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Chapter_06_DCF

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Click to edit Master subtitle style Chapter 6 Frameworks for Valuation: Enterprise DCF and Discounted Economic Profit Models Instructors: Please do not post raw PowerPoint files on public website. Thank you!
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22 Using DCF to Value Companies There are five well-known frameworks for valuing a company using discounted flows, the most common being enterprise discounted cash flow (DCF) . In theory, each framework will generate the same value. In practice, the ease of implementation and the interpretation of results varies across frameworks . In this presentation, we examine how to value a company using enterprise DCF and discounted economic profit. Model Measure Discount factor Assessment Enterprise discounted cash flow Free cash flow Weighted average cost of capital Works best for projects, business units, and companies that manage their capital structure to a target level. Discounted economic profit Economic profit Weighted average cost of capital Explicitly highlights when a company creates value. Adjusted present value Free cash flow Unlevered cost of equity Highlights changing capital structure more easily than WACC-based models. Capital cash flow Capital cash flow Unlevered cost of equity Compresses free cash flow and the interest tax shield in one number, making it difficult to compare operating performance among companies and over time. Equity cash flow Cash flow to equity Levered cost of equity Difficult to implement correctly because capital structure is embedded within the cash flow. Best used when valuing financial institutions. Frameworks for Valuation
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33 To value a company, you can either value the cash flows generated by the company’s economic assets or value each financial claim separately (debt equity, other financial claims, etc.). To value operations, discount free cash flow by the weighted average cost of capital. Valuing the Enterprise versus Financial Claims $ million After-tax cash flow to debt holders Debt value 1 Free cash flow 200.0 Cash flow to equity holders Equity value 227.5 1 Debt value equals discounted after-tax cash flow to debt holders plus the present value of interest tax shield . 110 140 100 120 180 20 70 15 65 110 90 70 85 55 70 427.5 Discount free cash flow by the weighted average cost of capital. 427.5 Enterprise value Enterprise Valuation of a Single-Business Company To value equity directly, discount equity cash flow by the cost of equity. Alternatively, value operations and subtract the value of debt.
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44 as se ts $ million Value of operating units 2 0 0 1 2 5 2 2 5 3 0 5 2 0 4 0 5 6 0 2 0 0 3 6 0 Uni t A Un it B Un it C Corpo rate ce nte r Valu e of operati ons Nonoper ating assets Enterp rise va lu e Valu e of d e bt Eq uity va lu e Defining Enterprise Value versus Equity Value A company’s equity value can be computed indirectly by calculating enterprise value first and then subtracting any nonequity claims, such as debt.
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