Entrepreneurial Finance and Venture Capital - #2
Marek Panfil Ph.D.
Department of Finance
valuation is both a theory (as one of the initial and most important components of Value
Based Management) and an art, based on the experience and intuition of business appraiser.
• However, we should be fully aware of the fact that even the application of the best theories
and methods of business valuation does not automatically reflect the real market value of
the assets at hand (especially in the short-term).
• It is impossible to account for certain unexpected and unforeseen events, such as: rapid
changes of the economic cycle, political transformations, wars, terrorist attacks, the changing
preferences of capital market players, fraud and corruption, or the resignations of founders
or managers.
• Life provides us with abundant evidence for the contribution of such events to the rapid
revaluation of companies, or even to their bankruptcies.
• The inclusion of risk in valuation models does not entirely eliminate the impact of
unpredictable events on company valuation.
M.Panfil, A.Szablewski, Introduction [in:] Business Valuation. A Basic Approach, Wycena
przedsiębiorstwa. Od teorii do praktyki, eds. M.Panfil, A.Szablewski, Poltext, Warsaw, 2011
Warsaw Warsaw Shanghai
2011 2012 2013
3
THE MOST POPULAR
VALUATION APPROACHES
Valuation Approaches
Income Based Asset Based Market Based
Value Estimate Value Estimate Value Estimate
Determining a value indication of Determing a value indication of a Determining a value indication
a business using one or more business based on the value of of a business by using one or
methods that convert anticipated the assets net liabilities. more methods that compare the
economic benefits into a present subject to similar businessess
single amount. that have been sold.
ASSET-BASED APPROACH
Asset-based approach comprises a number of methods establishing
the enterprise value through the value of its assets, corrected by
foreign liabilities Asset-based methods are based on the valuation
of individual assets and foreign liabilities valuations. They do not
take synergies into account, existing between parts of an enterprise
and related to their organized use. In valuation you need to take
into account: assets and off-balance sheet liabilities. The following
valuation methods are asset-based:
• adjusted net assets method / adjusted book value
• liquidation value method,
• replacement value method.
INCOME-BASED APPROACH
Income-based approach encompasses a group of methods based on the
assumption that the value is the sum total of future economic income flows,
discounted by the expected rate of return (cost of capital involved).The following
methods are income-based:
• DCF (Discounted Cash Flows) method, which may be based on FCFE (Free Cash
Flows to Equity) or on FCFF (Free Cash Flows to Firm),
• discounted economic profit method,
• adjusted present value
• discounted dividend method.
The result of a valuation with an income-based method must be corrected with
assets and liabilities not taken into account in forecast operating activity. The key
aspects in the income-based approach are to establish flows of economic incomes
and the correct capital cost for a given flow.
MARKET –BASED APPROACH
The multiples approach is a group of valuation methods establishing the
value of an enterprise through comparison with other companies.
• The approach is based on transaction prices on the market.
• The basic issue here is the choice of compared companies (peers) and
economic and financial measures (comparative multipliers).
• The selection of peers should be justified.
• Companies being compared should belong to the same industry or
part of it.
• In special cases you can relate to companies from related industries,
justifying your choice.
• Comparative multiplies used in valuations are based on key economic
and financial indicators describing the asset and income potential of
the company.
MULTIPLES
There are three types of multipliers, resulting both from debt and
equity:
• Multipliers based on market value, both on the public market and
from private transactions, like P/E, P/BV.
• Multipliers based on the value of the entire enterprise, that is
both equity and debts, like EV/EBIT (Enterprise Value/Earnings
Before Interest and Taxes), EV/EBITDA (Enterprise Value/Earnings
Before Interest, Taxes, Depreciation and Amortization).
• Multipliers based on sector-specific values, like EV/hectolitres of
beer, EV/number of subscribers, EV/unique users. Valuation based
on sector-specific multipliers may not be the only valuation method
employed.
PFSA (KNF) – financial penalty
Warsaw, 18.02.2011 (ISB) – Polish Financial Supervision
Authority imposed financial penalty (PLN 0.5M) on
UniCredit CAIB Securities UK Ltd.
