Summary Corporate Valuations
,Table of Contents
Lecture 1 Principles of Value Creation .................................................................... 7
Valuation Myths ............................................................................................................7
1.1 Principles of Valuation .......................................................................................8
DCF Valuation .................................................................................................................................. 8
1.2 Growth and ROIC ...............................................................................................8
Managerial Implications ................................................................................................................. 10
Relationship growth and ROIC ........................................................................................................ 10
1.3 The Company as a growing Perpetuity .............................................................. 10
Key Value Drivers ............................................................................................................................ 11
What drives Value? ......................................................................................................................... 11
1.4 ROIC and Competitive Advantages ................................................................... 12
Long-run ROIC = Sustainable Competitive Advantage .................................................................... 12
Sources of Competitive Advantage ................................................................................................. 13
Sustainability ................................................................................................................................. 14
Lecture 2 Frameworks for Valuation ..................................................................... 17
Introduction on Company Valuation ............................................................................ 17
Conceptual Model .......................................................................................................................... 18
How does a corporation generate value? ........................................................................................ 18
Price vs Value ................................................................................................................................. 18
Variations on DCF........................................................................................................................... 19
A Typical Valuation Process ......................................................................................... 19
Steps in DCF Method 1 ................................................................................................ 22
Forecast vs Terminal Value Period .................................................................................................. 23
Deriving Enterprise FCF .................................................................................................................. 23
Proxies Enterprise FCF ................................................................................................................... 24
Introducing the Residual Income Model Method 2........................................................ 25
Deriving Residual Income: Still needs to be DISCOUNTED ............................................................. 27
Example DCF .............................................................................................................. 28
Example RI model .......................................................................................................................... 30
Valuation Multiples Method 3 ...................................................................................... 31
Enterprise vs Equity Multiples ......................................................................................................... 31
Market Based View of Enterprise Value ........................................................................................... 32
Investor derived view of enterprise value ........................................................................................ 33
Applying Target Multiples ................................................................................................................ 34
Adjusted Present Value (NPV) Method 4 ....................................................................... 35
Workshop 1.......................................................................................................... 38
ROIC/ WACC vs Valuation ........................................................................................... 38
Deriving NOPAT ........................................................................................................... 39
, Decomposing Return on Invested Capital .................................................................... 39
Drivers of Returns ....................................................................................................... 40
ROIC vs RONIC............................................................................................................ 40
ROIC Alternatives ....................................................................................................... 41
Types of Expenses ....................................................................................................... 43
Sanity Checks ............................................................................................................. 43
Lecture 3 Terminal Value ...................................................................................... 46
3.1 Patterns of Growth ........................................................................................... 46
Sustaining Growth and Product Life Cycles .................................................................................... 46
Growth Pattern ............................................................................................................................... 47
Sustainability of Growth and ROIC.................................................................................................. 49
3.2 Continuing value: Key value drivers .................................................................. 50
Continuing Value ............................................................................................................................ 50
1. Key value driver formula......................................................................................................... 51
Continuing value and ROIC ............................................................................................................ 52
3.3 Continuing Value: Economic Profit ................................................................... 53
Comparison KVD and Ecoonomic-Profit CV.................................................................................... 57
3.4 Subtleties and pitfalls of coninuing value ......................................................... 58
How growth affects continuing value .............................................................................................. 58
Common Pitfalls: Naïve Base-Year Extrapolation ............................................................................ 61
Common Pitfalls: Overconservatism .............................................................................................. 61
Closing Thoughts ........................................................................................................ 62
Lecture 4 Reorganizing the Financial Statements, including capitalization of R&D
expenses and operating leases ............................................................................ 63
Overview .................................................................................................................... 63
Accounting Misclassifications ..................................................................................... 64
Misclassification 1: R&D ................................................................................................................. 65
Misclassification 2: Operating Leases............................................................................................. 67
Adjustments for non-recurring items .............................................................................................. 73
Adjustments for income from investments and divestitures ........................................................... 74
Capital and Equity reinvested in the firm......................................................................................... 75
Lecture 5 Cost of Capital ...................................................................................... 76
5.1 Cost of Capital ................................................................................................. 76
Cost of Equity ................................................................................................................................. 76
5.2 CAPM .............................................................................................................. 76
Risk-Free Rate: 10-Year Local Treasury ........................................................................................... 77
The Market Risk Premium ............................................................................................................... 77
Estimating Beta .............................................................................................................................. 78
5.3 Levering/ unlevering beta ................................................................................. 80
