Valuation: The Essence of Corporate Finance

The Essence of Corporate Finance VALUATION Presented by: www.GraduateTutor.com 1: the act or process of valuing 2: to estimate or determine market value of a thing Definition: (noun) Pronunciation?: 7,valyoo'āSHən/ Why do we need to value an asset (business, company, stock, art, etc.)? If then Valuation is also needed when pricing an asset for sale or purchase Management's objective is to We must be able to maximize VALUE measure of a business/ Often required by law VALUE! company... (Tax/Accounting/SEC...) How do we value an asset (business, company, stock, art, etc.)? 3. approaches or methods Options Multiples Method (Relative Valuation) Based Method Discounted Cash Flow Method (DCF) (covered here) %24 Present Value = future value time period (1+discount rate) According to the discounted Cash Flow Method Value of Sum Of The Present Value Of All Future Cash Flow any asset Future: includes only future All: includes recurring & one time cash flows, ignores past cash flow cash flows, savings generated, etc. Cash Flow: includes cash outflow and inflow. Does not refer to net income. (See box 1 below) Asset Cash Flow Discounted To Present Value Discount Rate Bonds Interest payments & principal repayment Yield Stocks Dividends & future selling price Expected return Business Free Cash Flow from the business (see box 1) Weighted Average Cost of Capital House Rental/other income & estimated selling price Expected return Art Future selling price Cost of capital Step 1: Estimate future cash flow over a period (forecast period) Step 2: Estimate growth rate after forecast period Time period to t, t3 tn+1 Cash Flow CFo CF, CF, CF3 CF. ....... CF, n+1 Assumes cash flow continues perpetually Cash flow during forecasted period Step 4: Discount terminal çash flow to present value Step 3: Discount future cash flow to present value CF. CF, CF3 + CF2 + CF, CF n+1 Value of + + any asset (1+r)º (1+r)1 (1+r)² (1+r)³ (1+r)n (r-g) Present values of cash flow Horizon Step 5: Sum up present values over the forecasted period Value CF = Cash flow r = discount rate g = Terminal growth rate Net free cash flow after all The factor that connects Rate at which the cash flow expenses, capital expenditure, changes in working capital, etc. will grow after the forecasted period future cash flow's value to today's value One of the hardest & most Incorporates V Risk of cash flow Formula: Net income + Depreciation- non cash items - capital expenditure - changes in working capital V Opportunity cost V Expected inflation important assumptions required and accounts for a large portion of the value arrived at Rate must match the time Conservatively approximated to be equal to historical inflation Note that this cash flow is period of cash flows r, = terminal discount rate maybe different from rate during the forecast period not net income Honesty, judgment and experience is required to estimate cash flow ADVANTAGES DISADVANTAGES Values the asset based Requires many assumptions to be made. Assumptions can be manipulated. Can become overly complex if not careful. on cash flow which is a real indicator of value. Not based on market sentiment but based on fundamentals. Got Questions on Valuation? Give us a call! Presented by www.GraduateTutor.com Phone: +1-214 691 8721 Email:[email protected] Sources: 1) merriam-webster.com definition as modified by GraduateTutor.com © 2) Google.com DISCOUNTED CASH FLOW METHOD The Essence of Corporate Finance VALUATION Presented by: www.GraduateTutor.com 1: the act or process of valuing 2: to estimate or determine market value of a thing Definition: (noun) Pronunciation?: 7,valyoo'āSHən/ Why do we need to value an asset (business, company, stock, art, etc.)? If then Valuation is also needed when pricing an asset for sale or purchase Management's objective is to We must be able to maximize VALUE measure of a business/ Often required by law VALUE! company... (Tax/Accounting/SEC...) How do we value an asset (business, company, stock, art, etc.)? 3. approaches or methods Options Multiples Method (Relative Valuation) Based Method Discounted Cash Flow Method (DCF) (covered here) %24 Present Value = future value time period (1+discount rate) According to the discounted Cash Flow Method Value of Sum Of The Present Value Of All Future Cash Flow any asset Future: includes only future All: includes recurring & one time cash flows, ignores past cash flow cash flows, savings generated, etc. Cash Flow: includes cash outflow and inflow. Does not refer to net income. (See box 1 below) Asset Cash Flow Discounted To Present Value Discount Rate Bonds Interest payments & principal repayment Yield Stocks Dividends & future selling price Expected return Business Free Cash Flow from the business (see box 1) Weighted Average Cost of Capital House Rental/other income & estimated selling price Expected return Art Future selling price Cost of capital Step 1: Estimate future cash flow over a period (forecast period) Step 2: Estimate growth rate after forecast period Time period to t, t3 tn+1 Cash Flow CFo CF, CF, CF3 CF. ....... CF, n+1 Assumes cash flow continues perpetually Cash flow during forecasted period Step 4: Discount terminal çash flow to present value Step 3: Discount future cash flow to present value CF. CF, CF3 + CF2 + CF, CF n+1 Value of + + any asset (1+r)º (1+r)1 (1+r)² (1+r)³ (1+r)n (r-g) Present values of cash flow Horizon Step 5: Sum up present values over the forecasted period Value CF = Cash flow r = discount rate g = Terminal growth rate Net free cash flow after all The factor that connects Rate at which the cash flow expenses, capital expenditure, changes in working capital, etc. will grow after the forecasted period future cash flow's value to today's value One of the hardest & most Incorporates V Risk of cash flow Formula: Net income + Depreciation- non cash items - capital expenditure - changes in working capital V Opportunity cost V Expected inflation important assumptions required and accounts for a large portion of the value arrived at Rate must match the time Conservatively approximated to be equal to historical inflation Note that this cash flow is period of cash flows r, = terminal discount rate maybe different from rate during the forecast period not net income Honesty, judgment and experience is required to estimate cash flow ADVANTAGES DISADVANTAGES Values the asset based Requires many assumptions to be made. Assumptions can be manipulated. Can become overly complex if not careful. on cash flow which is a real indicator of value. Not based on market sentiment but based on fundamentals. Got Questions on Valuation? Give us a call! Presented by www.GraduateTutor.com Phone: +1-214 691 8721 Email:[email protected] Sources: 1) merriam-webster.com definition as modified by GraduateTutor.com © 2) Google.com DISCOUNTED CASH FLOW METHOD