Advanced Corporate Finance Exercises Session 2 «From Accounting to FCF»

Transcription

1 Advanced Corporate Finance Exercises Session 2 «From Accounting to FCF» Professor Benjamin Lorent (blorent@ulb.ac.be) Teaching assistants: Nicolas Degive (ndegive@ulb.ac.be) Laurent Frisque (laurent.frisque@gmail.com) Frederic Van Parijs (vpfred@hotmail.com)

2 This session s Questions Session 2: Calculating Cash Flows All on The Brussels Hotel Holding company (BHHC) Focus on expansion, now via M&A, in Tongolville All in euro Q1: FCF: FCFE Q2: FCF: FCFF Q3: Accounting&FCF Computing and interpreting: BS, CF, FCFE & FCFF, P&L 2

3 Q1: Free Cash Flow to Equity: FCFE Story Questions: Story of session 1 Q4 continued: The Brussels Hotel Holding company (BHHC) in Tongolville Session 1: build 1 st hotel M&A: targeting acquisitions in leisure sector Equity participation in existing player Tax haven: 0% tax a) FCFE per year to t+6 b) Impact on FCFE if increased leverage DATA: for target Year t-1 EPS: 1.50 Depreciation t-1 : 0.30 (per share) CAPEX t-1 : 0.80 (per share) WCR: 0.20 (per share) Expected yearly growth for the next 5 Y: 15% δ=30% : Debt ratio: new financing at target! Tax rate=0% also for target! Payout = 0 => Dividend = 0$ After 5Y LT earnings growth: 5% WCR CAPEX = depreciation 3

4 Q1: From accounting to FCF: reminder Assets Fixed Assets Liabilities and owner equity Equity LT Debts Current Assets ST Debts Question(s) Can the WCR be negative? What can an increase in WCR signal? 4

5 Q1a: FCFE: getting started: step 1: t-1 Equity participation = FCFE step 1 c data for t-1 Year t -1 0 Comment 30% input! D = Debt 0,15? * to finance Net Assets of 0,50 C 0,35? ) * to finance D Net Assets EPS 1,50 see above FCFE 1,15 = EPS - capital requirement for Net Assets = 1,50-0,35 FCFE = EPS - amount needed to increase or = 1,15 BS or alternatively: Equity EPS - NFA - WCR + D = 1,50-0,5 + 0,15 5

6 Q1a: FCFE: getting started: step 2: t=0 FCFE = EPS C FCFE = EPS NA + D 6

7 Q1a: FCFE: getting started: step 3: until year 5 = t4 Step 3a until year 5 = t4 and Step 3b beyond yr5 Dif with between 3a and 3b = Capex = Dep Here capex +5% but technically no figure needed FCFE = EPS C FCFE = EPS NA + D 7

8 Q1a: FCFE: getting started: step 4: CF statement 8

9 Question: Q1b: FCFE: impact of change in leverage b) Impact on FCFE if increased leverage from 30% to higher Answer: No need for computation! The FCFE increases as the financing needs will be funded by extra debt Alternatively: less equity financing is needed and thus more is available to shareholders 9

10 Q2: Free Cash Flow to Firm: FCFF Story Q1 continued - The Brussels Hotel Holding company (BHHC) - in Tongolville - New CEO Mitchell Still M&A: BUT - Different sector - And most!: go for the whole company NEW: Tax: 50% Specific years now: 2010 => DATA: for target Questions: a) FCFF next 4 yrs b) Explain intriguing elements: impact? 1. Lawsuit 2. Goodwill write-off 10

11 Q2a: FCFF: getting started: step 1: 2010 Entire company = FCFF 11

12 Q2a: FCFF: getting started: step 1c: enlarged 12

13 Q2a: FCFF: getting started: step 2a: => year 4 13

14 Q2a: FCFF: getting started: step 2b: FCF Nopat = Net Operating Profit After Taxes = Noplat = Net Operating Profit less Adjusted Taxes Nopat = Noplat = After tax EBIT independent of financing 14

15 Q2b.1: FCFF: intriguing elements: Sunk costs 1) Charge already paid for a lawsuit ( ) Cash disbursement = (sunk cost) Idea is that sunk costs should not affect decision based on future cash flows E.g. if future of a project is less rosy, sunk costs should not lead to decision to continue Here future estimated cash flow are based on 2010 earnings 2010 earnings, and thus EBITDA & Nopat inlude a 1-off charge that should be considered exceptional and should not be included in the basis for estimating future cash flows adjustment needed Cash impact = costs & tax: so add back 100k and subtract tax (100k * 50%) = total of 50k 15

16 Q2b.2: FCFF: intriguing elements: Goodwill 2) amortisation charge for loss in goodwill There is no depreciation on Goodwill, only write-offs! 2010 depreciation of includes amortization which is not normal Should be added back to 2010 earnings through decrease depreciation charge (amortization was included so it needs to be excluded) Depreciation (& amortisation) should be = (instead of 2.000) In 2011, Dep = * 1,1 = Idea of adjustments Compute normalized earnings that reflect true state of bizz Always check cash nature of item Don t get lost in emotions and sunk costs! 16

17 Q3: Cash Flow & Accounting: FCFE & FCFF:computing and interpreting Story Question line Q1&2 continued - The Brussels Hotel Holding company (BHHC) - in Tongolville, CEO = Mitchell Still M&A:THE PROJECT - Different sector: cyclical retail - very thin margin - cash cycle is very important: WCR =crucial. Mixing accounting & cash flow: FCFE and FCFF Compute & interpreting Benchmarking for 1st time Specific years now: 2010 &

18 Q3: DATA Industry benchmark: EBIT margin of 5.84% EBITDA margin of 7.91% 18

19 BS: CF: FCF: P&L: Q3: Questions a) BS: draw summarized managerial balance sheet b) NWC: 1. Compute # and evolution 2. Analyze: what went wrong? c) cash-flow statement: compute for Direct method 2. Indirect method d) FCF Steadily acquire a majority stake e) FCF: Is it relevant to present a single year FCF? f) P&L: benchmarking 1. compare THE PROJECT to benchmarks in interpret the comparison g) P&L: discuss the merits of EBTIDA as cash proxy 19

20 Q3 a: BS 20

21 Q3 b: NWC Method 1: Current: An investment Method 2: Financing Method 3: WCR + Cash => Increase of the NWC, mainly due to increase in inventories and decrease in account payable. 21

22 Q3 c: CF statement: Formulas Difference is in calculating CFO: Indirect = Net Income (P&L) based = Indirect: NI + Dep WCR Change 22

23 Q3 c: CF statement Difference is in calculating CFO: Indirect = Net Income (P&L) based = Indirect: NI + Dep WCR Change 23

24 Q3 d & e: FCF 24

25 Q3 f: P&L: Benchmarking At very first sight it seems that the company is doing a good job in terms of profitability compared to its peers. However looking at the EBITDA metric it does not look so good. It seems that the D&A level is much lower compared to the industry. Questions to further investigate. Does the company correctly depreciate its assets? Could it jeopardise its future growth? 25

26 Q3 g: P&L: EBITDA Answer: The EBITDA measure does not take into account the WCR nor the need to invest and maintain productive capacity so it should not be used blindly. It is still a good proxy for operational cash generation, but not company cash generation Considerations - Capex tends to exceeds depreciation: to grow (not to mention maintain), inflation - Tax matters Consider using OpFCF: Operating FCF: pre or post-tax - Accounting manipulation: check changes in WCR: e.g. sudden increase in AR 26