Corporate Finance Theory

Transcription

1 Corporae Finance Theory I. Corporae Valuaion 1. Valuaion Approaches 2. Cos of Capial 3. Applicaion Issues II. Acquisiions, Divesiures, Resrucuring 1. M&A Aciviy and Explanaions 2. Defense acics

2 Inroducion Course maerial: Password: ( Corporae Finance Theory ) Conen: Lecure Slides Tuorials + Soluions ec. 2

3 Schedule Dae Time Conen Noe Tu. Oc 1 1: 13:3 Lecure Th. Oc 12 Fr. Oc 13 Tu. Oc 17 1: 13:3 Lecure Th. Oc 19 1: 13:3 Tuorial Fr. Oc :3 Tuorial Tu. Oc 24 1: 13:3 Lecure HKCF Th. Oc 26 1: 13:3 Tuorial Fr. Oc 27 12: 15:3 Tuorial Tu. Oc 31 Reformaionsag Th. Nov 2 Fr. Nov 3 Tu. Nov 7 1: 13:3 Lecure Th. Nov 9 1: 13:3 Tuorial Fr. Nov 1 12: 15:3 Tuorial Tu. Nov 14 1: 13:3 Lecure Th. Nov 16 1: 13:3 Tuorial Fr. Nov 17 12: 15:3 Tuorial Tu. Nov 21 1: 13:3 Lecure Th. Nov 23 17:45 21: Tuorial Fr. Nov 24 1: 13:3 Tuorial Tu. Nov 28 1: 13:3 Lecure Th. Nov 3 1: 13:3 Tuorial Q&A Session Fr. Dec 1 12: 15:3 Tuorial Q&A Session Sa. Dec 2 8:45 Final Exam 3

4 Lieraure CWS KGW Copeland/Weson/Shasri: Financial Theory and Corporae Policy, 4 h Ed., New York, 25. Koller/Goedhar/Wessels: Valuaion: Measuring and Managing he Value of Companies, 5h Ed., New York, 21. HHHLS HKM Heinrichs/Hess/Homburg/Lorenz/Sievers: Exended Dividend, Cash Flow and Residual Income Valuaion Models - Accouning for Deviaions from Ideal Condiions, 213, Conemporary Accouning Research, Vol. 3, p Hess/Kaul/Meuer: The Performance of Mechanical Earnings Forecass, 215, Working Paper. 4

5 Overview In his course we ask: (1) Wha is he value of a company or specific asses of his company? Why would we wan o know a all? Appropriae formulas? Required inpus? Obsacles & pracical problems? (2) Why would we wan o buy anoher company or is asses? How o generae value? Who profis? Invesor communicaion? (3) Wha o do if someone else wans o buy our company? Defend ourselves? Why? How o communicae? 5

6 Overview Why would we be ineresed in valuing a company or is specific asses? Corporae ransacions Purchase price in akeovers, mergers, acquisiions, Sraegic planning Idenify value drivers, enhance value, prepare a business for sale, Asse managemen Porfolio allocaion in privae equiy or public funds, insurance comp., Many regulaory purposes Fair value opinions for shareholders Allocaion of purchase price o specific asses, e.g. brand names Goodwill accouning Taxaion of inheriances, divorces, 6

7 Overview Main purpose of lecure: obain knowledge how o value companies General framework: Presen value of expeced fuure payoffs V = å = ( ) E X 1 (1 + k) Pracical problems: Forecas fuure payoffs over infinie horizon Esimae appropriae discoun rae Wha exacly is payoff? ( ) ( ) ( ) E X, E X, E X, k Ne Income, Dividend,... 7

8 Overview Earnings Scheme Sales Cos of Goods Sold Selling, General & Adminisraive Expense Depreciaion & Amorizaion = Operaing Profi afer Depreciaion Ineres & Relaed Expense + Non-operaing Income + Special Iems = Preax Income EBT Income Taxes Non-conrolling Ineres = Income before Exraordinary Iems + Exraordinary Iems + Disconinued Operaions = Ne Income NI 8

