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Valuation-Income Approach
Valuation-Income Approach
值)
The Income Approach:
Discounted Cash Flow Analysis
林家振
台灣大學管理學院商學研究所
Overview: The Basic DCF Formula
E (CF ) t
n
Present Value
t 0 (1 k )
t
We project cash flows in the future, The discount rate k represents the
discount them, and sum them all up equilibrium expected rate of return,
and contains a risk premium
Fundamental valuation elements (cash amount, timing and risk) are explicitly
estimated.
STEPS
Determine relevant horizon for projections
Explicit projection of cash flow
Revenue
Expense
Capital Expenditures
Add back depreciation & other non-cash expenses
Subtract investments in working capital, capital
expenditures.
Terminal Value
Discount Rate
EXPLICIT PROJECTION HORIZON
Shortest - 3 years
Longest - 20 years or more
Most - 5 - 10 years
Internal Inconsistency
Strong revenue growth generally requires significant investment
Start-ups generally have substantial working capital requirements
Capital expenditures in mature companies tend to exceed depreciation
(never vice versa in perpetuity)
Physical outputs should reconcile with physical inputs
60
50
historical projected
40
Revenue (millions) 30
20
10
0
Year 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024
Year
Debt-free cash flows are also known as: Levered cash flows are also known as
Asset cash flows, enterprise cash flows equity cash flows
Important point:
When using a debt-free DCF approach (i.e. almost all the time),
remember that the present value of cash flows gives an
indicated value of the enterprise, or Total Capital or MVIC or
Business Enterprise Value.
If you then want to determine the Market Value of Equity…
...you must subtract the PV of the subject company’s
debt.
If you apply an unlevered discount rate (such as WACC) to
levered (equity) cash flows you will make egregious errors.
Similarly for applying a levered discount rate (cost of equity) to
debt-free cash flows.
Revenue
- Operating Expenses (cash basis)
EBIT
- Taxes
= Debt-Free Net Income
+ Depreciation, Amortization and Deferred Charges
- /+ Change in Net Working Capital
- Capital Expenditures
= Available Cash Flow (Free Cash Flow)
Note that projections are usually expressed in nominal, rather than real, terms.
17 National Taiwan University, MBA
Determination of Free Cash Flow
EBIT
Represents the pretax income the company would have earned if it had no debt
Generally computed as Revenues less COGS and SGA expenses.
Often equal to the line "Operating Income" on the company's income statement.
Taxes on EBIT
Represent income taxes attributable to EBIT on an unlevered basis
Taxes should be stated on a cash basis (I.e., use tax depreciation & amortization)
Resulting amount is debt-free (unlevered) net income, also referred to as Earnings Before Interest and
After Taxes ("EBIAT") or Net Operating Profit less Adjusted Taxes ("NOPLAT") or “EBIT after tax”
Non-Cash Addbacks
Depreciation and Amortization (subtracted in computing EBIT)
Other non-cash charges
Depreciation 10 14 12 8 7
Capital Expenditure (15) (12) (8) (8) (8)
Change in Working Capital (6) (5) (5) (3) (2)
FCFt (1+g)
k-g
where:
FCFt = Free cash flow in the last year of the explicit projection period
g = assumed growth in perpetuity
k = discount rate (WACC)
NFA = Net fixed assets in the last year of the projection period
NWC = Net working capital in the last year of the projection
period
EBIT = EBIT in last year of the projection period
Value equals...
NOPAT(1-g/r)
k-g
where:
NOPAT = “normal operating profit after taxes”
= EBIT less cash taxes
r = expected rate of return on new investment
k
28 National Taiwan University, MBA
PwC Value Driver Model
If capital expenditures grow over time (even if only due to inflation) then
depreciation should be less than capital expenditures in a steady state.
Depreciation = w * Capital Expenditures
where w = the steady state ratio of tax depreciation to capital spending.
With straight-line tax depreciation: w = [1‑(1/(1+ g) n)]/gn
where g is the growth rate and n is the original tax life of fixed assets.
With MACRS depreciation and multiple asset lives, the relationship is
more complicated but can be calculated with a spreadsheet.
For specialized business with few (if any) publicly traded comparables…
The analysis is only as good as the projections ("Garbage In - Garbage Out"). Management
is sometimes invested in biased projections.
Performs poorly (relative to certain other techniques) when applied to businesses with lots
of real options (e.g. biotech R&D).
Tendency to start "believing" the model, especially when clients seek to integrate
projections with budgets.
Use liquidation value if the distress is terminal. Both the market and the
income approach are conditioned on a "going concern" value
Source: Damodaran, Aswath "Security Analysis for Investment and Corporate Finance"
34 National Taiwan University, MBA
Multiple scenarios in DCF Analysis
2000
1800
1600
1400
Revenue
1200
1000
800
600
400
200
0
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
10th percentile 50th percentile 90th percentile
100%
90%
P
r 80%
o
70%
b
a
60%
b
i
50%
l
i 40% There is approximately Expected Value
t a 13% chance that the $37,500,000
y 30%
value is below $0
20%
10%
0%
-$60,000 -$40,000 -$20,000 $0 $20,000 $40,000 $60,000 $80,000 $100,000 $120,000