, Modigliani and Miller ...................................................................................................................... 80
The levered and unlevered cost of equity ........................................................................................ 80
5.4 Factor Models .................................................................................................. 82
An Alternative Model: The Arbitrage Pricing Theory ......................................................................... 83
5.5 Cost of Debt .................................................................................................... 83
Estimating the Cost of Debt ............................................................................................................ 83
Yield to Maturity of Debt ................................................................................................................. 84
The Cost of Debt at Distressed Companies .................................................................................... 86
The Debt Cost of Capital ................................................................................................................ 86
Conclusions ............................................................................................................... 87
Lecture 6 Analyzing & Forecasting Performance ................................................... 88
Reinvestments ............................................................................................................ 88
Capital & Equity reinvested in the firm ............................................................................................ 88
Analysis ...................................................................................................................... 91
Analyzing Revenue Growth .......................................................................................... 91
Organic vs Reported Growth ........................................................................................ 92
Currency changes .......................................................................................................................... 92
M&A ............................................................................................................................................... 92
Understanding Value Creation: Decomposing Growth .................................................. 93
Nonfinancial Metrics: Building an Equation ................................................................. 94
Credit Health and Capital Structure ............................................................................ 94
Credit Health and Capital Structure – liquidity ............................................................. 95
Excess Cash ............................................................................................................... 96
Determining Operating Taxes....................................................................................... 96
Operating Taxes: Step 1 .................................................................................................................. 97
Operating Taxes: Step 2 .................................................................................................................. 97
Operating Taxes: Step 3 .................................................................................................................. 98
Closing Thoughts – Analyzing Firm Performance .......................................................... 98
Forecasting ................................................................................................................. 99
Length of the forecast period ........................................................................................................ 100
Overview of the Forecasting Process ......................................................................... 101
Step 1: Prepare Historical Financials ............................................................................................ 102
Step 2: Build the Revenue Forecast .............................................................................................. 103
Step 3: Forecast the Income Statement ........................................................................................ 103
Step 3: Forecast the Income Statement ........................................................................................ 104
Step 4: Forecast the Balance Sheet .............................................................................................. 106
Step 5: Forecast Required Financing ............................................................................................ 107
Step 6: Calculate ROIC and FCF ................................................................................................... 109
Other Issues in Forecasting ....................................................................................... 109
,Table of Contents
Lecture 1 Principles of Value Creation .................................................................... 7
Valuation Myths ............................................................................................................7
1.1 Principles of Valuation .......................................................................................8
DCF Valuation .................................................................................................................................. 8
1.2 Growth and ROIC ...............................................................................................8
Managerial Implications ................................................................................................................. 10
Relationship growth and ROIC ........................................................................................................ 10
1.3 The Company as a growing Perpetuity .............................................................. 10
Key Value Drivers ............................................................................................................................ 11
What drives Value? ......................................................................................................................... 11
1.4 ROIC and Competitive Advantages ................................................................... 12
Long-run ROIC = Sustainable Competitive Advantage .................................................................... 12
Sources of Competitive Advantage ................................................................................................. 13
Sustainability ................................................................................................................................. 14
Lecture 2 Frameworks for Valuation ..................................................................... 17
Introduction on Company Valuation ............................................................................ 17
Conceptual Model .......................................................................................................................... 18
How does a corporation generate value? ........................................................................................ 18
Price vs Value ................................................................................................................................. 18
Variations on DCF........................................................................................................................... 19
A Typical Valuation Process ......................................................................................... 19
Steps in DCF Method 1 ................................................................................................ 22
Forecast vs Terminal Value Period .................................................................................................. 23
Deriving Enterprise FCF .................................................................................................................. 23
Proxies Enterprise FCF ................................................................................................................... 24
Introducing the Residual Income Model Method 2........................................................ 25
Deriving Residual Income: Still needs to be DISCOUNTED ............................................................. 27
Example DCF .............................................................................................................. 28
Example RI model .......................................................................................................................... 30
Valuation Multiples Method 3 ...................................................................................... 31
Enterprise vs Equity Multiples ......................................................................................................... 31
Market Based View of Enterprise Value ........................................................................................... 32
Investor derived view of enterprise value ........................................................................................ 33
Applying Target Multiples ................................................................................................................ 34
Adjusted Present Value (NPV) Method 4 ....................................................................... 35
Workshop 1.......................................................................................................... 38
ROIC/ WACC vs Valuation ........................................................................................... 38
Deriving NOPAT ........................................................................................................... 39
