dcfcf - II. Estimating Cash Flows DCF Valuation Aswath...

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Aswath Damodaran 61 II. Estimating Cash Flows DCF Valuation
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Aswath Damodaran 62 Steps in Cash Flow Estimation n Estimate the current earnings of the firm If looking at cash flows to equity, look at earnings after interest expenses - i.e. net income If looking at cash flows to the firm, look at operating earnings after taxes n Consider how much the firm invested to create future growth If the investment is not expensed, it will be categorized as capital expenditures. To the extent that depreciation provides a cash flow, it will cover some of these expenditures. Increasing working capital needs are also investments for future growth n If looking at cash flows to equity, consider the cash flows from net debt issues (debt issued - debt repaid)
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Aswath Damodaran 63 Measuring Cash Flows Cash flows can be measured to All claimholders in the firm EBIT (1- tax rate) - ( Capital Expenditures - Depreciation) - Change in non-cash working capital = Free Cash Flow to Firm (FCFF) Just Equity Investors Net Income - (Capital Expenditures - Depreciation) - Change in non-cash Working Capital - (Principal Repaid - New Debt Issues) - Preferred Dividend Dividends + Stock Buybacks
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Aswath Damodaran 64 Measuring Cash Flow to the Firm EBIT ( 1 - tax rate) - (Capital Expenditures - Depreciation) - Change in Working Capital = Cash flow to the firm n Where are the tax savings from interest payments in this cash flow?
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Aswath Damodaran 65 Earnings Checks n When estimating cash flows, we invariably start with accounting earnings. To the extent that we start with accounting earnings in a base year, it is worth considering the following questions: Are there are any one-time charges that might be depressing income in the base year or one-time earnings that might be increasing income in the base year? Are the earning negative, and if so, why? Are there any financial or capital expenses intermingled with the operating expenses, and if so, how do we correct for them?
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Aswath Damodaran 66 One-Time Charges n Assume that you are valuing a firm that is reporting a loss of $ 500 million, due to a one-time charge of $ 1 billion. What is the earnings you would use in your valuation? o A loss of $ 500 million o A profit of $ 500 million Would your answer be any different if the firm had reported one-time losses like these once every five years? o Yes o No
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Aswath Damodaran 67 To get earnings right. .. n We need to normalize earnings, if the base year earnings are negative or abnormally low n We need to adjust earnings to reflect the effects of the accounting treatment of Some financing expenses as operating expenses Some capital expenses as operating expenses
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Aswath Damodaran 68 Negative Earnings: Why they are a problem n When earnings are negative, you cannot start with that number in the base year and expect to grow yourself out of the problem. n
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This note was uploaded on 01/27/2012 for the course FINANCE 101 taught by Professor Schmeits during the Spring '11 term at NYU.

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dcfcf - II. Estimating Cash Flows DCF Valuation Aswath...

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