lek - valuation techniques

8/20/2019 LEK - Valuation Techniques

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Valuation Techniques Review

The materials contained in this document are intended to supplement a discussion.These perspectives will only be meaningful to those in attendance.

L.E.K. Consulting LLC

One North Wacker Drive39th Floor

Chicago, IL 60606

USA

t: 312.913.6400

f: 312.782-4583

www.lek.com

January 8, 2003


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Learning Objectives

Discuss management’s mission

Present the fundamental principle behind all value creating acquisitions and divestitures

Discuss why it is difficult for buyers to create value with mergers and acquisitions

Present a process for creating value with mergers and acquisitions

Make a distinction between price and value

Review different models used to estimate prices and values

- Asset approaches- Multiples

- Premiums- Market Capitalization- Discounted Cash Flow (DCF)


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Management's mission is to create value for shareholders

This mission has long been accepted, and is consistent with fiduciary duty andresponsibility

If shareholders are not adequately compensated, the firm will be unable to attract newcapital required to compete and eventually lose its ability to benefit any stakeholder

Focusing on shareholder value allows managers to take the actions necessary to

ensure the company's capital is put to its best use

Less clearly understood is how to:

- measure value creation

- make decisions that are consistent with this mission- measure the progress of the organization

MANAGEMENT'S MISSION


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To create value, management must choose strategies that effectively balance theneeds of all stakeholders in the long run

MANAGEMENT'S MISSION

Key Corporate Stakeholders

Strategy

V a l u

e

Government V al u e

Shareholders

V a l u e

Local Community

V a l u e

Customers

V a l u e

Suppliers

V a l u e

Employees


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Shareholder value is the guiding link among management activities

MANAGEMENT’S MISSION

Employee &Investor

Communications

PerformanceMeasurement

and InformationSystems

FinancialPolicies &Practices

Maximizationof

Shareholder Value

Shareholder value management is making all operating, investing and financingdecisions according to their impact on value. It means changing the way you thinkabout running your business and creating a culture of concern for value.

StrategyFormulation

CorporateDevelopment

IncentiveCompensation

Shareholder Value Management


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The principle of finding the highest valued use for all assets guides all acquisitionand divestiture decisions

Principle:

PortfolioImplications:

ValuationCondition:

Find the Highest Valued Usefor All Assets

Keep or Potentially Acquire Divest or Avoid Buying

Value

to You

Value

to Others>

Value

to You

Value

to Others >

CREATING VALUE WITH M&A


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However, creating value from acquisitions can be difficult for buyers

CREATING VALUE WITH M&A

Average Returns from Acquisitions

Buyer Target-10%

0%

10%

20%

30%

40%1963-681968-801980-84

S h a r e h o l d e r R e t u r n s

Source: Bradley, Desai and Kim, “Synergistic Gains From Corporate Acquisitions and

Their Division Between Stockholders of Target and Acquiring Firms,” Journal of FinancialEconomics, 21.1 (1988)


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There are several elements of successful acquisitions

Elements Purpose Key Questions

Right Strategy • Clear objectives and

criteria• Well selected candidates

Can you make an acquisition

candidate more valuable?

Right information • Correct strategyformulation

• Product/market dynamics• Assessment of synergies• Proper valuation

Do you know exactly whatyou are buying?

Right Price • Establish "walk away"price with synergies

• Assess alternative

bidder's strategies

Will you create value for your shareholders?

Right Implementation • Integration teams• Value-linked targets and

timetables• Monitoring and incenting

Can you quickly gain thebenefits?

M&A PROCESS

Elements of Successful Acquisitions


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An appropriate acquisition process helps increase the probability that you will create value with mergers and acquisitions

Strategic

Fit

Target &MarketAssess

Valuation Deal

Structure Negotiation

Due

Diligence Integration

Search and

Screen

*Sequence can vary significantly

M&A PROCESS


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Which prices and values are we calculating?

PRICE VS. VALUE

Break Up

Asset

Market

Shareholder

Stand-Alone

With Synergies

To You

To Others

Current Stock

Your Offer

Other's Offers

Max. You Will Pay

Max. Others Will Pay

Closing Price

Price Value


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The value created in an acquisition is the difference between the target's value toyou and the price you paid

Definitions of price and value:

- Price is what you pay for something

- Value is what it is worth to you

For acquisitions, these definitions have an obvious implication:

Value - Price = Value Created

PRICE VS. VALUE


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The value of a company will be the highest of its acquisition, current and break upvalues

PRICE VS. VALUE

The Value Spectrum

STRATEGY SYNERGIES

Break Up

Value

Current

Value

Acquisition

Value

Also known asasset value or liquidation value

Assumes that thebest strategy for

the business is tocease operations

Also known asstand-alone value

Assumes that thebest strategy is thecurrent strategy

Also known asvalue withsynergies

Includes synergiesthe firm might be

able to create withother businesses


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Several methods can be applied to value companies, but they are not necessarily equivalent