, Decomposing Return on Invested Capital .................................................................... 39
Drivers of Returns ....................................................................................................... 40
ROIC vs RONIC............................................................................................................ 40
ROIC Alternatives ....................................................................................................... 41
Types of Expenses ....................................................................................................... 43
Sanity Checks ............................................................................................................. 43
Lecture 3 Terminal Value ...................................................................................... 46
3.1 Patterns of Growth ........................................................................................... 46
Sustaining Growth and Product Life Cycles .................................................................................... 46
Growth Pattern ............................................................................................................................... 47
Sustainability of Growth and ROIC.................................................................................................. 49
3.2 Continuing value: Key value drivers .................................................................. 50
Continuing Value ............................................................................................................................ 50
1. Key value driver formula......................................................................................................... 51
Continuing value and ROIC ............................................................................................................ 52
3.3 Continuing Value: Economic Profit ................................................................... 53
Comparison KVD and Ecoonomic-Profit CV.................................................................................... 57
3.4 Subtleties and pitfalls of coninuing value ......................................................... 58
How growth affects continuing value .............................................................................................. 58
Common Pitfalls: Naïve Base-Year Extrapolation ............................................................................ 61
Common Pitfalls: Overconservatism .............................................................................................. 61
Closing Thoughts ........................................................................................................ 62
Lecture 4 Reorganizing the Financial Statements, including capitalization of R&D
expenses and operating leases ............................................................................ 63
Overview .................................................................................................................... 63
Accounting Misclassifications ..................................................................................... 64
Misclassification 1: R&D ................................................................................................................. 65
Misclassification 2: Operating Leases............................................................................................. 67
Adjustments for non-recurring items .............................................................................................. 73
Adjustments for income from investments and divestitures ........................................................... 74
Capital and Equity reinvested in the firm......................................................................................... 75
Lecture 5 Cost of Capital ...................................................................................... 76
5.1 Cost of Capital ................................................................................................. 76
Cost of Equity ................................................................................................................................. 76
5.2 CAPM .............................................................................................................. 76
Risk-Free Rate: 10-Year Local Treasury ........................................................................................... 77
The Market Risk Premium ............................................................................................................... 77
Estimating Beta .............................................................................................................................. 78
5.3 Levering/ unlevering beta ................................................................................. 80
, Modigliani and Miller ...................................................................................................................... 80
The levered and unlevered cost of equity ........................................................................................ 80
5.4 Factor Models .................................................................................................. 82
An Alternative Model: The Arbitrage Pricing Theory ......................................................................... 83
5.5 Cost of Debt .................................................................................................... 83
Estimating the Cost of Debt ............................................................................................................ 83
Yield to Maturity of Debt ................................................................................................................. 84
The Cost of Debt at Distressed Companies .................................................................................... 86
The Debt Cost of Capital ................................................................................................................ 86
Conclusions ............................................................................................................... 87
Lecture 6 Analyzing & Forecasting Performance ................................................... 88
Reinvestments ............................................................................................................ 88
Capital & Equity reinvested in the firm ............................................................................................ 88
Analysis ...................................................................................................................... 91
Analyzing Revenue Growth .......................................................................................... 91
Organic vs Reported Growth ........................................................................................ 92
Currency changes .......................................................................................................................... 92
M&A ............................................................................................................................................... 92
Understanding Value Creation: Decomposing Growth .................................................. 93
Nonfinancial Metrics: Building an Equation ................................................................. 94
Credit Health and Capital Structure ............................................................................ 94
Credit Health and Capital Structure – liquidity ............................................................. 95
Excess Cash ............................................................................................................... 96
Determining Operating Taxes....................................................................................... 96
Operating Taxes: Step 1 .................................................................................................................. 97
Operating Taxes: Step 2 .................................................................................................................. 97
Operating Taxes: Step 3 .................................................................................................................. 98
Closing Thoughts – Analyzing Firm Performance .......................................................... 98
Forecasting ................................................................................................................. 99
Length of the forecast period ........................................................................................................ 100
Overview of the Forecasting Process ......................................................................... 101
Step 1: Prepare Historical Financials ............................................................................................ 102
Step 2: Build the Revenue Forecast .............................................................................................. 103
Step 3: Forecast the Income Statement ........................................................................................ 103
Step 3: Forecast the Income Statement ........................................................................................ 104
Step 4: Forecast the Balance Sheet .............................................................................................. 106
Step 5: Forecast Required Financing ............................................................................................ 107
Step 6: Calculate ROIC and FCF ................................................................................................... 109
Other Issues in Forecasting ....................................................................................... 109