9 Overview Income Saemens Income Saemens of S&P 5 Firms (Average, in Mill. $) Sales/Turnover (Ne) 12,72 13,5 12,293 13,27 14,432 15,984 17,494 18,583 18,518 16,674 18,118 2,33 2,542 21,1 21,534 - Cos of Goods Sold 8,516 8,924 8,36 8,899 9,327 1,376 11,131 11,941 12,78 11,83 11,717 13,72 13,389 13,678 13,888 - Selling, Gen. & Admin. 1,617 1,736 1,72 1,887 2,176 2,36 2,526 2,718 2,89 2,761 2,871 3,47 3,153 3,183 3,317 - Depreciaion & Amorizaion ,5 1,52 Operaing Inc. afer Depr. 1,913 1,654 1,659 1,842 2,277 2,627 3,129 3,158 2,172 2,3 2,694 3,35 3,53 3,234 3,276 - Ineres and Relaed Expense , Nonoper. Income (Expense) Special Iems Preax Income 1, ,243 1,66 1,947 2,256 1,995 1,61 1,433 2,163 2,429 2,441 2,734 2,779 - Income Taxes Nonconrolling Ineres Income bef. Exraord. Iems ,68 1,33 1,515 1, ,492 1,722 1,657 1,934 1,939 + Exraord. Im. & Discon. Oper Ne Income (Loss) ,54 1,328 1,575 1, ,52 1,749 1,667 1,988 1,959 9

10 Overview Cash Flow Ne Income + Ineres Paymens Tax Shield (i.e. ax savings due o deducable ineres) = Ne Operaing Profi Less Adjused Taxes + Depreciaion (and oher non-cash cos componens) Capial Expendiures (i.e. invesmens in fixed asses) Ne Working Capial Increases = Free Cash Flow + Tax Shield Ineres Paymens + Change in Deb ( Deb Redempions, + New Deb Issued) = Flow o Equiy 1

11 Overview Cash Flow Cash Flows o Equiy of S&P 5 Firms (Average, in Mill. $) Ne income ,54 1,328 1,575 1, ,52 1,749 1,667 1,988 1,959 + Depreciaion & Amorizaion ,5 1,52 CAPEX ,28-1, ,149-1,268-1,293-1,396 Acquisiions Oher Long-erm Invesmens , ,254-1,29-1, ,14-1,171-1,2 Dela Working Capial , Change in Deb ,285 1, , Oher Financing , FTE ,32 1,227 1, ,391 1,84 1,499 1,572 11

12 Overview Income vs. Cash Flow Ne Income and Cash Transfers o Shareholders Average S&P 5 Firm (in Mill. $) Ne Income ,54 1,328 1,575 1, ,52 1,749 1,667 1,988 1,959 FTE ,32 1,227 1, ,391 1,84 1,499 1,572 Cash Dividends Share Buybacks New Issuances Dividends & Subsiues ,229 1, ,24 1,182 1,394 1,651 Payou Raio (Cash only) 31% 78% 441% 34% 34% 36% 3% 42% 9% 47% 3% 29% 35% 34% 38% Payou Raio (incl. Subs.) 49% 15% 672% 53% 56% 71% 78% 19% 69% 58% 52% 69% 71% 7% 84% 12

13 I. Corporae Valuaion 1. Valuaion Approaches 1.1. Fundamenal Valuaion Principle 1.2. Muliples 1.3. Discouned Cash Flow 1.4. Residual Income Model 2. Cos of Capial 3. Applicaion Issues II. Acquisiions, Divesiures, Resrucuring Lieraure: Copeland/Weson/Shasri (25), Ch

14 1.1. Fundamenal Valuaion Principle Fundamenal Valuaion Principle Presen Value The value of any securiy is solely deermined by is expeced fuure paymens X o he holder of he securiy over is enire life ime T V = T å = ( ) E X 1 (1 + k) where k is he appropriae discoun rae, i.e., he reurn invesors require considering he riskiness of paymens. 14

15 1.1. Fundamenal Valuaion Principle V = T å = ( ) E X 1 (1 + k) This is applicable o wide range of securiies, for example, Bonds: X more or less secure fuure coupon and redempion paymens T fixed repaymen dae Socks: X uncerain fuure cash paymens o shareholders, i.e., expeced dividends or dividend subsiues T= uncerain life of he company, in principle, infinie horizon Opions: X uncerain proceeds from exercising he opion, e.g., difference beween fuure sock price and srike price T fixed expiraion dae 15

16 1.1. Fundamenal Valuaion Principle Dividend Discoun Model EQ = å = ( ) E D 1 (1 + k) Infinie horizon problem T= Assuming ha dividends grow a a consan growh rae g, i.e., 1 g, leads o he sandard Gordon Growh Model = 1 + EQ D k - g = 1 g D1 k - g Remember å = 1 (1 + g) 1 + g = (1 + k) k - g 16

