### A Complete Corporate Valuation

```A Complete Corporate
Valuation for a Simple
Company
DES Chapter 2
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Three types of value
Book value: the company’s historical
value as shown on its financial
statements.
Market value: the current price at which
an asset can be bought or sold.
Intrinsic value: estimate of the value an
individual buyer places on an asset.
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Objective:
Objective is to provide a sound basis for
estimating the intrinsic value of a stock.
This intrinsic value is also called its
fundamental value.
The process is known as fundamental
valuation—Warren Buffet is very
successful at identifying a company’s
fundamental value!
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The three basic concepts of
valuation
Investors can only spend cash so "Cash is
good and more cash is better."
Cash today is worth more than cash
tomorrow.
Risky cash flows are worth less than safe
cash flows.
These three imply the value of a company
depends on the size, timing, and riskiness of
its cash flows.
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Steps in the corporate valuation
Determine weighted average cost of capital
Estimate expected future free cash flows--cash flows available to all investors—called
free cash flows (FCFs).
Discount free cash flows at the average rate
of return required by all investors
Find value of company
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Estimating the Weighted Average
Cost of Capital (WACC)
Company has two types of investors
Debtholders
 Stockholders

Each type of investor expects to receive
a return for their investment
The return an investor receives is a
“cost of capital” from company’s
viewpoint.
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Cost of Debt
MPR’s cost of debt: rD = 9%.
But MPR can deduct interest, so cost to
MPR is after-tax rate on debt.
If tax rate is 40%, then after-tax cost of
debt is:

After-tax rD = 9%(1-0.4) = 5.4%.
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Cost of Equity
Cost of equity, rs, is higher than cost of
debt because stock is riskier.

MPR: rs = 12%
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Weighted Average Cost of
Capital
WACC is average of costs to all investors,
weighted by the target percent of firm that is
financed by each type.
For MPR, target percent financed by equity:

wS = 70%
For MPR, target percent financed by debt:

wD = 30%
DES Chapter 2
(More….)
9
WACC (Continued)
WACC = wD rD (1-T) + wS rS
= 0.3(9%)(1 - 0.4) + 0.7(12%)
= 10.02%
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Free Cash Flow (FCF)
FCF is the amount of cash available
from operations for distribution to all
investors (including stockholders and
debtholders) after making the necessary
investments to support operations.
A company’s value depends upon the
amount of FCF it can generate.
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Calculating FCF
FCF = net operating profit after taxes
minus investment in operating capital
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Financial Statements
Balance sheet

Assets (all of MPR’s assets are used in
operations)

Operating assets


Operating current assets
Property, plant, and equipment (PPE)
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Operating Current Assets
Operating current assets are the CA
needed to support operations.
Op CA include: cash, inventory,
receivables.
 Op CA exclude: short-term investments,
because these are not a part of operations.

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Operating Current Liabilities
Operating current liabilities are the CL
resulting as a normal part of operations.
Op CL include: accounts payable and
accruals.
 Op CA exclude: notes payable, because
this is a source of financing, not a part of
operations.

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Balance Sheet: Assets
2007
Op. CA
162,000.0
Total CA 162,000.0
Net PPE
199,000.0
Tot. Assets 361,000.0
2008
168,000.0
168,000.0
210,042.0
378,042.0
DES Chapter 2
2009
176,400.0
176,400.0
220,500.0
396,900.0
16
Balance Sheet: Claims
2007
Op. CL
57,911.5
Total CL 57,911.5
L-T Debt
136,253.0
Total Liab.194,164.5
Equity
166,835.5
TL & Eq. 361,000.0
2008
62,999.7
62,999.7
143,061.0
206,060.7
171,981.3
378,042.0
DES Chapter 2
2009
66,150.0
66,150.0
150,223.0
216,373.0
180,527.0
396,900.0
17
Income Statement
2007
Sales
400,000.0
Costs
344,000.0
Op. prof. 56,000.0
Interest
11,678.7
EBT 44,321.3
Taxes (40%) 17,728.4
NI
26,592.7
Dividends
21,200.0
5,392.7
2008
420,000.0
361,994.2
58,005.8
12,262.8
45,743.0
18,297.2
27,445.8
22,300.0
5,145.8
DES Chapter 2
2009
441,000.0
374,881.6
66,118.4
12,875.5
53,242.9
21,297.2
31,945.7
23,400.0
8,545.7
18
NOPAT (Net Operating Profit
After Taxes)
NOPAT is the amount of after-tax profit
generated by operations.
NOPAT is the amount of net income, or
earnings, that a company with no debt
or interest-income would have.
NOPAT
= (Operating profit) (1-T)
= EBIT (1-T)
DES Chapter 2
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Calculating NOPAT
NOPAT = (Operating profit) (1-T)
= EBIT (1-T)
NOPAT09 = 66.1184 (1-0.4) = 39.67104
million.
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Calculating Operating Capital
Operating capital (also called total
operating capital, or just capital) is the
amount of assets required to support
the company’s operations, less the
liabilities that arise from those
operations.
The short-term component is net operating
working capital (NOWC).
 The long-term component is factories,
land, equipment.

