valenh - Value Enhancement: Back to Basics Aswath Damodaran...

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Aswath Damodaran 146 Value Enhancement: Back to Basics
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Aswath Damodaran 147 Price Enhancement versus Value Enhancement
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Aswath Damodaran 148 Discounted Cash Flow Valuation: The Steps n Estimate the discount rate or rates to use in the valuation Discount rate can be either a cost of equity (if doing equity valuation) or a cost of capital (if valuing the firm) Discount rate can be in nominal terms or real terms, depending upon whether the cash flows are nominal or real Discount rate can vary across time. n Estimate the current earnings and cash flows on the asset, to either equity investors (CF to Equity) or to all claimholders (CF to Firm) n Estimate the future earnings and cash flows on the asset being valued, generally by estimating an expected growth rate in earnings. n Estimate when the firm will reach “stable growth” and what characteristics (risk & cash flow) it will have when it does. n Choose the right DCF model for this asset and value it.
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Aswath Damodaran 149 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 Premium DISCOUNTED CASHFLOW VALUATION
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Aswath Damodaran 150 Cashflow to Firm EBIT(1-t) : 2196 - Nt CpX 1549 - Chg WC 253 = FCFF 394 Expected Growth in EBIT (1-t) .8206*.0996 = .0817 8.17 % 465 503 544 589 637 Forever Stable Growth g = 4%; Beta = 0.87 Country risk prem = 0% Reinvest 40.2% of EBIT(1-t): 4%/9.96% Terminal Value 5 = 2024/(.0686-.04) = 70,898 Cost of Equity 9.05% Cost of Debt (4.24%+ 0.20%)(1-.4908) = 2.26% Weights E = 84.16% D = 15.84% Discount at Cost of Capital (WACC) = 9.05% (0.8416) + 2.26% (0.1584) = 7.98% 50.457 - 9809= 40.647 Per Share: 7.73 E Riskfree Rate : Government Bond Rate = 4.24% + Beta 0.87 X Risk Premium 4.0% + 1.53% Unlevered Beta for Sector: 0.79 Firm’s D/E Ratio: 18.8% Mature Mkt Premium 4% Country Risk Premium 1.53% Telecom Italia: A Valuation (in Euro Reinvestment Rate 82.06% Return on Capital 9.96% WC : 13% of Revenues
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Aswath Damodaran 151 Current Cashflow to Firm EBIT(1-t) : 1,395 - Nt CpX 1,012 - Chg WC 290 = FCFF 94 Reinvestment Rate =93.28% Expected Growth in EBIT (1-t) .9328*.1162= .1084 10.84 % Stable Growth g = 5%; Beta = 1.00; ROC=11.62% Reinvestment Rate=43.03% Terminal Value 5 = 1397/(.10-.05) = 27934 Cost of Equity 11.16% Cost of Debt (6%+ 1.00%)(1-.35) = 4.55% Weights E = 100% D = 0% Discount at Cost of Capital (WACC) = 11.16% (1.00) + 4.55% (0.00) = 11.16% Asset Value: 16923 + Cash: 4091 - Debt: 0 =Equity 21,014 -Options 538 Value/Share $12.11 Riskfree Rate : Government Bond Rate = 6% + Beta 1.29 X Risk Premium 4% Unlevered Beta for Sectors: 1.29 Firm’s D/E Ratio: 0% Historical US Premium 4% Country Risk Premium 0% Compaq: Status Quo Reinvestment Rate 93.28% Return on Capital 11.62% (1998) EBIT(1-t) - Reinv FCFF $2,451 $ 1054 $1,397 $1,546.62 $1,714.30
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valenh - Value Enhancement: Back to Basics Aswath Damodaran...

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