1. • “Value is what we receive & price is what we
pay”…… Warner Buffet
• Condition for buying a product or service
• Value>= Price
2. • Cash Flow
Dividend Discount
Model (DDM)
Free Cash Flow to Firm
(FCFF)
Free Cash Flow to Equity
(FCFE)
FCFF is what available for distribution to all stakeholders of the company.
FCFF= EBIT(1-t) + Depreciation – Capex +/- Working capital changes
FCFE= EBIT(1-t) + Depreciation – Capex +/- Working capital changes – Interest
/loan repayment
3. Steps to be followed in valuation
1. Forecasts Free cash flow
FCFF= EBIT* (1-tax rate)+Depreciation- Capex +/-
Changes in WC
2. Estimate Cost of capital (WACC)
3- Estimate long-term (perpetual growth rate)
4. Estimate present value of FCF at a discount of
WACC
5. Sum of present value of FCF
4. 6. Estimate terminal value-
Last projected year’s FCF* (1+ perpetual growth
rate)/(WACC - perpetual growth rate)
7. Estimate PV of terminal value-
Terminal value/ (1+WACC)^ year
8. Estimate Enterprise value (EV)
(Sum of present value of FCF) + (PV of terminal
value)
Steps to be followed in valuation
5. 9. EV= Equity + Debt – Cash
Equity = EV – Debt + Cash
10. Equity/ No. of outstanding shares
Steps to be followed in valuation
6. • EV is the measure for calculating how much it
would cost to buy a company’s business free
of its debts and liabilities. It can be thought of
as a theoretical takeover price of a company’s
business.
• Enterprise Value (EV)= PV( FCFF)
• EV= Equity + Debt – Cash
• Equity = EV – Debt + Cash
7. Absolute Valuations vs. Price-Value
Sense
• Instead of finding the absolute valuation of
business, we may like to compare ‘what we get’
with ‘what we pay’ to arrive at sense of valuation.
What we pay is the price and what we get is the
earnings and assets of the business.
• Therefore, if we can compare price with earnings
and assets, we can get a sense of valuation – not
the absolute valuation but whether something is
cheap or expensive.
8. Earnings Based Valuation Matrices
• Dividend Yield – Price to Dividend Ratio
• = Dividend per share (DPS)/Current price of
stock
9. Earning Yield - Price to Earnings Ratio:
• Price to Earnings Ratio = Current price of stock/
Earnings Per Share (EPS)
One question that may be asked here is which earnings to use to compute the ratio
– trailing (rolling 12 months) or forward.
10. Growth Adjusted Price to Earnings
Ratio (PEG Ratio)
• [Current price of stock/ Earnings Per
Share]/Growth rate
• PEG ratio is less than 1, business may be
treated as undervalued.
• If there are two businesses with P/E ratios 10
and 25 but with different growth potentials of
7% and 30% for next few years,
11. Enterprise Value to EBDITA Ratio
• If market capitalization of a company is Rs.
100,000, debt on balance sheet is Rs. 50,000
and cash and cash equivalents are Rs. 10,000,
EBIT is Rs. 10,000
• EV to EBIT ratio would be???
• Sometimes market participants use EBDITA
instead of EBIT
• Higher this ratio, more expensive the business.
And, lower this ratio, cheaper the business.
12. Enterprise Value (EV) to Sales Ratio
• When EV to EBIT or EV to EBDITA ratios start
showing signs of expensiveness, then market
participants, to justify cheapness of
businesses, move to measures such as EV to
Sales Ratio.
13. Assets based Valuation Matrices
• Price to Book Value Ratio
• Price to book value ratio = Market price per share/
Book value per share
• Or
• Price to book value ratio = Market capitalization/
Book value of equity or net-worth
• This ratio indicates, how much we are paying to
buy each Rs. of book value of equity.
14. • Consider a business with a net-worth of Rs.
100,000 and Market capitalization is Rs.
500,000 and RoE of 45%. if the investor wants
15% minimum return on capital invested, how
much he should willing to pay?
15. • EV to Capital Employed ratio = Enterprise Value /
Capital Employed (Total Equity + Total Debt)
• Consider a business with net-worth is Rs.
100,000, debt on the Balance Sheet is Rs.
100,000,Market capitalization is Rs. 500,000, cash
and cash equivalents on the balance sheet are nil
and ROCE (EBIT/Capital Employed) is 45% per
annum.
16. • Find out
• Capital Employed
• EV
• EV to Capital Employed Ratio
• For example, if the investor wants a 20%
minimum return on capital, then how much the
investor would be willing to pay EV?
Editor's Notes
BV-1 Llac 45,000/0.15= 3 lac (he should pay as Mcap)
ROE – 45% 15%
Return- 45,000 45,000
Capital Employed = 100,000 + 100,000 = 200,000
EV = 500,000 + 100,000 = 600,000
EV to Capital Employed Ratio = 600,000/200,000 = 3
the investor would not be willing to pay EV of more than 2.25 times (45/20) of employed
capital in the business viz. Rs. 450,000.