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Net Operating Working Capital
NOWC = Operating current assets
– Operating current liabilities
This is the net amount tied up in the
“things” needed to run the company on a
day-to-day basis.
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Net Operating Working Capital
NOWC = Operating CA – Operating CL
NOWC09 = \$176.4 – \$66.15
= \$110.25 million
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Operating Capital
Operating capital =
 Net
operating working capital
(NOWC) plus
 Long-term capital, such as factories,
land, equipment.
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Operating Capital = NOWC + LT Op.
Capital
Capital09 = \$110.25 + \$220.50
= \$330.75 million
This means in 2009 MPR had \$330.75
million tied up in capital needed to support
its operations. Investors supplied this
money. It isn’t available for distribution.
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Investment in operating capital
Operating capital in 2008 was
\$315.0423 million
Operating capital in 2009 was \$330.75
million
MPR had to make a net investment of
\$330.75 – \$315.0423 = \$15.7077
million in operating capital in 2009.
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Calculating FCF
FCF = NOPAT – Investment in operating
capital
FCF09 = \$39.67104 – (330.75 – 315.0423)
= \$39.67104 – \$15.7077
= \$23.96334 million
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There are five ways for a
company to use FCF
1. Pay interest on debt.
2. Pay back principal on debt.
3. Pay dividends.
marketable securities, investments in
other companies, etc.)
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Reinvestment
Bucket
DES Chapter 2
Free Cash Flow
Bucket 29
How Did MPR use its FCF?
Paid dividends: \$23.4 million
Paid after-tax interest of: \$12,875.5 (1-0.4) =
\$7.7253 million
For a total of \$31.1253 million! This is \$7.162
million more than the \$23.9 million FCF
available! Where did it come from?
MPR increased its borrowing by \$150.223 –
\$143.061) = \$7.162 million to make up the
difference.
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Corporate Valuation
Forecast financial statements and use
them to project FCF.
Discount the FCFs at the WACC
This gives the value of operations
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Value of Operations:

FCFt
VOp  
t
t 1 1  WACC 
Of course, this requires projecting free cash flows out
forever.
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Constant growth
If free cash flows are expected to grow at a
constant rate of 5%, then this is easy:
FCF
2009
23.963
2010
25.161
2011
26.419
2012
27.740
2013
29.127
2014
30.584
There is an easy formula for the present value of free
cash flows that grow forever at a constant rate…
DES Chapter 2
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Constant Growth Formula
The summation can be replaced by a
single formula:
FCF1
VOp 
WACC g 
FCF0 (1  g )

WACC g 
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The value of operations
FCF0 (1  g )
VOp 
WACC  g 
\$23.96334(1  0.05)
VOp 
0.1002 0.05
 \$501.225million
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Value of Equity
Sources of Corporate Value
Value of operations = \$501.225 million
 Value of non-operating assets = \$0 (in this
case)

Claims on Corporate Value

Value of Debt = \$150.223 million
Value of Equity = ?
Value of Equity = \$501.225 - \$150.223 =
\$351.002 million, or just \$351 million.
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Value of Equity
Price per share
= Equity / # of shares
= \$351 million / 10 million shares
= \$35.10 per share
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A picture of the breakdown of
MPR’s value
Debt
Equity
DES Chapter 2
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Return on Invested Capital
(ROIC)
ROIC can be used to evaluate MPR’s
performance:
ROIC = NOPAT / Total operating capital in
place at the beginning of the year
DES Chapter 2
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ROIC calculation
ROIC09 = NOPAT09 / Capital08
ROIC09 = 39.67104 / 315.0423 = 12.6%.
This is a good ROIC because it is greater than
the return that investors require, the WACC,
which is 10.02%. So MPR added value
during 2009.
DES Chapter 2
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(also called Economic Profit)
EVA is another key measure of
operating performance.
EVA is trademarked by Stern Stewart,
Inc.
It measures the amount of profit the
company earned, over and above the
amount of profit that investors required.
EP = NOPATt – WACC(Capitalt-1)
DES Chapter 2
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Calculating EVA
EVA = NOPAT- (WACC)(Begng. Capital)
EVA09 = NOPAT09 – (0.1002)(Capital08)
EVA09 = \$39.67104 – (0.1002)(315.0423)
= \$39.67104 – \$31.56742
= \$8.1038 million
(More…)
DES Chapter 2
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Economic profit…
This shows that in 2009 MPR earned about \$8
million more than its investors required.
Another way to calculate EP is
EPt = (ROIC – WACC)Capitalt-1
= (0.125923 – 0.1002)\$315.0423
= \$8.1038 million
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Intuition behind EP
If the ROIC – WACC spread is positive, then the
firm is generating more than enough “profit,”
and is increasing value. But, if the ROIC –
WACC spread is negative, then the firm is
destroying value, in the sense that investors
would be better off taking their money and
investing it elsewhere.
DES Chapter 2
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Applications of the corporate
valuation model
Mergers and acquisitions

Evaluate how much a target is worth under
various operating scenarios
Value-based management

Make decisions with the goal of increasing the
company’s value
Fundamental investing

Identify firms that are worth more than the current
stock price
DES Chapter 2
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