17 1.1. Fundamenal Valuaion Principle Exercise: Daa/Assumpions Expeced Earnings per Share Expeced Dividend per Share (o be paid a =1) Expeced long erm growh Required rae of reurn 1,5 USD 1,5 USD 3% 1% Wha is he fair value of he sock? 1 1 = = 1.5 = EQ D1 k g Wha would be he fair value wih zero growh? 1 1 = = 1.5 = EQ D1 k 17

18 1.1. Fundamenal Valuaion Principle Dividend Discoun Model Insead, if we assume ha dividends do no grow righ away (i.e., from ime = on) bu ha consan growh kicks in a a laer poin in ime (i.e., from ime T on) we ge a 2-phase version of he Gordon Growh Model EQ ( ) T E D å D T + 1 = 1 k 1 1 = + (1 + ) k - g (1 + k) T 1 s phase Individual dividend forecass 2 nd phase Consan dividend growh 1 2 T T+1 T+2 T

19 1.1. Fundamenal Valuaion Principle Exercise: Daa/Assumpions Analys Esimaes (EPS) =1 1,5 USD =2 2,1 USD Hisorical payou raio 3% Required rae of reurn 1% Assumed long erm growh 3% Find he fair value according o DDM! V T D D T + 1 = å + T = 1 (1 + k) (1 + k) ( k -g) Earn p Sh payou raio Div p Sh PV Earn p Sh payou raio Div p Sh PV 3% 3% 1 1,5 3%,45,41 1 1,5 2 2,1 3%,63,52 2 2,1 3 2,16 3%,6489 7,66 3 8,59 19

20 I. Corporae Valuaion 1. Valuaion Approaches 1.1. Fundamenal Valuaion Principle 1.2. Muliples 1.3. Discouned Cash Flow 1.4. Residual Income Model 2. Cos of Capial 3. Applicaion Issues II. Acquisiions, Divesiures, Resrucuring Lieraure: Copeland/Weson/Shasri (25), Ch. 14 Koller/Goedhar/Wessels (21), Ch. 14 2

21 1.2. Muliples Basic Idea: Some (arge) company is valued based on curren marke prices of oher companies wih similar characerisics (comparable company approach) Assessmen is based on financial daa relaed o company s (fuure) profiabiliy, e.g., (expeced) Ne Income, EBIT, EBITDA, 21

22 1.2. Muliples Main Versions: Comparable Company Approach (sock marke oriened) Oher Comparison Mehods (no focused on sock marke) Similar Public Company Mehod Share price in relaion o cerain key financial daa of an enerprise Recen Acquisiion Mehod Prices of recen public ransacions in relaion o cerain key daa of an enerprise Sales Mehod e.g. deermine corporae value based on sales Oher Quaniaive Comparisons e.g. value a axi company based on number of axi licenses Muliples 22

23 1.2. Muliples Basic procedure: 1. Selec a peer group Try find many companies wih similar characerisics (especially companies ha are similar w.r.. value drivers, i.e., profi growh, operaive risk, leverage, payou, ) 2. Calculae cerain muliple(s) for he peer group companies Muliple Marke value Comparison value Calculae average / median muliple for he peer group 3. Apply average muliple(s) o arge company Marke value Average muliple Comparison value 23

24 1.2. Muliples In pracice, los of differen muliples are used Typical denominaors : Earnings (wih various definiions: NI, EBIT, EBITDA, Earnings excl. special iems, ) Cash Flows Sales figures Book value of equiy Typical numeraors: enerprise value (= marke value of equiy + deb) equiy value (= marke value of equiy alone) 24

25 1.2. Muliples Example: The many differen definiions of earnings and heir impac on PER The firs sep when discussing a valuaion based on a muliple is o ensure ha everyone is using he same definiion for ha muliple 25

26 1.2. Muliples Caerpillar (in mill. $) Cash and Shor-Term Invesmens 6,322 7,476 PER SHARE FIGURES Toal Curren Asses 38,335 38,867 Toal Asses 84,896 84,681 Asses per Share Toal Liabiliies 64,18 67,855 Book Deb per Share Sockholders Equiy 2,878 16,826 Book Equiy per Share Liabiliies and Sockholders Equiy 84,896 84,681 Sales 55,656 55,184 Sales per Share Cos of Goods Sold 37,646 36,67 Gross Profi (Loss) 18,1 18,577 Selling, General and Admin. Expense 7,593 7,832 Operaing Income before Depreciaion 1,417 1,745 EBITDA per share Depreciaion and Amorizaion 3,81 3,16 Operaing Income afer Depreciaion 7,336 7,585 EBIT per Share Ineres & Relaed Expense 1,192 1,18 Nonoperaing Inc., Special Iems, Oher -1,8-1,37 Income Taxes 1,319 1,38 Ne Income (Loss) 3,789 3,695 NI per Share Sock Price ($, fiscal year end) Equiy Value (per Share) Common Shares Ous. (mill., fisc yr end) Enerprise Value (per Share) Given Caerpillars las annual financial informaion, wha would be reasonable muliples? P/E-Raio (NI) Enerprise Value / EBIT Enerprise Value / EBITDA Enerprise Value / Sales Marke o Book

