Distributed To
What is
Valued?
Enterprise
(FCF/WACC)
FCF
WACC
Providers of
D&E
Operations
APV
FCF, ITS
(1)
K
u
for FCF;
K
u
or K
d
for
ITS
Providers of
D&E
Operations
Equity
DCF
FCFE
K
e
Equity holders
Common
equity
Dividend
Expected
Dividends to
Stockholders
K
e
Equity holders
Common
equity
Fall 2020
173
DCF Models
(1)
ITS = i x t

COMPARISONS OF DCF MODELS
Fall 2020
174
DCF Models
Enterprise
DCF
APV
Equity
Cash Flow
Dividend
Discount
Cash Flow
Discount Rate
Interest Tax
Shield
Recommende
d Applications
EBIT
– Taxes on EBIT
= NOPLAT
+ Depreciation
– Capex
– Increase in
operating working
capital
WACC = K
e
(E/V) +
K
d
(1 – t)(D/V)
In the discount rate
Constant
Debt/Capital +
Constant tax
rate
FCF calculated as in
Enterprise model
ITS calculated separately
K
u
for FCF; K
u
or K
d
for ITS
Calculated separately
When amount of debt in
capital structure is
specified in terms of
dollars as opposed to a
percentage of firm value
Net Income
+ Depreciation
–
Capex
–
Incr. in operating
w/c
–
Increase in nonoper.
assets
+
Incr. in debt and pfd.
stock
K
e
In Cash Flows
Banks
Dividends
K
e
In Cash Flows
Utilities, REITs,
Stable growth
companies

ECONOMIC PROFITS MODEL
Model 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= IC
0
+ PV of future Economic Profits
Where IC
0
= book value of IC beginning of explicit
forecast period
Definition of economic profits in any year:
Economic Profits = (ROIC – WACC) x IC = NOPLAT – (IC x WACC)
Where IC = invested capital at beginning of year
Formulas for stable company with constant growth rate and constant
ROIC going forward:
V
0
=
FCF
1
=
IC
0
+ IC
0
(ROIC – WACC)
=
NOPLAT
1
(1 – g/ROIC)
WACC – g
WACC – g
WACC – g
DCF model
Economic Profits model
McK Value Driver
model
Economic Profits is often called EVA (Economic Value Added)
Fall 2020
175
DCF Models

MULTI-STAGE ECONOMIC PROFITS MODEL
FOR UNEVEN GROWTH
Value = current book value of IC + PV of future
Economic Profits in explicit forecast period + PV of TV
TV = Economic Profits
T+1
WACC – g
Where Economic Profits
T
is Economic Profits in last
year of explicit forecast period
Choice 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 2020
176
DCF Models

VALUATION USING ECONOMIC PROFITS MODEL
Actual
Explicit Forecast Period
2019
2020
2021
2022
2023
2024
ROIC
20%
18%
16%
14%
11%
9%
−WACC
9%
9%
9%
9%
9%
9%
= Spread
9%
7%
5%
2%
0%
x IC
(1)
575
662
734
786
825
= Economic
Profits
52
46
37
16
0
.
(1)
Beginning of year values
Assumes ROIC = WACC in 2024 and
thereafter
, 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 sales
Fall 2020
177
DCF Models

VALUATION USING ECONOMIC PROFITS
MODEL – cont.
VALUATION
PV of Economic Profits, 2020-2024 @ 9%
$126
PV of TV (ROIC = WACC)
0
IC, beg. year 2020
575
Value
Operations
$701
Value of debt (a given)
210
Value of equity 12/31/19
$491
Fall 2020
178
DCF Models