CAPITAL AND MONEY MARKETS ASSIGNMENT

Equity Valuation

Sudip Bain 2011 D06

EXECUTIVE SUMMARY
The discounted cash flow (DCF) analysis represents the net present value (NPV) of projected cash flows available to all providers of capital, net of the cash needed to be invested for generating the projected growth. This has been used to calculate the value of a company in this assignment. Free cash flow to equity (FCFE) has been taken into account for this purpose. FCFE = PAT Capital Expenditure + depreciation Change in Working capital Preference dividend + (New debt issued Debt repayment) + (New Preference issue Preference repayment) Change in investment in marketable securities Here the aim is to calculate the fair value of the co. by projecting the future cash flows for 3 years (2012, 2013 and 2014) and then discounting them with the cost of equity so as to get the present value of the future inflows and then calculate the fair price of the stock of the company.

DCF model- Tata Power Company

1. DCF analysis is used to value a firm and the firms equity securities by valuing its free cash flow to the firm (FCFF) and free cash flow to equity (FCFE). Free cash flow to equity (FCFE) is the cash flow available to the firms common equity holders after all operating expenses, interest and principal payments have been paid, and necessary investments in working and fixed capital have been made. FCFE is the cash flow from operations minus capital expenditures minus payments to (and plus receipts from) debtholders. 2. Historical financial information in the DCF valuation 2011 2010 2009 2008 2007 Earnings after tax ,Interest 1,130.83 1,286.08 1,137.59 1,016.22 766.83 and principal payments and Capex + Depreciation CAGR 8.08%

The historical information is used to make likely forecasts of Earnings after tax ,Interest and principal payments and Capex growth using the CAGR. Projections of future sales are made by looking at historical values In this example the business has had an annual organic growth, CAGR of 8.08%. FUTURE Projections Earnings after tax 2007 766.83 Forecasted period 2008 2009 2010 2011 2012 2013 1016.22 1137.59 1286.08 1130.83 1222.185 1320.92 2014 1427.632

3. Historical working capital Total Current Assets Total Current Liabilities Net Working Capital 2,839.00 2,632.64 2,277.61 1,916.83 2,830.93 2,273.30 1,767.97 1,624.05 1,354.03 1,194.67 565.70 864.67 653.56 562.80 1,636.26

2011 Net Sales 6,901.45 Net Working 565.7 Capital % of sales 8.196828

2010 7,104.22 864.67

2009 7,257.05 653.56

2008 5,909.60 562.8

2007 4,918.53 1636.26

CAGR 0.070092

12.17122 9.005863 9.523487 33.26726

Now we estimate total current assets in the projection period. Using the average during the past four years in relation to sales.Than we estimate total current Liabilities in the projection period. Using the average during the past four years in relation to sales. Average OF % OF 14.43293 SALES The difference (increase or decrease) between current year and previous year is now added to the cash flow. A growing business will normally take on more working capital for each year, which will lower the free cash flow. 2012 2013 2014 Forecasted sales 7385.185 7902.825 8456.747 net working capital (%of 1065.899 1140.609 1220.556 sales) Change in working capital 500.1985 74.71066 154.6579 from previous year 2012 Working Capital was 565.7 crores. 4. The Free Cash Flow is now calculated for every year in the projection period. We Substract change in working capital (forecasted) from the forecasted Earnings after tax ,Interest and principal payments and Capex to arrive at FCFE. 2012 2013 2014 Unlevered free Cash Flow 721.9865 1246.21 1272.974 (FCFE) 5. Cost of Equity calculation TATA Power 2011 2010 2009 2008 2007 136.57 137.8 74.84 149.5 59.34 BETA Sensex 17300 17464 9716 20286 12982 0.977641 Returns Tata Power 0.00900637 -0.456894049 0.997594869 -0.603076923 -1 Returns Sensex 0.009479769 -0.44365552 1.087896254 -0.360051267 -1 Cost of equity 8.3201%

Cost of Equity= Rf + (Rm-Rf) Beta, Rm=8.08%

Rf, is the risk free rate is assumed to be the 91 day t-bill, 8.2007%. Market growth rate is taken as 8.08% considering industry growth rate as same. We get the cost of equity as 8.3201% using the above formula. 6. Equity Value The value of equity is found by discounting FCFE at the required rate of return on equity (r): Since FCFE is the cash flow remaining for equity holders after all other claims have been satisfied, discounting FCFE by r (the required rate of return on equity) gives the value of the firms equity. Dividing the total value of equity by the number of outstanding shares gives the value per share 2012 2013 2014 666.5306 1062.119 1001.59 2730.245

PV of FCFE EQUITY VALUE

Per Share value= Equity value/ Number of shares outstanding Total Number of shares outstanding= 237307236 So, Per share value= Rs 115.05 Closing price of Tata Power Company on 1st February 2012 was Rs. 110.15