Company Valuation

Abstract

Company valuation is the core of many corporate finance courses, and it represents one of the most challenging tasks to perform in relation to the analysis of company financials.

Appendices

Problems

• 1. Assuming we are valuing a going concern, which of the following types of income streams would be most appropriate for valuing the company?

  • (a) Earnings before interest and taxes

  • (b) Free cash flows

  • (c) Operating income after taxes

  • (d) Price to earnings ratio

• 2. The following estimates have been made for 2006:

  Operating income (EBIT): 6000 €

  Depreciation: 500 €

  Cash taxes to be paid 950 €

  Income from nonoperating assets: 60 €

  No capital investments or changes to working capital are expected. Based on this information, the projected free cash flows for 2006 are:

  • (a) 5610 €

  • (b) 4550 €

  • (c) 4490 €

  • (d) 6550 €

• 3. Marshall Company is considering acquiring Lincoln Associates for 600,000 €. Lincoln has total outstanding liabilities valued at 200,000 €. The total purchase price for Marshall to acquire Lincoln is:

  • (a) 200,000 €

  • (b) 400,000 €

  • (c) 600,000 €

  • (d) 800,000 €

• 4. The valuation process will often analyze several value drivers to understand where value comes from. Which of the following value drivers would be least important to the valuation?

  • (a) Return on invested capital

  • (b) Earnings per share

  • (c) Cash flow return on investment

  • (d) Economic value added

• 5. You have been asked to calculate a terminal value for a valuation forecast. The normalized free cash flow within the forecast is 11,400 €. A nominal growth rate of 3% will be applied along with a weighted average cost of capital of 15%. Using the dividend growth model, the terminal value that should be added to the forecast is:

  • (a) 78,280 €

  • (b) 86,200 €

  • (c) 95,000

  • (d) 97,850

• 6. Information from a valuation model for Gemini Corporation is summarized below:

  Total present value of forecasted free cash flows: 150,000 €

  Terminal value added: 450,000 €

  Total present value of nonoperating assets: 20,000 €

  Total present value of outstanding debts: 120,000 €

  If Gemini has 20,000 shares of outstanding stock, the value per share of Gemini is:

  • (a) 15.00 €

  • (b) 25.00 €

  • (c) 30.00 €

  • (d) 35.00 €

Case 8.1: Company Valuation

Cashgrow Ltd

The Case

Cashgrow Ltd is a well-established company operating in the field of renewable energies. They recently topped up to a record $1.85 bn in sales after launching a new power generator with increased efficiency and environmental friendliness.

The generator has been the last of a series of successful projects undertaken by the company, which comes from 5 years of continuous growth in sales, gross income, and net income.

For this reason, and given the need for the company to increase the scale of its operations, the management of Cashgrow decided that the company will go public in the coming year.

Going public means the company will go through an IPO, with related consequences in terms of market capitalization, share appreciation, and cash inflows. The IPO will coincide with the most important capital restructuring for the company since its birth.

Jihad is one of the senior financial analysts working in the team of the CFO office. He has been selected to lead a team of analysts who will carry on a preliminary valuation of the company Equity to have an idea of what to expect from the IPO.

After consulting his team, Jihad tells the management that they are going to apply a discounted cash flow (DCF) approach to the valuation of Cashgrow. That should give a good estimation of the market value of the company.

The valuation team gathers the most important financial statement items as well as the main variables involved in the analysis. The entries from both the balance sheet and the income statement are summarized in Table 8.7.

Table 8.7 Accounting items of Cashgrow in the last 5 years

Since Cashgrow is not yet public, the valuation must be run by using comparable firms and the sector as a source of financial information. In particular, there are three companies that are comparable to Cashgrow. The financial variables of those companies and the market that are pertinent to the analysis are summarized in Table 8.8.

Table 8.8 Financial variables of the companies and the market

Given that the company has substantial debt in the book, Jihad specifies to the managers that the team will be valuing the company based on a two-stage free cash flow to firm (FCFF) variant of the DCF model.

Questions

• 1. If you were Jihad, how would you proceed for the calculation of the company’s value? What are the main steps in the two-stage FCFF valuation model?

• 2. How can the variables in Tables 17.1 and 17.2 be used to calculate the parameters needed in the analysis?

• 3. What choices would you make for the growth of the cash flows over time? How can you justify these choices?

• 4. What model would you use to calculate the cost of equity of the firm?

• 5. What discount rate would you apply to the projected cash flows to run the valuation? What model would you use to calculate it?