Valuation Fundamentals Questions & Answers

Valuation Fundamentals Questions & Answers Steps to DCF Analysis 1. Calculate unlevered free cash flows 2. Calculate weighted average cost of capital 3. Calculate terminal value 4. Calculate enterprise value by determining present value of FCFs and terminal value 5. Solve for equity value and share price Calculating Unlevered Free Cash Flow EBITDA Proxy for operating CF -D&A Need to capture D&A tax shield -------- EBIT Operating Profit -Taxes LT effective tax rate * EBIT -------- NOPAT Net operating profit after taxes +D&A Add back non-cash expense -Capex Subtract fixed income +/-△ in OWC +/-△ in other Other operating items -------------- Unlevered FCF CF avail. to all capital providers WACC Formula [Ke x E / (D+E)] + [ Kd x (1 - T) x D/ D + E)] Ke = cost of equity Kd = cost of debt E = market value of equity D = market value of debt T = marginal tax rate Cost of Equity / CAPM Ke = Rf + [β * (Rm - Rf)] Ke = cost of equity Rf = Risk-free rate β = Beta Rm = market rate of return Rm - Rf = market risk premium Ke = required annual rate of return that a company's equity investors expect to receive Risk-Free Rate Rate on a "zero-risk" investment 10-year treasury note is used as a proxy Market Risk Premium Difference between expected return in equity markets and the frisk-free rate Additional return an investor needs for added risk of investing in equity Beta Measures a stock's reaction to movements in the equity market Beta of 1: expected return on stock = return on market portfolio Beta 1: expected return on stock return on market portfolio Beta 1: expected return on stock return on market portfolio Terminal Value Details Captures value of a company's steady state CF's after forecast period (60-80% of company value) Exit multiple method: -Assumes company is worth a multiple of an operating metric (typically EBITDA) - Use LTM Perpetuity Growth method: - Assumes company's FCF in last forecast year grows at a constant rate indefinitely - growth rate typically in 2-4% range. Should not exceed growth rate of the economy Calculating Terminal Value Exit Multiple: Multiple * Financial Metric n Perpetuity Growth: FCFn * (1+g) / (WACC - g) FCF = unlevered free cash flow n = terminal year of projection period g = perpetuity growth rate WACC = Weighted Average cost of capital