27 1.2. Muliples I/S B/S Deb & Equiy Equiy alone Sales operaing coss EBITDA Deprec. & Amorizaion EBIT Ineres expense EBT Taxes Ne Income Curren Asses Fixed Asses Toal Asses Curren Liabiliies Long-erm Liabiliies Toal Liabiliies Shareholders Equiy Toal Liabiliies & Shareholders Equiy 27

28 1.2. Muliples Muliples based on eniy value (Enerprise- / Eniy- / Asse-Value-Muliples) Muliples based on equiy value (Equiy-Muliples) applied marke prices: Eniy value (aggregaed marke price of equiy and deb) non-operaing asses = Enerprise value (Marke value of operaing business aciviy) applied reference value : should be generaed by oal capial, e.g., EBIT, EBITDA, Oper. Cash Flow, Sales, EnV EnV EnV EBITDA EBIT Sales Applied marke values: Equiy value (marke capializaion) applied reference value: should be relaed o equiy (e.g. earnings, EBT, equiy book value, FTE, ) Price Equiy book value / Share Price Earnings / Share However, also muliples using oal capial based denominaor and equiy based numeraor, e.g. Marke capializaion Sales 28

29 1.2. Muliples Theoreical foundaion of P/E raio PER P NI wih P NI marke price per share ne income per share Saring poin DDM: P D 1 (1 k) wih D k dividend per share risk adjused ineres rae 29

30 1.2. Muliples Assume ha payou raio p is fixed, i.e., D = p NI, hen P = å = 1 D (1 + k) = å = 1 p NI (1 + k) Moreover, assume ha ne income (and dividend) grows a a consan rae g, hen 1 + g P = p NI k - g Then he P/E raio is P 1 + g = p NI k - g 3

31 1.2. Muliples P 1 + g = P/ E raio = p NI k - g Hence, he P/E raio depends on he companies risk adjused discoun rae k or he company s expeced risk he (expeced) growh rae of earnings g he (expeced) payou raio p So, company valuaion based on P/E raios only makes sense if he peer group has very similar risk, growh and payou characerisics Can we assume ha his is given wihin an indusry? 31

32 1.2. Muliples Theoreical foundaion of muliples (cond.) Price o sales raio PS / = P S Subsiue NI = pm S ino he P/E raio (wih pm = profi margin) P P 1 + g = = p NI pm S k -g Then, we ge he price sales raio as P 1 + g = pm p S k - g 32

33 1.2. Muliples Theoreical Foundaion of muliples (cond.) Price o book raio: Subsiue NI = RoE BV ino he P/E raio P P 1 + g = = p NI RoE BV k -g wih RoE = reurn on equiy BV = book value of equiy Then we ge he price o book raio as P 1 + g = RoE p BV k - g 33

34 1.2. Muliples Some Empirical Findings P/E Raios of S&P 5 firms based on las available financial saemens: FY 214 P/E Raio P/E Raio Sd RoE (las 1 years) Average Payou Raio (las 1 years) 34

35 1.2. Muliples Price / NI per Share (S&P 5, 5%-95% Fracile, ) Enerprise Value / EBITDA per Share (S&P 5, 5%-95% Fracile, ) 35

36 1.2. Muliples Price / NI per Share (only S&P 5 companies wih reasonable P/E raios, 214) Enerprise Value / EBITDA per Share (only S&P 5 companies wih reasonable EV/EBITDA raios, 214) 36

37 1.2. Muliples Summary Valuaion based on muliples is widely applied in pracice Advanages: Muliples are easy o apply and deliver quick resuls Muliples require only a few easily available daa (marke prices, company daa), calculaion as well very easy Easy o undersand and o communicae Concep is (seemingly) easy o undersand for cliens, press and by comparison easy o communicae Close o marke valuaion Valuaion based on curren marke prices reflecing how he marke prices similar asses Sound heoreical foundaion Close relaion o DDM value drivers (hough ofen only proxies used) 37

