AdvancedRiskManagement FNC615

MBAII Finance
DrNawazish Mirza
nawazish@nmirza.com
1
AdvancedCorporateFinance MBAII BusinessValuation AdvancedCorporateFinance MBAII BusinessValuation
BusinessValuationusingNPV
Approach
LahoreSchoolofEconomics LahoreSchoolofEconomics
AdvancedCorporateFinance MBAII BusinessValuation
BusinessValuation
PresentValueFutureBenefits
Earnings/Profits
Keyistoassessthesources fromwherefuture
benefitswillemanate
CashFlow
CashFlowtoShareholders
LahoreSchoolofEconomics
Dividends
CapitalAppreciation
CashFlowstoallStakeHolders
FreeCashFlows
AdvancedRiskManagement FNC615
MBAII Finance
DrNawazish Mirza
nawazish@nmirza.com
2
AdvancedCorporateFinance MBAII BusinessValuation
BusinessValuation
Intro to Free Cash Flows
d d / h h h fl ll Dividends/Repurchase are the cash flows actually
paid to stockholders
Free cash flows are the cash flows available for
distribution.
Possible issues with Dividends
The firm is not dividend paying,
LahoreSchoolofEconomics
e s o d de d pay g,
The firm is dividend paying but dividends differ
significantly from the firms capacity to pay
dividends.
Retention for Future Expansion
AdvancedCorporateFinance MBAII BusinessValuation
BusinessValuation
Cash flows can be measured to
All claimholders in the firm
Just Equity Investors
EstimationofCashFlows
Estimatetheearnings ofthefirm
Iflookingatcashflowstoequity,lookatearningsafterinterestexpenses i.e.net
EBIT (1- tax rate)
- ( Capital Expenditures - Depreciation)
- Changein non-cash working capital
=FreeCash Flow to Firm(FCFF)
Net Income
- (Capital Expenditures - Depreciation)
- Changein non-cash Working Capital
- (Principal Repaid - New Debt Issues)
- Preferred Dividend
Dividends
+Stock Buybacks
LahoreSchoolofEconomics
g q y, g p
income
Iflookingatcashflowstothefirm,lookatoperatingearningsaftertaxes
Considerhowmuchthefirminvestedtocreatefuturegrowth
Iftheinvestmentisnotexpensed,itwillbecategorizedascapitalexpenditures.To
theextentthatdepreciationprovidesacashflow,itwillcoversomeofthese
expenditures.
Increasingworkingcapitalneedsarealsoinvestmentsforfuturegrowth
AdvancedRiskManagement FNC615
MBAII Finance
DrNawazish Mirza
nawazish@nmirza.com
3
AdvancedCorporateFinance MBAII BusinessValuation
BusinessValuation
FreeCashFlowtoFirm
EBIT(1 taxrate)
(CapitalExpenditures Depreciation)
(+)Increase(Decrease)inWorkingCapital
=FreeCashflowtothefirm
LahoreSchoolofEconomics
AdvancedCorporateFinance MBAII BusinessValuation
BusinessValuation
Investment in Net Capital Expenditure
Net capital expenditures represent the difference Net capital expenditures represent the difference
between capital expenditures and depreciation.
Depreciation is a pseudo cash inflow
In general, the net capital expenditures will be a
function of how fast a firm is growing or expecting to
grow. High growth firms will have much higher net
capital expenditures than low growth firms
LahoreSchoolofEconomics
capital expenditures than low growth firms.
Assumptions about net capital expenditures can
therefore never be made independently of
assumptions about growth in the future.
AdvancedRiskManagement FNC615
MBAII Finance
DrNawazish Mirza
nawazish@nmirza.com
4
AdvancedCorporateFinance MBAII BusinessValuation
BusinessValuation
LahoreSchoolofEconomics
AdvancedCorporateFinance MBAII BusinessValuation
BusinessValuation
LahoreSchoolofEconomics
IfthereisaSalvageValue,WhatwillbetheImpact?
Assumesalvagevalueoftheassetsoldwas$100andCompanyfallsintaxclassof40%.
AdvancedRiskManagement FNC615
MBAII Finance
DrNawazish Mirza
nawazish@nmirza.com
5
AdvancedCorporateFinance MBAII BusinessValuation
BusinessValuation
WorkingCapitalInvestment
In accounting terms, the working capital is the difference
b ( h d between current assets (inventory, cash and accounts
receivable) and current liabilities (accounts payables, short
term debt and debt due within the next year)
A cleaner definition of working capital from a cash flow
perspective is the difference between noncash current
assets (inventory and accounts receivable) and nondebt
current liabilities (accounts payable)
Any investment in this measure of working capital ties up
LahoreSchoolofEconomics
Any investment in this measure of working capital ties up
cash. Therefore, any increases (decreases) in working
capital will reduce (increase) cash flows in that period.
When forecasting future growth, it is important to forecast
the effects of such growth on working capital needs, and
building these effects into the cash flows.
AdvancedCorporateFinance MBAII BusinessValuation
BusinessValuation
opportunity costs of capital
market value weight
make assumptions for
continuation value
check different
scenarios
LahoreSchoolofEconomics
AdvancedRiskManagement FNC615
MBAII Finance
DrNawazish Mirza
nawazish@nmirza.com
6
AdvancedCorporateFinance MBAII BusinessValuation
BusinessValuation
DISCOUNTED CASHFLOW VALUATION
Cash flows
Firm: Pre-debt cash
flow
Equity: After debt
cash flows
Expected Growth
Firm: Growth in
Operating Earnings
Equity: Growth in
Net Income/EPS
CF1 CF2 CF3 CF4 CF5
Firm is in stable growth:
Grows at constant rate
forever
Terminal Value
CFn
......... Value
LahoreSchoolofEconomics
Forever
Discount Rate
Firm:Cost of Capital
Equity: Cost of Equity
Firm: Value of Firm
Equity: Value of Equity
Length of Period of High Growth
AdvancedCorporateFinance MBAII BusinessValuation
BusinessValuation
LahoreSchoolofEconomics