Corporate valuation

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CORPORATE VALUATION

2. TABLE OF CONTENTS
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I OVERVIEW OF VALUATION
II INTRODUCTION TO VALUATION
III VALUATION ANALYSIS
IV HISTORICAL ANALYSIS
V FORECASTING OF FUTURE PROJECTIONS
VI POST PROJECTION CASH FLOW MAPPING
VII DISCOUNTING CASH FLOWS METHOD
VIII DISCOUNTING FACTOR
IX TERMINAL VALUE
X FCFF AND FCFE
XI LIMITATIONS OF DCF
XII CLOSING THOUGHTS

3. I. OVERVIEW OF VALUATION
Business Valuationdepends upon
Purpose of
valuation
Stage of
business
Past f inancials
Expected
f inancial
results
Industry
scenario
Business Valuationis the process of determining the "EconomicWorth" of a
Company based on its Business Model and External Environmentand
supported with reasons and empirical evidence.
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4. VALUATION IS HYBRID OF ART & SCIENCE
PRICE IS NOT THE SAME AS VALUE
VALUEVARIESWITH PERSON, PURPOSEAND TIME
TRANSACTION CONCLUDES ATNEGOTIATED PRICES
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II. INTRODUCTION TO VALUATION

5. Mergers & Acquisitions Regulations DisputeResolution
Succession Planning VoluntaryAssessment ESOPs
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II. INTRODUCTION TO VALUATION
THE NEED

6. Determine
Purpose of
Valuation
Establish Valuation
Date Collate Data
IndustryAnalysis
Historical Analysis
of Company
Adjustments&
Recasts
Evaluate Future
Projections
Implement
Selected Valuation
Methodologies
Assign Weightages
to Methodologies
& Report
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II. INTRODUCTION TO VALUATION
THE PROCESS

7. III. VALUATION ANALYSIS
❖ Compare the valuation of one security to another security
❖ Compare the valuation of one security to a group of securities
❖ Compare the valuation of security in historical context
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8. AnalyseRelevant
EconomicData-
Global&
Domestic
Analyse
Competition &
MarketPosition
Comprehend
Regulations
Determine
FutureGrowth
Rates
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IV. HISTORICAL ANALYSIS
INDUSTRY

9. IV. HISTORICAL ANALYSIS
COMPANY
Analyse
Historical
Financial
Statements
AnalyseCapital
Structure & Cost
of Capital
SWOT Analysis
Determine
FutureGrowth
Rates &
Correlatewith
Industry
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10. TrendAnalysis
Revenue
TrendAnalysis
Expenditure
Ratio Analysis
Profitability & Efficiency
Capital Expenditure
Notes to Accounts
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IV. HISTORICAL ANALYSIS
FINANCIAL STATEMENTS

11. IV. HISTORICAL ANALYSIS
ADJUSTMENTS & RECASTS
Adjustments&
Recasts
Excludegains or
losses from
businessoperations
that havebeen
discontinued
Eliminate any one-
time gains or losses
from the
disposition of
assets
Factor outthe
effectof any
business
interruptions
Factor outamounts
of non-operating
nature
Adjustoff-balance
sheetitems
Removeabnormally
high or low profits
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12. Determine
Y-o-Y RevenueGrowth
VariableExpenditure
As a % of Revenue
FixedExpenditure
Historical Data
Depreciation
Historical Data+
Additional Capex
Interest
As a % of AverageDebt
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Taxation
EffectiveTax Rateas on
Valuation Date
V. FORECASTING OF FUTURE
PROJECTIONS

13. Determine
ReceivablesCycle
DetermineInventory
Cycle
DeterminePayables
Cycle
Evaluatethe Capex
Requirement
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Evaluatethe Sources of
Funds
V. FORECASTING OF FUTURE
PROJECTIONS

14. VI. POST PROJECTION CASH FLOW
MAPPING
TerminalGrowthRate < Growth Rate of Economy
Evaluatethe TerminalGrowthRate
Determine the Yearof StableCash Flows
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15. • Expresses the present valueof the business
attributableto all claimants(likeequity
shareholders,debt holders,preference
shareholdersetc.) as a function of its future
cash earning capacity
• Cash flows are discountedusing WACC
Free Cash Flows to the Firm
(FCFF)
• Expresses the present valueof the business
attributableto equity shareholdersas a
function of its future cash earning capacity
• Cash flows are discountedusing Ke
Free Cash Flows to Equity
(FCFE)
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VII. DISCOUNTED CASH FLOWS METHOD

16. T
erminal
Value
FreeCash
Flows
Cost of
Equity(Ke)
Cost of
Capital
(WACC)
Beta, Market
Risk
Premium,
Company
Specific Risk
Premium
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VII. DISCOUNTED CASH FLOWS METHOD
CONSTITUENTS

