BITS Pilani

presentation
BITS Pilani Dr. Nivedita Sinha
Hyderabad Campus Department of Economics & Finance
Agenda

 Foundation building for Valuation

 Prospective analysis
 Cash flows
 What are the relevant cash flows?
 What is free cash flow to firm and free cash flow to equity

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Question 1 – Application of
Horizontal & Vertical analysis
Prospective Analysis

You are an intern with an Investment Banking firm.

You have been given the task to project the Balance sheet
and Profit & Loss statement of co. ABC in order to value
the company. Given Profit & Loss and Balance sheet for
the Years 2017-2019. Project the P&L and Balance sheet
for 2020 using the most recent assumptions
Refer to excel Lecture 6_Answer 1

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Defining cash flows

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Relevant cash flows to the
project

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Relevant cash flows contd.

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Market cannibalization refers to a reduction in sales volume or market
share of a product as a result of the introduction of a new product made
by the same company
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DCF and Inflation

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 Equity versus Project free cash flow
 Equity free cash flow (FCFE): Focuses on the CF that is available for
distribution to the firm’s common shareholders

EFCF levered firm = (EBIT-I) (1-T) + DA – WC – CAPEX-P+NP

= EBIT(1-T) + DA –I(1-T) –WC – CAPEX –P + NP
Where P : Principal payments on the firm’s outstanding debt
NP: Net proceeds from the issuance of debt
WC: Change in operating Working capital
 Project free cash flow (FCFF): Focuses on the CF available for distribution to
both the firm’s creditors and equity holder
PFCF levered firm = EFCF levered firm + I (1-T) + P –NP
Creditors CF are I + P –NP. Tax savings from govt. Equals I x T
Hence, CF to creditors net of tax saving I-IxT + P – NP
PFCF levered firm = EBIT (1-T) + DA – WC – CAPEX

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Depreciation and amortization

• Do not represent cash payments

• They arise due to matching principle in accounting
(expenses be matched with revenues whenever it is
reasonable), firms use it to match expenditures made for
long-lived assets against the revenues they help
generate
• These expenses are tax deductible
• EBIT(1-T)+ DA can be written as (EBITDA-DA)(1-T) +
DA = EBITDA(1-T) –DA+DA*T +DA which is like taking
Depreciation tax shield in our calculation

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CAPEX

• To sustain a firm’s productive capacity and provide for

growth in future cash flows, firms must periodically make
investments in long-lived assets
• Investments made for expanding plant capacity and
replacing old equipment
• CAPEX (t) = Net PPE (t)- Net PPE (t-1) + Depreciation
(t)
• CAPEX(t) = Gross PPE (t) – Gross PPE (t-1)

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Changes in Operating Net
Working capital
• Just as firm must invest in PPE (Property , Plant and
equipment) as it is growing, it must invest in current
assets such as inventories and accounts receivable.
• This investment is partially financed by increases in
accounts payable and other current liabilities.
• So this additional investment is taken as change in net
operating working capital

• Operating Net Working capital (t) = [Current Assets –

Cash and marketable securities) – (Current Liabilities –
Current portion of interest bearing debt)]
• Change in WC (t)= Operating Net WC (t) – Operating
Net WC (t-1)
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Thank you!

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