38 1.2. Muliples Summary Disadvanages: Empirical Resuls somewha disappoining weak relaion o value driver proxies; exreme values; wide flucuaions Imporan o be precise in definiion of muliple Muliples coming under same name may be defined differenly Difficul o selec appropriae peers especially if peers differ w.r. value drivers (growh, risk) One-dimensional comparison valuaion is based on one single corporae key financial (e.g., EBIT or sales); saisical analysis beneficial (e.g., regression o accoun for value drivers) Muliples provide only relaive valuaion problemaic if marke / peer group is overvalued; self-reinforcing in ho markes 38

39 I. Corporae Valuaion 1. Valuaion Approaches 1.1. Fundamenal Valuaion Principle 1.2. Muliples 1.3. Discouned Cash Flow 1.4. Residual Income Model 2. Cos of Capial 3. Applicaion Issues II. Acquisiions, Divesiures, Resrucuring Lieraure: Copeland/Weson/Shasri (25), Ch. 14 Koller/Goedhar/Wessels (21), Ch. 2, 6 39

40 1.3. Discouned Cash Flow Model overview Sandard approach o calculae he fair value of companies: V = å = ( ) E X 1 (1 + k) where X is some expeced payoff (e.g., Dividends, Free Cash Flow, Cash Flow o Equiy, Residual Income, ) and k is a risk-adjused discoun rae, e.g., obained via he CAPM: ( ) k = r + b E ér ù ë û -r f m f This discoun rae may be adjused for he firm s leverage and is ax siuaion. 4

41 1.3. Discouned Cash Flow Major model ypes Dividend Discoun Model EQ = å = ( ) E D 1 (1 + k) Discouned Cash Flow Model (e.g. WACC Model) EQ + Deb = å = ( ) E FCF 1 (1 + WACC ) Residual Income Valuaion Model (Ohlson Model) EQ = BookValue + å = ( ) E ResInc 1 (1 + k) 41

42 1.3. Discouned Cash Flow Required inpus: 1. Esimae expeced uncerain payoffs X of a company for year 1, 2, e.g., dividend, free cash flow, flow o equiy, residual income, 2. Deermine relevan risk-adjused rae of reurn, e.g. k, WACC, Noe: numeraor and denominaor mus fi ogeher 42

43 1.3. Discouned Cash Flow Cash Flow Scheme Ne Income + Ineres paid (a) + Taxes paid = Earnings before ineres and axes (EBIT) Taxes on EBIT (= axes paid + ax shield) (b) = Ne Operaing Profi Less Adjused Taxes (NOPLAT) + Depreciaion and oher non-cash expendiures (c) Invesmens in angible/inangible asses (CapEx) (d) Working capial increases (e) = Free Cash Flow (FCF) + Tax shield = Toal Cash Flow (TCF) Gross Cash Flow (heoreical 1% equiy-financing) Gross Cash Flow (considers acual deb financing) Ineres & deb service (f) = Flow o Equiy (FTE) Ne Cash Flow (considers acual deb financing) 43

44 1.3. Discouned Cash Flow Commens (a) Ineres expense Only explici ineres or also implici ineres? (b) Taxes on EBIT = Taxes payable if company would have no deb = Taxes acually paid + Tax Shield (i.e., savings due o deducible ineres) (c) non-cash expendiures Depreciaion (I/S) Amorizaion (I/S) Addiions o provisions (I/S) non-cash income Revaluaions (if in I/S) Release of provisions (I/S) (d) Invesmen payous: Invesmens in fixed asses, inangible asses and long-erm financial asses 44

45 1.3. Discouned Cash Flow Commens (e) Decrease/increase in working capial Δ WC = Δ Curren Asses Δ Curren Liabiliies = Δ cash + Δ Invenories + Δ accouns receivables + Δ securiies + Δ prepaymens received Δ accouns payables Δ noes payable Wha abou excess cash? (f) Deb service = Ne redempion of deb = Deb repaymens Deb issuance 45

46 1.3. Discouned Cash Flow Differences beween FTE and Dividend? FTE no paid ou enirely bu some par reinvesed, e.g., o faciliae more growh? 46

47 1.3. Discouned Cash Flow Cash Flow Scheme Shorcus Ne Income + Ineres Tax Shield + Depreciaion CapEx Δ Working Capial Ne Income + Depreciaion CapEx Δ Working Capial = Free Cash Flow + Ne Change in Deb ( Redempions + Issuances) = Flow o Equiy 47

48 1.3. Discouned Cash Flow Example: We have he following projeced financial saemens 1 Curren Asses Fixed Asses Toal Asses Curren Liabiliies Long erm Liabiliies Comon Sock Re Earn Equiy Liab. & Equiy Sales 1,. 1,5. CoGS Depreciaion EBIT Ineres EBT Taxes Ne Income