LOTOS EQUITY RESEARCH ( Nov. 21th 2008)
a.Valuation wasn’t based on two methods
b.Some fixed tangible assets weren’t included in ABV (NAV)
c.Lack of sensitivity analysis
Source: http://wyborcza.biz/biznes/
VALUE DRIVERS
Source: M.Panfil, A.Szablewski, History, standards and techniques of enterprise valuation [in:] Business Valuation, eds. M.Panfil, A.Szablewski, Poltext, Warsaw, 2012, p. 27
DCF VALUATION MODEL
EBIT (1-CIT) Expected growth
+ Depreciation Reinvestment Rate
- Capex Return on Capital
+ Cash on Non-oper. Asets
- Change in WC
= FCFF Firms in stable growth
TV = FCFFn+1 (1+g) / (r – gn)
FCFF1 FCFF2 FCFF3
Equity Value (FCFE) – Debt
(deductable) + Cash & Cash
FCFFn
Equivalents = Enterprise Value
(FCFF)
Cost of Equity x (E / D+E) + Cost of Debt x (1-CIT) x (D/(E+D) = WACC
(E / D+E); (D/(E+D)- weighting based on Equity and Debt (deductable)
Cost of Equity = Risk free rate + Beta * Equity Premium Risk
Source: Damodaran A, Valuation, www.damodaran.com
FCFE VALUATION
• NET PROFIT
• + DEPRECIATION
• - CAPITAL EXPENDITURES (CAPEX)
• - CHANGE IN WORKING CAPITAL
• + CASH INFLOWS FROM LOANS, CREDITS, COMERCIAL
PAPERS
• - CASH OUTFLOWS FROM ABOVE FINANCIAL INSTRUMENTS
• ----------------------------------------------------------
• FREE CASH FLOWS TO EQUITY
1. Prepare a forecast of financial statements
2. FCFE calculation
3. Equity rate calculation
4. Discounting of FCFE
5. Terminal Value calculation
6. Present value of TV
7. Equity Value
Process of FCFE valuation
TV = AFCFEn (1 +g) / (rE - g)
AFCFEn – average FCFE from the last year of forecast
rE – equity rate from the last year of forecast
g – growth rate after the last year of forecast
Terminal Value for FCFE
FCFE VALUATION
•A
g (growth rate) = 3% from 2017
EBIT * (1 - CIT)
+ DEPRECIATION & AMORTIZAION
- CAPITAL EXPENDITURES (CAPEX)
- CHANGE IN NET WORKING CAPITAL
---------------------------------------------------
FREE CASH FLOWS TO FIRM
FCFF VALUATION
ACCOUNTS RECEIVABLE CHANGE IN NET
+ INVENTORIES WORKING
- ACCOUNTS PAYABLE
-------------------------------------
CAPITAL
NET WORKING CAPITAL
1. Prepare a forecast of financial statements
2. FCFF calculation
3. Calculation of WACC
4. Discounting of FCFF
5. Terminal Value calculation
Proces of FCFF
6. Present value of TV valuation
7. Firm (Enterprise) Value
8. Net Debt calculation
9. Equity Value
TV = AFCFFn (1 +g) / (WACCn - g)
AFCFEn – average FCFF from the last year of forecast
WACCn – equity rate from the last year of forecast
g – growth rate after the last year of forecast
TERMINAL VALUE FOR FCFF
•A
FCFF Valuation
WHY COST OF EQUITY IS HIGHER THEN COST
OF DEBT?
1. SHAREHOLDERS TAKES MORE RISK THEN CREDITORS
2. TAX SHIELD EFFECT (30% FROM COST OF DEDUCTABLE DEBT
RETURNS STAYS IN THE COMPANY)
CAPM MODEL
CE = Rf + e (Rm - Rf)
CE - Cost of equity
Rf – risk free rate (e.g., yield on the 10-year T-Bonds in Canada or the
US)
Rm – expected rate from market portfolio
e – index Beta
(Rm - Rf) – market risk premium
CAPM is based on the premise that equity
investors need to be compensated for their
assumption of systematic risk in the form of a
risk premium. Systematic risk is the risk related
to the overall market, which is also known as
non-diversifiable risk. A company’s level of
systematic risk depends on the covariance of its
share price with movements in the overall
market, as measured by its BETA
WACC Analysis – based on EY practice
Notes Low High Based on review of our guideline
1 companies.
Based on review of the 5 and 10 years
historical betas of our guideline
Assumed net debt / total capital ratio Note 1 40% 30% companies, Betas obtained from
2 Bloomberg.
Assumed unlevered beta Note 2 0.90 1.10
Risk component: Relevered Beta = Unlevered Beta x (
3 1 + Net Debt / Equity x (1 - Tax Rate))
Relevered beta Note 3 1.32 1.43
The Equity Risk Premium
Equity risk premium Note 4 6.0% 6.0% approximates the difference between
7.92% 8.58% the expected rate of return on a
Risk free rate Note 5 2.79% 2.79% 4 mark et portfolio and
Size premium Note 6 2.54% 3.58% the risk -free rate on long-term
Other risks 2.0% 4.0% Government bonds.
Source: Yield on US Government 20
Cost of equity 15.3% 19.0%
year bonds per US Treasury website
5 as at the Valuation Date.
Pre-tax cost of debt Note 7 6.80% 7.70% Source: Duff & Phelps 2016 - size
Less taxes at 30.0% (2.04%) (2.25%) premiums are based on mark et
6 capitalization of mark et participants.
After-tax cost of debt 4.76% 5.45%
Based on review of relevant US
corporate bonds 15Y-30Y B to BB-
Cost of capital - nominal 11.10% 14.90% rating bond yields, based on guideline
Inflation adjustment at 2.0% Note 8 2.18% 2.25% 7 companies.
Based on Oxford Economics - long-
Cost of capital - real 9% 13% term forecasted US inflation rate of
8 2%.
