CASH FLOW VALUATION METHODS
METHODS ASSET CASH FLOWS EQUITY CASH FLOWS FREE CASH FLOWS
Whole Firm Equity Value Whole Firm
...
|/ Less: Interest |/
|/ Less: Debt Payments |/
|/ Plus: Debt Issues |/
|/ |/ |/
ASSET
CASH FLOW
EQUITY
CASH FLOW
FREE
CASH...
NOTE:
Sales ($) $5,000 COMPUTER MUST BE SET TO SOLVE BY ITERATION (OPTIONS MENU - CALCULATIONS)
Unlevered Beta 1.00
Riskfr...
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07. cash flow valuation methods (deb sahoo)

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07. cash flow valuation methods (deb sahoo)

  1. 1. CASH FLOW VALUATION METHODS METHODS ASSET CASH FLOWS EQUITY CASH FLOWS FREE CASH FLOWS Whole Firm Equity Value Whole Firm Measures Cash Flow available to both equity and debt holders Measures Cash Flow Available to Stockholders After Payments to Debt Holders are Deducted from Operating Cash Flows Measures Value of Whole Firm - Cash Flows Do Not Include Tax Benefits of Debt Since That is in Discount Rate REPRESENTS REPRESENTS REPRESENTS Includes Benefits of tax deductible interest payments Equity Cash Flows Equal Capital Cash Flows minus Debt Cash Flows Cash Flows Available to Firm if Interest Was Not a Tax-Deductible Expense DISCOUNT RATE DISCOUNT RATE DISCOUNT RATE Discount Rate is Pre-Tax Rate That Corresponds to Riskiness of Firm Equity Cash Flows are Riskier Than Cash Flows With Debt, so Discount Rate is Higher Includes Benefit of Tax Deductible Interest in Discount Rate - so After-Tax Discount Rate is appropriate BEGINNING PURPOSE OF MEASURES TO ADJUST ACCOUNTING FIGURES DISCOUNT Use CAPM to Determine Appropriate Discount Rate - Use Asset Beta Use CAPM to Determine Appropriate Discount Rate - But Use Equity Beta Appropriate Discount Rate is WACC RATES Since ACF Values Whole Firm Since ECF Values Equity Cash Flows Since FCF Values Whole Firm Note: Unlevered Beta = Levered Beta / (1 + D/E Ratio) Expected Return = Riskfree Rate + [ (Asset Beta) * (Risk Premium) ] e.g., Equity = 60%, Levered Beta = 1.667 WACC = ( Debt / Value) ( 1 - Tax Rate ) * kD + ( Equity / Value ) * kE Note: Before Tax Rates Unlevered Beta = 1 /(1 + .40/.60) = 1.0 Expected Return = Riskfree Rate + [ (Equity Beta) * (Risk Premium) ] |/ |/ |/ Subtract Actual Taxes [(Tax Rate) * (EBIT - Interest)] Subtract Actual Taxes [(Tax Rate) * (EBIT - Interest)] Subtract Hypothetical Taxes (Tax Rate) * EBIT) |/ |/ |/ VALUATION APPROACH CASH FLOW VALUATION APPROACHES | Deb Sahoo | MBA, Finance, University of Michigan | MS, EE, University of Southern California | B-Tech, EE, IIT | Less: Working Capital Increase Equals Operating Cash Flow 3. Subtracting Changes in Working Capital SUMMARY OF CASH FLOW VALUATION METHODS Earnings Before Interest & Taxes EBIT Plus: Depreciation Less: Capital Expenditures 2. Adding Depreciation Beginning Point for All 3 Measures is Earnings Before Interest & Taxes or EBIT Purpose of Cash Flow Measures is to Transform Accounting Recognition of Receipts and Expenses Into Cash Flow Definitions Adjustments Include: 1. Subtracting Capital Expenditures
  2. 2. |/ Less: Interest |/ |/ Less: Debt Payments |/ |/ Plus: Debt Issues |/ |/ |/ |/ ASSET CASH FLOW EQUITY CASH FLOW FREE CASH FLOW Discount At Expected Asset Return (Before tax rates) Discount at Expected Equity Return Discount at Weighted Average Cost of Capital (After tax rates)
  3. 3. NOTE: Sales ($) $5,000 COMPUTER MUST BE SET TO SOLVE BY ITERATION (OPTIONS MENU - CALCULATIONS) Unlevered Beta 1.00 Riskfree Rate (Return on Debt) 10.00% Risk Premium 8.00% Debt Ratio (Debt %) 40.00% Depreciation ($) $500 Change in Working Capital $0 Capital Expenditures ($) $500 EBIT Margin (%) 40.00% Tax Rate (TR) 40.00% ASSET CASH FLOW VALUATION EQUITY CASH FLOW VALUATION FREE CASH FLOW VALUATION Debt $2,927 $2,927 $2,927 Debt = Debt% * Firm Value Debt = Debt% * Firm Value Debt = Debt% * Firm Value Sales $5,000 $5,000 $5,000 EBIT Margin 40.00% 40.00% 40.00% EBIT $2,000 $2,000 $2,000 Depreciation $500 $500 $500 Capital Expenditures ($500) ($500) ($500) Change in Working Capital $0 $0 $0 OPERATING CASH FLOW $2,000 $2,000 $2,000 Taxes $683 $683 $800 Taxes = TR * (EBIT - Interest) Taxes = TR * (EBIT - Interest) Taxes = TR * (EBIT) Interest $293 $293 $293 $293 Debt Cash Flow $1,317 $1,024 $1,200 Asset Cash Flow Equity Cash Flow Free Cash Flow 18.00% 23.33% 16.40% Expected Asset Return (Ra) Expected Equity Return (Re) Weighted Average Cost of Capital (WACC) $7,317 $4,390 $7,317 Value of Asset or Firm Value Value of Equity Free Cash Flow Value or Firm Value $2,927 Debt Value $7,317 Value of Equity & Debt or Firm Value INPUTS VALUATION MODEL | Deb Sahoo | MBA, Finance, University of Michigan | MS, EE, University of Southern California | B-Tech, EE, IIT | CASH FLOW VALUATION MODEL

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