49 1.3. Discouned Cash Flow 1 Curren Asses Fixed Asses Toal Asses Curren Liabiliies Long erm Liabiliies Comon Sock Re Earn Equiy Liab. & Equiy Sales 1,. 1,5. CoGS Depreciaion EBIT Ineres EBT Taxes Ne Income Tax rae s = 3% From his we can calculae FCF and FTE as = 1 = 1 Ne Income Ne Income In. Paid Tax Shield Depreciaion 5. +Depreciaion 5. CapEx 75. CapEx 75. WC Increas 9. WC Increas 9. +Change in Deb 15. FCF 39.5 FTE

50 1.3. Discouned Cash Flow Infinie horizon problem V = å = 1 ( ) E X (1 + k) Valuaion equaions require payoff forecass over an infinie horizon Soluions (1) Growh models Assume ha fuure payoffs grow a some average rae g (2) Two- or hree-phase models g X = X (1 + g) Assume ha equilibrium growh kicks in laer when firm is more maure ( I.3. Applicaion Issues) g å = 1 (1 + k) (1 + ) 1 + g V = X = X k - g 5

51 1.3. Discouned Cash Flow DCF Model Varians V = å = ( ) E X 1 (1 + k) Equiy approach V X k Flow o Equiy (FTE) Equiy EQ FTE FTE Cos of equiy (levered) k s L Eniy approaches Weighed Average Cos of Capial (WACC) Toal capial EQ + Deb FCF FCF Cos of oal capial WACC s Adjused Presen Value (APV) Toal capial EQ + Deb FCF FCF Tax shield s i Deb -1 Cos of equiy (unlevered) k s Risk-free ineres rae i 51

52 1.3. Discouned Cash Flow (1) Adjused Presen Value (APV) Model EQ FCF s i Deb- 1 = å + å -Deb = 1(1 + ks ) = 1 (1 + i) FCF s i Deb -1 Free cash flow (o shareholders and lenders) afer deducing heoreical axes (i.e., ignoring ax shield) ax shield (no included in he FCF) k s Shareholders required reurn if firm would have no deb (i.e., ignoring acual leverage) i required rae of reurn on risk-free ax shield Valuaion resul: Eniy value! 52

53 1.3. Discouned Cash Flow (2) Flow o Equiy (FTE) Model EQ = å = FTE 1 (1 + ks ) L FTE Cash flow o equiy afer deducing acual axes (i.e., accouning for ax shield) k s L Shareholders required rae of reurn (i.e., accouning for leverage L and ax s) L Deb ks = ks + ( ks -i) (1 -s) EQ Valuaion resul: Equiy value! 53

54 1.3. Discouned Cash Flow (3) WACC Model EQ FCF = å 1 (1 ) -Deb = + WACCs FCF Free cash flow (o shareholders and lenders) afer deducing heoreical axes, (i.e., ignoring ax shield) WACC s Weighed average cos of capial (accouning for ax effecs s, which were negleced in cash flow) L EQ Deb WACCs = ks + i (1 -s) EQ + Deb EQ + Deb Valuaion resul: Eniy value! 54

55 1.3. Discouned Cash Flow Consan payoff growh versions... g > FTE: EQ = å = 1 FTE L s (1 + k ) = FTE k L s 1 - g WACC: EQ FCF = å - Deb = 1 (1 + WACCs ) FCF1 = - WACC - g s Deb APV: EQ FCF s i Deb- 1 = å + å -Deb = 1(1 + ks ) = 1 (1 + i) FCF1 s i Deb = + -Deb k - g i - g s 55

56 1.3. Discouned Cash Flow Example: We have he following projeced saemens = 1, 2, 3, Curren Asses 1,1 1,1 Fixed Asses 2,5 2,5 Toal Asses 3,6 3,6 Curren Liab. 1 1 Long erm Liab. 1,5 1,5 Comon Sock 1,7 1,7 Re Earn 2 2 Equiy 1,9 1,9 Liab. & Equiy 3,6 3,6 = 1, 2, 3, Sales 5, 5, CoGS 4,15 4,15 Depreciaion EBIT 6 6 Ineres 6 6 EBT Taxes Ne Income There is no growh (g = ). The firm pays 4% p.a. on is deb (i = 4%) and 3% axes (s = 3%). If he firm would have no deb is cos of equiy would be 1% (k s = 1%). 56

