Business valuation x431 9 jan mar 2011 PPT

Business Valuation UC Berkeley Extension UC Berkeley Extension X431.9 X431.9 Bob Coackley Bob Coackley Introductions  Class is a 6.30 pm each Wednesday. Class is a 6.30 pm each Wednesday. Please be on time. Please be on time.  All out-of-class exercises are to be in by All out-of-class exercises are to be in by the following class date. the following class date.  If you are going to miss a class, please If you are going to miss a class, please send an e-mail to send an e-mail to bob.coackley@ceo-excel.com bob.coackley@ceo-excel.com  Class info is on Yahoo Groups at: Class info is on Yahoo Groups at: http:// http:// finance.groups.yahoo.com/group/busval finance.groups.yahoo.com/group/busval / / Log in to Log in to join. join. Where Has All The Money Gone  Possibly $Tr 3.6 losses in the banking system Possibly $Tr 3.6 losses in the banking system  Losses for private/institutional investors in Losses for private/institutional investors in stocks/bonds stocks/bonds  Loss of book value of GDP Loss of book value of GDP  Who now has all this? Who now has all this? Business Valuation Applications  Mergers and LBO’s Mergers and LBO’s  Investment analysis for undervalued stocks Investment analysis for undervalued stocks  IPO pricing IPO pricing  VC funding VC funding  Stock repurchase timing Stock repurchase timing  Value Based Management Value Based Management Accounting Review  Purpose of the 3 main Financial Reports Purpose of the 3 main Financial Reports  Depreciation – Is it Real? Is it cash? Depreciation – Is it Real? Is it cash?  Is the P&L the full story? Is the P&L the full story?  What is Operating Profit? What is Operating Profit?  What is EBIT? What is EBIT?  What is EBITDA? What is EBITDA?  What is NOPAT? What is NOPAT? NOPLAT  Net Operating Profit Less Adjusted Taxes Net Operating Profit Less Adjusted Taxes - the profits generated from a company’s core - the profits generated from a company’s core operations less the income taxes related to the operations less the income taxes related to the core operations. core operations. Economic Profit  EP= NOPLAT – Capital Charge EP= NOPLAT – Capital Charge  We will expand on this concept and formula We will expand on this concept and formula later later Free Cash Flow  FCF – FCF – The total cash available for distribution to owners & The total cash available for distribution to owners & creditors after funding all worthwhile investment creditors after funding all worthwhile investment activities. activities. FCF = NOPLAT + NonCash Operating Expenses – FCF = NOPLAT + NonCash Operating Expenses – investments in Invested Capital. investments in Invested Capital. FCF Example  NOPLAT NOPLAT 210 210  Depreciation Depreciation 20 20  Gross Cash Flow Gross Cash Flow 230 230  Decrease (Incr) in inventory Decrease (Incr) in inventory (25) (25)  Increase (Decr) in AP Increase (Decr) in AP 25 25  Capex Capex (70) (70)  Gross Investment Gross Investment (70) (70)  FCF FCF 160 160 Discounted Cash Flow  Backbone of modern finance Backbone of modern finance  Forecast relevant cash flows Forecast relevant cash flows  Calculate a figure of merit Calculate a figure of merit  Compare to company acceptance criteria Compare to company acceptance criteria Cf: Hewlett-Packard “Return Factor” Cf: Hewlett-Packard “Return Factor” ‘ ‘ $5 of Op Profit for $1 of R&D expense’ $5 of Op Profit for $1 of R&D expense’ [...]... Home Depot Source of Capital Proportion of Total Capital Cost of Capital Marginal Tax Rate After Tax Oppty Cost Contr To Weighted Avge Debt 8.3 4.7 38.2 2 .9 0.2 Equity 91 .7 9. 9 9. 9 9. 1 WACC 100.0 9. 3 WACC = D D + E Kd (1-Tm) + D E + Can you replicate the Opportunity Cost and the WACC? Ke E Valuation concepts    In the real market you create value by earning a return on invested capital that exceeds... 10%)  Answer = $0 .90 9   Check - Invest $0 .90 9 at 10% = $0 .90 9+ 090 9 = $1! Multiple Period Discounting    Use a Financial Calculator, or Use Tables (Present Value Table) Note: when cash flows are the same each year, they are known as “annuities” Net Present Value (NPV)     Use the cash flow from Container Loading Pier and calculate present value of future cash flows (= $ 49. 75M) (at 10% discount... cash flows (= $ 49. 75M) (at 10% discount rate) Investment = $40M Conclusion is that the company grows wealth of $9. 75M by investing in the Pier NPV is $9. 75M Benefit Cost Ratio (BCR)  A.k.a “Profitability index” BCR = Present Value of cash inflows Present Value of cash outflows Ex: Pier BCR = ( 49. 75)/($40) = 1.24 Internal Rate of Return (IRR)  Find the interest rate where PV of cash inflows equals PV...Cash Flows for Container Loading Pier $M  0 Cash Year Flow 1 2 3 4 5 6 7 8 9 10 ($40) 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 17 $17 $7.5 1 $40 2 3 Cash Flow Diagram 4 5 6 7 8 9 10 Time Value of Money     3 factors 1) Inflation 2) Certainty 3) Opportunity Cost Compounding F2 Single Period Compounding $1 F1=$1+(10%)($1) F1=... the growing perpetuity? 6 What is the formula for finding the value of a t-year growing annuity with growth rate g with the first payment of C one period from now? 7 Joe Williams has just taken out a $ 190 ,000 mortgage at an interest rate of 7% If the mortgage calls for 15 equal annual installments, what is the amount of each installment? 8 Suppose you have just won the lottery and must choose one of... effect of compounding Example 10% APR = 10.25% EAR if compounded every six months HW #1                       1 If the present value of $320 paid one year from now at date 1 is $ 290 , what is the one-year discount factor? 2 If the present value of $460 paid one year from now at date 1 is $430, what is the one-year discount rate? 3 Consider a perpetuity that pays $60 a year each... on invested capital that exceeds the opportunity cost of capital Growth creates more value as long as the return on capital exceeds the cost of capital The value of a company’s shares is based on the market’s expectations of future performance Risk Analysis Risk vs Return  2 questions……  1) What’s the rate of return?  2) Is the return sufficient to justify the risk Risk vs Return Expected Return... and flip a coin in one year to “either receive $50K or pay $10K”  2) Pay $10,000 today and receive $15K in one year  Diversification Portfolio Risk Unsystematic Risk Systematic Risk Interest Rates, Business Cycles etc 5 10 Number of Stock in Portfolio 15 Estimating Investment Risk  3 methods……  1) Sensitivity Analysis – use several potential returns (pessimistic; optimistic; most likely)  2) Scenario... risk OR use criteria for IRR that include the premium for risk CAPM  Capital Asset Pricing Model  The expected rate of return of a security equals the risk free rate plus the security’s Beta times the market risk premium  E(Ri) = rf + Bi [ E(Rm) - rf ] Note: [E(Rm) - rf] is common to all securities CAPM (2) Er Cisco General Mills 0.5 1.5 B (Systematic risk)