward
regulations)
• Estimate post-tax EBIT (NOPAT)
3. New & High Growth Companies – Other cashflow
assumptions
• Reinvestment
• Use revenue/capital ratio of peer industry to estimate reinvestment – how much
additional revenue is generated by each INR of additional investment
• If appropriate, assume a lag between investment and revenue.
• Terminal value assumptions
• Terminal growth assumption similar to that for established peers.
• Terminal ROIC – based on sustainable advantage, else converge to WACC
4. Discount Rate
• Debt to Equity Ratio
• Transition towards target the industry average, or optimal D/E
• Cost of Equity
• Use bottom-up unlevered betas based on peer average
• Adjust the beta for estimated debt to equity
• As the firm moves towards maturity, adjust the beta towards 1
• Cost of Debt
• Forecast indicative interest coverage for the future
• As the firm matures, the cost of debt will move towards that of stable companies
• Use the same tax rate as for NOPAT
5. Value of Equity
• Value of Equity
• Estimate value of firm using DCF, including discounted terminal value
• Add cash/non-operating assets, subtract debt & minority interest
• Value of Equity per share
• Adjust the number of shares for dilution
6. Dilution due to ESOPs
• Method 1: Fully diluted approach (not preferred)
• Divide the value of equity by the fully diluted number of shares (number of shares +
number of vested options)
• Method 2: Treasury stock approach
• Add the exercise proceeds from the options to the equity value before dividing by the
fully diluted number of shares
• Method 3: Option valuation approach
• Use dilution adjusted Black Scholes model to estimate the value of options
• Dilution adjustment for share price on exercise of options = (share price x n shares +
option price x n options)/(n shares + n options); iterate since option price is both input
and output
• Subtract the total estimated value of options from equity value before dividing by
number of shares