57 1.3. Discouned Cash Flow From he projeced saemens we ge FCF and FTE as = 1, 2, 3, = 1, 2, 3, NI 378. NI In. Paid 6. Tax Shield Depreciaion Depreciaion 25. CapEx 25. CapEx 25. WC Increase. WC Increase. + Change in Deb FCF 42. FTE 378. Noe: wih no growh we have Depreciaion = CapEx FCF = EBIT (1 s) FTE = NI 57

58 1.3. Discouned Cash Flow APV: EQ FCF s i Deb 1 = + - Deb ks - g i - g 42 3% 4% 15 = = 315 1% 4% FTE: L s s s k = k + ( k -i) (1-s) Deb EQ = 1% + (1% - 4%) (1-3%) = 12% EQ FTE1 378 = = = 315 L k 12% s WACC: L EQ Deb WACCs = ks + i (1 -s) EQ + Deb EQ + Deb = 12% + 4% (1-3%) = 9.323% EQ FCF 42 = - = - 15 = % 1 Deb L ks 58

59 1.3. Discouned Cash Flow Noes: If correcly applied, APV, WACC and FTE model yield idenical values! However, FTE and WACC model require o know he firm s leverage in order o calculae appropriae cos of capial. Bu o calculae leverage one needs o know he marke value of equiy! This is called he Circulariy Problem. ( I.3 Applicaion Issues) 59

60 I. Corporae Valuaion 1. Valuaion Approaches 1.1. Fundamenal Valuaion Principle 1.2. Muliples 1.3. Discouned Cash Flow 1.4. Residual Income Model 2. Cos of Capial 3. Applicaion Issues II. Acquisiions, Divesiures, Resrucuring Lieraure: Copeland/Weson/Shasri (25), Ch. 14 6

61 1.4. Residual Income Model Residual Income Model (RIM) or Economic Value Added (EVA) Basic model: EQ = BkEQ + å = 1 E ( ResInc ) L s (1 + k ) Marke Value of equiy EQ = Book Value of equiy BkEQ + Presen value of residual incomes PV(ResInc 1, ResInc 2, ) Residual Income = Ne Income above ResInc = NI k sl BkEQ -1 invesors earnings demands (i.e. above required reurn on equiy) 61

62 1.4. Residual Income Model Deducing RIM from DDM (or alernaively from FTE) EQ = å = 1 E( D ) (1 + k) (I) wih D oal dividend paymens of he company (ne ransfer o shareholders) E(D ) expeced dividend paymens in = k risk adjused ineres rae (k k sl ) 62

63 1.4. Residual Income Model Alernaive deducion from FTE (since DDM and FTE are idenical) Main assumpion Cash Flow o Equiy of he FTE-approach is disribued enirely Dividends D = Ne ransfers o shareholders (Dividends + Share buybacks, Increase of capial = negaive dividends) = Cash Flow o Equiy (FTE ) Under he assumpion of complee disribuion, he DDM-model uses he same numeraor as he FTE-approach (D = FTE ) Consequenly he discoun rae has o be he same: k = k F s Hence DDM and FTE are idenical! 63

64 1.4. Residual Income Model Clean Surplus Relaion (principle of congruence) Any value changes in asse and liabiliies mus be passed hrough income saemen! No I/S independen recording in equiy posiion ( diry surplus accouning ) Book value of equiy a he beginning of fiscal year BkEQ -1 + Ne income NI + Dividends (including all shares) Capial increases Ne capial ransfer o shareholder D = Book value of equiy a he end of fiscal year BkEQ Clean Surplus Relaion: BkEQ = BkEQ -1 + NI D 64

65 1.4. Residual Income Model Clean Surplus Relaion: BkEQ = BkEQ -1 + NI D (II) According o clean surplus accouning he book value of equiy can only change due o ne income and capial ransfers o shareholders (dividends) or from shareholders (capial increase) Oher changes of he book value of equiy which are no passed hrough income saemen are called diry surplus accouning, e.g. revaluaions no impacing ne income, differences from foreign exchange conversion, issuance of employee shares, 65

66 1.4. Residual Income Model Solving Clean Surplus Relaion (II) for D : D = NI - ( BkEQ - BkEQ - ) 1 change in book value of equiy and insering ino (I) EQ = å = 1 E( D ) (1 + k) yields EQ = å = 1 E ( NI - BkEQ + BkEQ ) -1 (1 + k) (III) Hence, he marke value of equiy can be expressed exclusively in erms of financial saemen iems (i.e., ne incomes and book values of equiy) 66

