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Aswath Damodaran
1
Value Multiples
Aswath Damodaran
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Value/Earnings and Value/Cashflow Ratios
n
While Price earnings ratios look at the market value of equity relative to
earnings to equity investors, Value earnings ratios look at the market value of
the firm relative to operating earnings. Value to cash flow ratios modify the
earnings number to make it a cash flow number.
n
The form of value to cash flow ratios that has the closest parallels in DCF
valuation is the value to Free Cash Flow to the Firm, which is defined as:
Value/FCFF =
(Market Value of Equity + Market Value of DebtCash)
EBIT (1t)  (Cap Ex  Deprecn)  Chg in WC
n
Consistency Tests:
•
If the numerator is net of cash (or if net debt is used, then the interest income from
the cash should not be in denominator
•
The interest expenses added back to get to EBIT should correspond to the debt in
the numerator. If only long term debt is considered, only long term interest should
be added back.
Aswath Damodaran
3
Value/FCFF Distribution
Enterprise Value/FCFF
800
600
400
200
0
Std. Dev = 21.77
Mean = 20.6
N = 3063.00
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Value of Firm/FCFF: Determinants
n
Reverting back to a twostage FCFF DCF model, we get:
•
V
0
= Value of the firm (today)
•
FCFF
0
= Free Cashflow to the firm in current year
•
g = Expected growth rate in FCFF in extraordinary growth period (first
n years)
•
WACC = Weighted average cost of capital
•
g
n
= Expected growth rate in FCFF in stable growth period (after n
years)
V
0
=
FCFF
0
(1 + g) 1
(1 + g)
n
(1+WACC)
n
WACC  g
+
FCFF
0
(1+g)
n
(1+g
n
)
(WACC  g
n
)(1 + WACC)
n
Aswath Damodaran
5
Value Multiples
n
Dividing both sides by the FCFF yields,
n
The value/FCFF multiples is a function of
•
the cost of capital
•
the expected growth
V
0
FCFF
0
=
(1 + g) 1
(1 + g)
n
(1 + WACC)
n
WACC  g
+
(1+g)
n
(1+g
n
)
(WACC  g
n
)(1 + WACC)
n
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Alternatives to FCFF  EBIT and EBITDA
n
Most analysts find FCFF to complex or messy to use in multiples
(partly because capital expenditures and working capital have to be
estimated). They use modified versions of the multiple with the
following alternative denominator:
•
aftertax operating income or EBIT(1t)
•
pretax operating income or EBIT
•
net operating income (NOI), a slightly modified version of operating
income, where any nonoperating expenses and income is removed from
the EBIT
•
EBITDA, which is earnings before interest, taxes, depreciation and
amortization.
Aswath Damodaran
7
Value/FCFF Multiples and the Alternatives
n
Assume that you have computed the value of a firm, using discounted
cash flow models. Rank the following multiples in the order of
magnitude from lowest to highest?
o
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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.
 Spring '11
 Schmeits
 Finance

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