Firm valuation (2) Class 7 Financial Management,

Transcription

1 Firm valuation (2) Class 7 Financial Management,

2 Today Firm valuation x Free cashflows x Profitability, financial ratios, and terminal value Reading x Brealey and Myers, Chapter x Wilson Lumber Co.

3 Two approaches Firm valuation Focus on cashflows to equityholders Equity = PV of dividends Useful with moderate growth, constant payout ratio Focus on cashflows generated by assets Assets = PV of free cashflows More general, because cashflows may not be paid out Equity = assets debt 3

4 Balance sheet Assets Liabilities and Equity Current Assets Current Liabilities Long-Term Debt Fixed Assets 1. Tangible fixed assets 2. Intangible fixed assets Shareholders Equity Value = PV(FCFs) Value = Debt + PV(divs) 4

5 FCF approach Asset value PV of assets = FCF 1 1r FCF 2 (1 r) 2... FCF H (1 r) H Term. value H (1 r) Free cashflow Cash generated by the assets after all reinvestment FCF = EBIT (1 W) + depreciation 'NWC CAPX FCF = EBIT (1 W) 'Net assets FCF = Operating cashflow (before interest) CAPX 5

6 Working capital Assets Current assets cash accounts receivable inventory Long-term assets equipment buildings land intangibles Liabs. and equity Current liabilities accounts payable Long-term debt bank loans bonds Equity common stock retained earnings Net assets = Total assets current liabilities (excl. s-t debt) 6

7 Sustainable growth 16% 12% Cash deficits g > g* Plowback 70% Growth 8% Plowback 30% 4% 0% Cash surpluses g < g* 1.0% 5.0% 9.0% 13.0% 17.0% 21.0% 25.0% Return on equity 14

8 Forecasting Sustainable growth Long-run growth = sustainable growth Faster in the short run, but not forever Forecast must be internally consistent Growth forecasts should be consistent with payout policy and profitability CitiBank financial goals, 1988 Growth: 15% ROE: 18% Payout: 30% Leverage ratio (debt / assets): 95% Are these goals feasible? 15

9 Time Warner, 1989 Warner Communications ($ million) Cashflow projections Oper. income $ ,145 1,320 1,482 1,655 Taxes After-tax income Depreciation Deferred taxes CAPX ' in NWC Miscellaneous Free cashflow $ ,001 1,117 1,243 Source: Lazard Freres (advisor to Warner) 16

10 Firm valuation Discount rate = 11.5% Time Warner FCF 1 FCF 2 FCF 3 FCF H Term. value Firm value =... 1r (1 r) 2 (1 r) 3 (1 r) H (1 r) H ,243 T.V. = Equity value = Firm value Debt ($970 million) Terminal value three ways Constant growth Multiples (financial ratios of comparable firms) NPVGO 17

11 Terminal value 1 Constant growth Forecasted growth after 1994 = 5% 1,243 u Terminal value = FCF 1995 r g = $20,079 million Is the forecast internally consistent? Projected earnings = $993; projected book equity = $5,055 Reinvestment = CAPX Depr. + 'NWC = = $5 million g* = ROE u plowback = (993 / 5,055) u (-5 / 993) = 0% 18

12 Time Warner, 1989 Warner Communications ($ million) Cashflow projections Oper. income $ ,145 1,320 1,482 1,655 Taxes After-tax income Depreciation Deferred taxes CAPX ' in NWC Miscellaneous Free cashflow $ ,001 1,117 1,243 Source: Lazard Freres (advisor to Warner) 19

13 Financial ratios Multiples of comparable firms P/E ratio Price-to-cashflow Price-to-sales Market-to-book equity Determinants of P/E and M/B Terminal value 2 1 ª price º P/E u r «price NPVGO¼» payout M/B = (r / ROE) plowback Higher if NPVGO is large 20

14 350 P/E ratios, Dec Histogram All U.S. stocks P/E ratio 21

15 800 B/M ratios, Dec Histogram All U.S. stocks B/M ratio 22

16 Financial ratios Terminal value 2 P/E ratio Comparables P/E = 18 Earnings 1994 = 993 Terminal value = 18 u 993 = $17,874 M/B ratio Comparables M/B = 2.79 BV1994 = 5,055 Terminal value = 2.79 u 5,055 = $14,103 23

17 Zero NPVGO Terminal value 3 How much will Warner be worth if its competitive advantage is eliminated by 1994? (Sustainability question in strategy) NPVGO = 0 Value = EPS / r Earnings 1994 = 993 Terminal value = 993 / = $8,635 24

18 Debt = $970 million Time Warner ,243 T.V. Firm value = Terminal Firm Equity Per Approach Value Value Value Share Constant growth $20,079 P/E 17,874 M/B 14,103 Zero NPVGO 8,635 Actual offer = $70 / share $13,522 $12,552 $ ,374 11, ,412 9, ,566 6,

19 Time Inc. stock price, 1989 $ Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 26