attempt to estimate the expected cash flows that will be generated by

Attempt to estimate the expected cash flows that will

This preview shows page 2 - 5 out of 13 pages.

- attempt to estimate the expected cash flows that will be generated by combination - usually include very specific assumptions - period where abnormal growth occurs – the period of time when the company is expected to yield a competitive advantage. - after the competitive advantage is exhausted the constant growth is included in the terminal value calculation 2.) Terminal Value - based on the final cash flow estimated during the forecast period - constant growth assumption and indefinite period of time - perpetual flow of constantly growing cash flows = estimation of the present value of the cash flows generated after the forecast period. NB! When working with calculation of the terminal value – conservative assumptions must be made Since valuation happens over a long period of time – small changes have a profound effect. 2 | P a g e Terminal Value = FCF t x ( 1 + g ) ( WACC – g ) FCF t = the free cash flow during the final year of the forecast period consisting of t years g = the constant growth rate assumed after the forecast period WACC = the company’s weighted cost of capital
Image of page 2

Subscribe to view the full document.

Calculating Free Cash Flow - Step 1 – estimate the expected free cash flow ( amount available to company’s capital providers after provision for investments in fixed and working capital) - During the process of estimating FCF – focus is placed on determining the operating cash flow attributable to the business combination - These calculations include any changes in income and expenses as well as assets due to the combination 3 | P a g e Example ( Page 110 ) Assume that the board of directors of WCB Ltd. is considering other expansion investments , and identified a target company that would enable them to achieve the desired expansion. They approached you to calculate a value for this company, Beta Ltd ., which they could use as an estimate of the fair value of the acquisition. Beta Ltd.’s WACC amounts to 10%. As part of your analysis, you forecasted Beta Ltd.’s free cash flow (FCF) for the next five years, and after Year 5, a constant growth rate of 5% is assumed. Your FCF estimations for the next five years are as follows: Currently Year 1 Year 2 Year 3 Year 4 Year 5 FCF 10 000 12 000 15 000 19 000 22 000 24 000 Step 1 – calculate terminal value FCF 5 x (1 + g) = 24000 x ( 1 + 0.05 ) = R504 000 (WACC- g) ( 0.10 – 0.05 ) Step 2 – calculation of company value CF 1 = 12000 CF 2 = 15000 CF 3 = 19000 CF 4 = 22000 CF 5 = 528000 (24000 + 504000) i = 10% NPV = ?? R380 453.52 FCF = EBIT (1-T) + NCI – CAPEX – ΔNOWC EBIT = earnings before finance costs (interest) and tax T = marginal tax rate NCI = Non-Cash Items , like depreciations, amortisation and impairment of goodwill CAPEX = capital expenditure on fixed assets ΔNOWC = change in the net operating working capital (trade receivables, trade payables, inventory)
Image of page 3
4 | P a g e Example (Page 112) Suppose that WCB Ltd. identified another potential target company that is operating in an unrelated industry.
Image of page 4

Subscribe to view the full document.

Image of page 5

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern

Ask Expert Tutors You can ask 0 bonus questions You can ask 0 questions (0 expire soon) You can ask 0 questions (will expire )
Answers in as fast as 15 minutes