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valenhItaly - Value Enhancement: Back to Basics M ila n , I...

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Aswath Damodaran 1 Value Enhancement: Back to Basics Milan, Italy July 9, 2004 Aswath Damodaran http://www.damodaran.com
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Aswath Damodaran 2 Price Enhancement versus Value Enhancement
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Aswath Damodaran 3 Cashflow to Firm EBIT (1-t) - (Cap Ex - Depr) - Change in WC = FCFF Expected Growth Reinvestment Rate * Return on Capital FCFF 1 FCFF 2 FCFF 3 FCFF 4 FCFF 5 Forever Firm is in stable growth: Grows at constant rate forever Terminal Value= FCFF n+1 /(r-g n ) FCFF n ......... Cost of Equity Cost of Debt (Riskfree Rate + Default Spread) (1-t) Weights Based on Market Value Discount at WACC= Cost of Equity (Equity/(Debt + Equity)) + Cost of Debt (Debt/(Debt+ Equity)) Value of Operating Assets + Cash & Non-op Assets = Value of Firm - Value of Debt = Value of Equity Riskfree Rate : - No default risk - No reinvestment risk - In same currency and in same terms (real or nominal as cash flows + Beta - Measures market risk X Risk Premium - Premium for average risk investment Type of Business Operating Leverage Financial Leverage Base Equity Premium Country Risk DISCOUNTED CASHFLOW VALUATION
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Aswath Damodaran 4 Expected Growth in EBIT (1-t) .30*.0454=.0136 1.36% Stable Growth g = 4%; Beta = 1.0; Debt Ratio = 46% Cost of capital = 7.02% ROC= 7.02%; Tax rate=34% Reinvestment Rate=g/ROC =4/7.02 = 55.78% Terminal Value 5 = 7.35/(.0702-.04) = 231.69 Cost of Equity 9.30% Cost of Debt 8.50%(1-.38) = 5.27% Weights E = 54% D = 46% Discount at Eu Cost of Capital (WACC) = 9.30% (.54) + 5.27% (0.46) =7.45 % Op. Assets 203.14 + Cash: 48.60 - Debt 166.10 =Equity 85.64 Value/Sh ! 0.54/sh Riskfree Rate : ! Riskfree Rate= 4.50% + Beta 1.20 X Mature market premium 4 % Unlevered Beta for Sectors: 0.785 Firm’s D/E Ratio: 85% Ducati: Status Quo Reinvestment Rate 30% Return on Capital 4.54% Term Yr 16.62 - 9.27 = 7.35 On June 23 2004 Ducati was trading at ! 1.23 per share Average Reinvestment Rate (1999-2003) = 30% Actual Operating income in 2003 = ! 6.30 million Average Operating income over last 5 years = ! 22.63 million Return on capital based upon average income = 4.54% Tax Rate = 38% 1 2 3 4 5 EBIT(1-t) ! 14.22 ! 14.41 ! 14.61 ! 14.81 ! 15.01 - Reinvestment ! 4.27 ! 4.32 ! 4.38 ! 4.44 ! 4.50 FCFF ! 9.95 ! 10.09 ! 10.23 ! 10.37 ! 10.51
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Aswath Damodaran 5 The four drivers of value Cash flows Firm: Pre-debt cash flow Equity: After debt cash flows Expected Growth Firm: Growth in Operating Earnings Equity: Growth in Net Income/EPS CF 1 CF 2 CF 3 CF 4 CF 5 Forever Firm is in stable growth: Grows at constant rate forever Terminal Value CF n ......... Discount Rate Firm:Cost of Capital Equity: Cost of Equity Value Firm: Value of Firm Equity: Value of Equity DISCOUNTED CASHFLOW VALUATION Length of Period of High Growth
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Aswath Damodaran 6 The Paths to Value Creation Using the DCF framework, there are four basic ways in which the value of a firm can be enhanced: The cash flows from existing assets to the firm can be increased, by either – increasing after-tax earnings from assets in place or – reducing reinvestment needs (net capital expenditures or working capital) The expected growth rate in these cash flows can be increased by either – Increasing the rate of reinvestment in the firm – Improving the return on capital on those reinvestments The length of the high growth period can be extended to allow for more years of high growth.
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valenhItaly - Value Enhancement: Back to Basics M ila n , I...

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