17. VII. DISCOUNTED CASH FLOW METHOD
PROCESS
Understandthe Business Model/Plan
Identify Business Cycle
AnalyzeHistoricalFinancial Performance
ReviewIndustry and RegulatoryTrends
UnderstandFuture Growth Plans
(including Capex needs)
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18. VII. DISCOUNTED CASH FLOW METHOD
PROCESS
SegregateBusiness and Other Cash Generating Assets
Identify Surplus Assets
(assets not utilized forBusiness say Land/Investments)
PrepareBusiness Projections
DiscountBusiness Projections to Present
(Explicit Periodand Perpetuity)
Add Valueof Surplus Assetsand Subtract Valueof
ContingentLiabilities
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19. ❖ Cost of Capital:
▪"Cost of capital" means "the opportunity cost of all capital invested in an entity ”.
Breaking down the above sentence:
• “Opportunity cost” is the loss one incurs when one alternative investment is chosen
over the other.
• “All capital invested” is the total funds invested into a business. On an entity level,
this refers to the fact that we are measuring the opportunity cost of all sources of
capital which includes debt and equity both.
❖ Steps for calculating Cost of Capital
VIII. DISCOUNTING FACTOR
Deducethe costof capital components
Ascertain the capitalstructure
Weigh the components
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20. CAPITALASSET PRICING MODEL
(CAPM)
Ke = Rf+Beta*(Rm-Rf)+ARP
Ke = Costof Equity
Rf = Risk free Rate of Return
Beta = Beta Coefficient
Rm = MarketReturn
ARP = Additional Risk Premium
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VIII. DISCOUNTING FACTOR
COST OF EQUITY (Ke)

21. InterestRate after Adjusting for Tax
Deductions
Kd = I*(1-t)
Kd = Costof Debt
I = InterestRate
t = Tax Rate
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DISCOUNTING FACTOR
COST OF DEBT (Kd)

22. CAPITALSTRUCTURE
• We calculatethe contributionof each sourceof capital as follows:
• Equity= E / (E+D)
• Debt= D / (E+D) Where,
• E = Equity
• D = Debt
WEIGHTAGE
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• The WACCequationis the aggregateof cost of each capital component which is
multipliedby its proportional weight:
• Formula:
• WACC= Ke*E/(E+D) + Kd *D/(E+D)
VIII. DISCOUNTING FACTOR
CAPITAL STRUCTURE & WEIGHTAGE

23. IX. TERMINAL VALUE
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Terminal Value
Liquidation Value Multiple Approach Stable Growth Model

24. IX. TERMINAL VALUE
STABLE GROWTH MODEL
Capitalizes FCF after definiteforecastperiod as agrowing perpetuity
EstimateTerminalValueusing TerminalValueMultiplier applied on
terminalyear cash flows
Gordon Formula is often used to derivethe Terminal Cash
Flows by applying thelastyear cash flows as a multiple of the growth rate
and discounting factor (1+g)/(WACC-g)
Estimated Terminal Value is then discounted to present day at company’s
cost of capital based on the discounting factor of terminal year projected
cash flows
Usually comprises a Largepartof TotalValueand is sensitiveto small
changes
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Note: “g” refers to terminal growth rate

25. X. FREE CASH FLOWS TO FIRM
PROCEDURE
Step1:Arrive at EBIT Earning before interestandtaxes
Step2:Multiply with(1-tax rate) EBIT * (1-tax rate) *
Step3:Arrive at Operatingprofitafter tax Operating profit after tax =
Step4:Addback non cashcost (already subtractedearlier) NonCash Cost +
Step5:Subtract Capital Expenditures Capital expenditures -
Step6:Add/Subtract Changes inNCWC Increase/Decrease inNCWC +/-
Step 7:AddTerminalValue TerminalValue +
Step8:Arrive at FreeCashFlowstoFirm Free cashflow tofirm =
Step9:Discount the FCFF for each yearwiththe costof capital DiscountedFree CashFlow toFirm =
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Note: “NCWC” refers to Non-cash Working Capital

26. X. FREE CASH FLOWS TO EQUITY
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PROCEDURE
Step1:Arrive at PBT Profit BeforeTax
Step2:Multiply with(1-tax rate) PBT*(1-tax rate) *
Step 3:Arrive at PAT Profit After Tax =
Step4:Addback non cashcost (already subtractedearlier) NonCash Cost +
Step5:Subtract Capital Expenditures Capital expenditures -
Step6:Add/Subtract Changes inNCWC Increase/Decrease inNCWC +/-
Step 7:Take into account the effectof changes indebt Changes inDebt +/-
Step8:AddTerminalValue TerminalValue +
Step9:Arrive at FreeCashFlowstoEquity Free cashflow toEquity =
Step10:Discount theFCFEfor eachyear withthe cost of
equity
DiscountedFree CashFlow to
Equity
=

27. Requires lotsof inputs &
informationcomparedto other
methods
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Inputs are difficult to estimate
and can be manipulated
Discountedcash flow modelsmay
very well find every stockin a
sector or even a marketto be
over valued, if marketperceptions
have run ahead of fundamentals
XI. LIMITATIONS OF DCF

28. SOME GOOD READS ON VALUATION
Books on Valuationby Aswath Damodaran
Books on Valuationby Shannon P.Pratt
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29. Let’s Discuss More on Valuation
Questions/Comments
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