67 1.4. Residual Income Model For noaional simpliciy drop he expecaions operaor, i.e., EQ = å = NI - BkEQ + BkEQ -1 1 (1 + k) (III) inser k BkEQ -1 k BkEQ -1 = EQ = å = 1 NI - BkEQ + BkEQ -1 (1 + k) = å = 1 é NI - BkEQ + BkEQ + k BkEQ -k BkEQ êë (1 + k) ù úû rearrange his equaion slighly EQ ébkeq + k BkEQ NI -k BkEQ BkEQ = å + - = 1 êë (1 + k) (1 + k) (1 + k) ù úû é(1 + k) BkEQ NI -k BkEQ BkEQ = å + - = 1 êë (1 + k) (1 + k) (1 + k) -1-1 ù úû 67

68 1.4. Residual Income Model expand he sum EQ é(1 + k) BkEQ NI -k BkEQ BkEQ = å + - = 1 êë (1 + k) (1 + k) (1 + k) -1-1 ù úû (1 + k) BkEQ NI -k BkEQ BkEQ (1 + k) BkEQ NI -k BkEQ BkEQ = (1 + k) (1 + k) (1 + k) (1 + k) (1 + k) (1 + k) simplify (1+k) erms (1 + k) BkEQ NI1 -k BkEQ BkEQ (1 + k) BkEQ NI -k BkEQ BkEQ = (1 + k) (1 + k) (1 + k) (1 + k) (1 + k) (1 + k) and cancel ou BkEQ erms NI1 -k BkEQ BkEQ1 BkEQ1 NI2 -k BkEQ1 BkEQ2 = BkEQ (1 + k) (1 + k) (1 + k) (1 + k) (1 + k) 68

69 1.4. Residual Income Model The remaining erms are: EQ NI -k BkEQ NI -k BkEQ BkEQ (1 + k) (1 + k) (1 + k) = BkEQ T T Assuming ha BkEQ (1 + k) T T we ge EQ NI -k BkEQ NI -k BkEQ (1 + k) (1 + k) = BkEQ EQ = BkEQ + å = 1 NI -k BkEQ (1 + k) -1 (IV) 69

70 1.4. Residual Income Model Insering he definiion of Residual Income ino (IV) ResInc = NI - k BkEQ - 1 Residual- Income Ne income of period adequae rae of reurn on equiy (V) finally yields he Residual Income Model: EQ = BkEQ + å = ResInc 1 (1 + k) (VI) Fair value of equiy Curren book value of equiy Presen value of expeced fuure residual incomes (= Goodwill) 7

71 1.4. Residual Income Model Inerpreaion: EQ = BkEQ + å = ResInc 1 (1 + k) Residual income represens he income in excess of shareholders required (risk adjused) reurn on book equiy ResInc = NI - k BkEQ - 1 If a company only generaes he reurn shareholders require (i.e., k) hen he marke value equals he book value of equiy EQ = BkEQ If a company is able o generae a higher reurn han wha shareholders require, i generaes addiional value, i.e., i adds economic value for shareholders. å = 1 ResInc (1 + k) > The erms abnormal earnings, excess earnings or economic value added are synonymously used for residual income. 71

72 1.4. Residual Income Model Example (cond.): = 1, 2, 3, Curren Asses 1,1 1,1 Fixed Asses 2,5 2,5 Toal Asses 3,6 3,6 Curren Liab. 1 1 Long erm Liab. 1,5 1,5 Comon Sock 1,7 1,7 Re Earn 2 2 Equiy 1,9 1,9 Liab. & Equiy 3,6 3,6 = 1, 2, 3, Sales 5, 5, CoGS 4,15 4,15 Depreciaion EBIT 6 6 Ineres 6 6 EBT Taxes Ne Income g =, s = 3%, i= 5%, k s = 1%, k sl = 12% L 1 1 s ResInc = NI - k BkEQ = % 1,9 = 15 EQ ResInc1 15 = BkEQ + = 1,9 + = 5,15 L k 12% s 72

73 1.4. Residual Income Model Noe: If correcly applied, he Residual Income Model yields he same value as APV, WACC or FTE In he example, residual income is posiive, i.e., he company is earning a higher reurn on is book equiy han invesors require: RoE 1 NI1 378 = = = BkEQ 1, % Therefore, he company is more worh han is ne asse book value, i.e., he book value of equiy 73

74 1.4. Residual Income Model Exensions of basic model: Ohlson (1995) Residual income follows AR(1) process wihou drif If a company is able o generae a residual income, ha income should gradually be decreasing as compeiion ses in. Oher companies will ry o imiae an above average business model, if he company is no able o proec i (hrough paens, enry barriers ) Ohlson/Jüner-Nauroh (25) Inroducion of alernaive excess profi dynamic (eps growh) 74