chap 15 - The Free Cashflow to Firm Model Aswath Damodaran...

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Aswath Damodaran 1 The Free Cashflow to Firm Model Aswath Damodaran
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Aswath Damodaran 2 DaimlerChrysler: Rationale for Model n DaimlerChrysler is a mature firm in a mature industry. We will therefore assume that the firm is in stable growth. n Since this is a relatively new organization, with two different cultures on the use of debt (Daimler has traditionally been more conservative and bank-oriented in its use of debt than Chrysler), the debt ratio will probably change over time. Hence, we will use the FCFF model.
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Aswath Damodaran 3 Daimler Chrysler: Inputs to the Model n In 1999, Daimler Chrysler had earnings before interest and taxes of 9,324 million DM and had an effective tax rate of 46.94%. n Based upon this operating income and the book values of debt and equity as of 1998, DaimlerChrysler had an after-tax return on capital of 7.15%. n The market value of equity is 62.3 billion DM, while the estimated market value of debt is 64.5 billion n The bottom-up unlevered beta for automobile firms is 0.61, and Daimler is AAA rated. n The long term German bond rate is 4.87% (in DM) and the mature market premium of 4% is used. n We will assume that the firm will maintain a long term growth rate of 3%.
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Aswath Damodaran 4 Daimler/Chrysler: Analyzing the Inputs n Expected Reinvestment Rate = g/ ROC = 3%/7.15% = 41.98% n Cost of Capital Bottom-up Levered Beta = 0.61 (1+(1-.4694)(64.5/62.3)) = 0.945 Cost of Equity = 4.87% + 0.945 (4%) = 8.65% After-tax Cost of Debt = (4.87% + 0.20%) (1-.4694)= 2.69% Cost of Capital = 8.65%(62.3/(62.3+64.5))+ 2.69% (64.5/(62.3+64.5)) = 5.62%
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Aswath Damodaran 5 Daimler Chrysler Valuation n Estimating FCFF Expected EBIT (1-t) = 9324 (1.03) (1-.4694) = 5,096 mil DM Expected Reinvestment needs = 5,096(.42) = 2,139 mil DM Expected FCFF next year = 2,957 mil DM n Valuation of Firm Value of operating assets = 2957 / (.056-.03) = 112,847 mil DM + Cash + Marketable Securities = 18,068 mil DM Value of Firm = 130,915 mil DM - Debt Outstanding = 64,488 mil DM Value of Equity = 66,427 mil DM Value per Share = 72.7 DM per share Stock was trading at 62.2 DM per share on August 14, 2000
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Aswath Damodaran 6 Circular Reasoning in FCFF Valuation n In discounting FCFF, we use the cost of capital, which is calculated using the market values of equity and debt. We then use the present value of the FCFF as our value for the firm and derive an estimated value for equity. Is there circular reasoning here? o Yes o No n If there is, can you think of a way around this problem?
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7 Tube Investment: Rationale for Using 2-Stage FCFF Model n Tube Investments is a diversified manufacturing firm in India. While its growth rate has been anemic, there is potential for high growth over the next 5 years. n
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chap 15 - The Free Cashflow to Firm Model Aswath Damodaran...

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