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Distributed ToWhat isValued?Enterprise(FCF/WACC)FCFWACCProviders of D&EOperationsAPVFCF, ITS(1)Kufor FCF;Kuor Kdfor ITSProviders of D&EOperationsEquityDCFFCFEKeEquity holdersCommon equityDividendExpected Dividends to StockholdersKeEquity holdersCommon equityFall 2020173DCF Models (1)ITS = i x t
COMPARISONS OF DCF MODELSFall 2020174DCF Models EnterpriseDCFAPVEquity Cash Flow Dividend DiscountCash FlowDiscount RateInterest Tax ShieldRecommended ApplicationsEBIT– Taxes on EBIT= NOPLAT+ Depreciation– Capex– Increase in operating workingcapitalWACC = Ke(E/V) + Kd(1 – t)(D/V)In the discount rateConstant Debt/Capital + Constant tax rate FCF calculated as in Enterprise modelITS calculated separatelyKufor FCF; Kuor Kdfor ITSCalculated separatelyWhen amount of debt in capital structure is specified in terms of dollars as opposed to a percentage of firm valueNet Income+ Depreciation– Capex – Incr. in operating w/c – Increase in nonoper. assets+ Incr. in debt and pfd.stockKeIn Cash FlowsBanksDividendsKeIn Cash FlowsUtilities, REITs, Stable growthcompanies
ECONOMIC PROFITS MODELModel estimates the value of operations by discounting the expected economic profits by WACC and then adding book value of invested capital in place at the beginning of the first year of the forecast.Value= IC0+ PV of future Economic ProfitsWhere IC0= book value of IC beginning of explicitforecast periodDefinition of economic profits in any year:Economic Profits = (ROIC – WACC) x IC = NOPLAT – (IC x WACC)Where IC = invested capital at beginning of yearFormulas for stable company with constant growth rate and constant ROIC going forward:V0= FCF1= IC0+ IC0(ROIC – WACC)= NOPLAT1(1 – g/ROIC)WACC – gWACC – g WACC – gDCF modelEconomic Profits model McK Value DrivermodelEconomic Profits is often called EVA (Economic Value Added)Fall 2020175DCF Models
MULTI-STAGE ECONOMIC PROFITS MODEL FOR UNEVEN GROWTHValue = current book value of IC + PV of future Economic Profits in explicit forecast period + PV of TVTV = Economic ProfitsT+1WACC – g Where Economic ProfitsT is Economic Profits in last year of explicit forecast periodChoice of ROIC – WACC spread for TV computation takes into account same considerations as in cash flow models (zero or some excess return to be maintained indefinitely)Fall 2020176DCF Models
VALUATION USING ECONOMIC PROFITS MODELActualExplicit Forecast Period201920202021202220232024ROIC20%18%16%14%11%9%−WACC9%9%9%9%9%9%= Spread9%7%5%2%0%x IC(1)575662734786825= Economic Profits524637160 .(1)Beginning of year valuesAssumes ROIC = WACC in 2024 andthereafter, so Economic Profits in 2024 = 0 and TV = 0! IC forecasted as % of sales(in effect, we do this in Enterprise DCF model when we project future W/C needs, capex and depr. as % of salesFall 2020177DCF Models
VALUATION USING ECONOMIC PROFITS MODEL – cont.VALUATIONPV of Economic Profits, 2020-2024 @ 9%$126PV of TV (ROIC = WACC) 0IC, beg. year 2020575ValueOperations$701Value of debt (a given)210Value of equity 12/31/19$491Fall 2020178DCF Models
ECONOMIC PROFITS MODELSCondition needed for reasonable estimate of intrinsic value:Stable capital structure in market value terms