Lecture 14 - Valuing Business

Maths-based, so do them for practise

What is capital budgeting?

Evaluating individual projects using NPV

What formula is used in capital budgeting?

What is business valuation?

Valuing the whole firm

How is firm value calculated?

Discounting all future cash flows

What is the main difficulty in valuing a business?

Estimating future free cash flows

What is a key difference between projects and firms?

Firms have potentially infinite life

Why is business valuation difficult?

Future cash flows are uncertain

What must be estimated?

Long-term cash flows

What is free cash flow (FCF)?

Cash flow available to all investors after operations and investments

What is FCF formula?

Alternative FCF formula?

• PAT - profit after tax

• Capex - capital expenditure

• ΔNWC - change in net working capital

What is cash flow from operations?

Profit after tax plus depreciation

What is PAT formula?

What is unlevered firm value VU?

Value of firm assuming no debt

When can perpetuity be used?

When cash flows are constant forever

What is perpetuity formula?

Value equals cash flow divided by discount rate

What is formula for unlevered firm value in perpetuity?

VU equals UCF divided by RU

What is EBIT?

Earnings before interest and tax

What does EBIT measure?

Operating performance

What is profit after tax?

EBIT minus tax

What is VU?

Value of unlevered firm

What does VU assume?

No debt financing

What is RU?

Cost of capital for all-equity firm

What does RU reflect?

Business risk only

What is APV?

Adjusted Present Value

What does APV do?

Adds financing effects to base value

What is APV formula in business valuation?

VL equals VU plus PV of financing effects

What is VL​ in the APV method?

Value of the levered firm

What is VU​ in the APV method?

Value of the unlevered firm

What is PV of tax shield in perpetuity?

Tc multiplied by D

What is PV of tax shield (general)?

Sum of discounted tax savings

What is tax shield?

Tax saving from interest

What is equity value E?

VL minus D

What is formula for cost of equity RE with leverage?

RE equals RU plus D divided by E times (1 minus Tc) times (RU minus RD)

What does D/E represent?

Leverage

What does (RU − RD) represent?

Risk premium

What is FTE method for business valuation?

Values equity using levered cash flows

What is LCF?

Cash flow after interest and tax

What is formula for equity value in FTE?

E equals LCF divided by RE for perpetuity

What is LCF?

Levered cash flow after interest and tax

What happens when cash flows change over time?

Cannot assume perpetuity immediately

(So must forecast each year)

Why can’t we assume perpetuity immediately?

Cash flows change before stabilising

What is the DCF model?

Valuing firm by discounting future FCF and terminal value

What does DFC stand for?

Discounted cash flow model

What is DCF formula?

PV equals sum of discounted FCF plus discounted terminal value

What is horizon period H?

Forecast period before steady state

What is horizon value PVH?

Value of firm after forecast period

What is horizon period H?

Forecast period before steady growth

What is horizon value formula for perpetuity?

PVH equals FCF H+1 divided by WACC

What is horizon value formula for growth?

PVH equals FCF H+1 divided by (WACC minus g)

What is g?

Long-term growth rate of cash flows

What discount rate is used in business valuation?

WACC

What does WACC give in valuation?

Total firm value

How do you find equity value from firm value?

Subtract debt from firm value

What is Rio Corporation example about?

Valuing a firm with changing cash flows

What inputs are given in Rio example?

Sales growth costs working capital assets tax rate and discount rate

How is FCF calculated each year?

Profit after tax plus depreciation minus investment minus change in working capital