METHODOLOGY CALCULATION FOCUS STRATEGY

VALUED

Net Assets Assets - Liabilities Value Break-up

Comparable Multiples- Price/Earnings- Price/Cash Flow- Market Value/Book Value- Price/Sales

Calculate using current prices:P/E x EarningsP/CF x Cash FlowMarket/Book x Book ValueP/Sales x Sales

Price Current

Comparable Transactions- Premium to market value- Premium to book value- Acquisition Multiples

(Shares x Price ) + a premiumBook Value + a premiumCalculate using acquisition prices:P/E x EarningsP/CF x Cash FlowMarket/Book x Book ValueP/Sales x Sales

Price Synergistic

DCF Cash flows forecasted under thecurrent strategy discounted at theweighted average cost of capital

Value Current

DCF with synergies Cash flows forecasted usingsynergistic strategy discounted atweighted average cost of capital

Value Synergistic

PRICE VS. VALUE

Common Valuation Methods


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Because of the dynamics of the bidding environment, only unique synergies canbe reliably saved for buyers' shareholders

PRICE VS. VALUE

Example: Two Bidder Transaction

Target's

CurrentValue

Bidder A'sWalk Away

Bidder B'sWalk Away

Common Synergies(go to Seller)

UniqueSynergies(go to

Buyer)

Deal Price

Bidder A

Bidder B

It is not enough to be able to create synergies

You must be able to create more synergies than other bidders


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DCF is the appropriate valuation method for most companies

DCF yields the value of a business, not just its price

DCF value is driven by the factors that affect value of all businesses

- Cash flows- Timing- Risk

It can be used to estimate either current value or a target’s unique synergistic value

- Use expected cash flows under the current strategy to calculate a current value- Use cash flows that include the unique synergies to estimate a synergistic value

By using expected cash flows, DCF links value to changes in strategy

DISCOUNTED CASH FLOW FRAMEWORK


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The DCF framework discounts operating cash flows to estimate a company'svalue

DISCOUNTED CASH FLOW FRAMEWORK

(C)

Forecast PeriodResidual Period

+

+

=

- =

2003 2004 2005 2006 2007 2008 - - - - - - - -

Residual Value

CF CF CF CF CF1 2 3 4 5

(A)

(B)

(D)

(E)

Present Value

of OperatingCash Flow

Present Valueof Residual

Value

Non OperatingAssets

Corporate ValueMarket Value

of Debt and other Obligations

Shareholder Value


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Because value is a function of cash flow, the components of operating cash flow are known as value drivers

2002 Cash Flow from OperationsAcme Corporation

($MILLIONS)

Sales $250.0

Cash Operating Expenses (236.5)Cost of Goods Sold (196.4)

SG&A (38.8)

Economic Depletion (1.3)

Operating Profit $13.5

Cash Taxes (4.1)

Net Operating Profit After Tax (NOPAT) $9.4

Incremental Fixed Capital Investment (1.4)

Total Fixed Capital Investment (2.7)

Economic Depletion 1.3

Incremental Working Capital Investment (2.9)

Operating Cash Flow $5.1

ESTIMATING OPERATING CASH FLOW (A)


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A simple set of value drivers can be used to forecast cash flows

Forecast Cash Flow from OperationsAcme Corporation

($Millions)


2003 2004 2005

Sales (10.8% Growth) $277.0 $306.9 $340.0

Operating Expenses (261.9) (290.2) (321.5)

Operating Profit (5.4% of Sales) $15.0 $16.7 $18.5

Cash Taxes (36% of Op. Profit) (5.4) (6.0) (6.6)

NOPAT $9.6 $10.7 $11.8

Incr. Fixed Capital Investment(5.0% of Change in Sales) (1.3) (1.5) (1.7)

Incr. Working Capital Investment(10.0% of Change in Sales) (2.7) (3.0) (3.3)

Operating Cash Flow $5.6 $6.2 $6.9


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The weighted average cost of capital is used to discount cash flows to a present value

It is the weighted average return required by a company's debt and equity investors

In order to create value, companies must earn a return greater than the cost of capital

Cost of capital varies across business units, companies and industries and is affectedby capital structure

If the cost of capital is not known, it is impossible to know whether value is beingcreated


Weighted Average Cost of Capital Formula

K = Kd x (1 - T) x + Ke xDebt

Debt + EquityEquity

Debt + Equity( )( )

KKdTDebtEquityKe

======

Weighted Avg. Cost of CapitalCost of DebtCash Tax RateMarket Value of DebtMarket Value of EquityCost of Equity

Where:


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The cost of equity is calculated using the Capital Asset Pricing Model (CAPM)

h Risk-free rateqThe return investors could make by investing in a perfectly safe securityqUse the ten-year government bond yield

h Market risk premiumqThe amount above the risk-free rate that investors demand for accepting the systematic

risk that cannot be diversified away when investing in the stock market

h Adjustment for firm risk

qThe extent to which a company has more or less systematic risk than the marketqAlso adjusts for the amount of financial leverage a company has in its capital structure

Cost of Equity =Return on a

Risk-Free

Investment

+ Market Risk

Premium X

Adjustmentfor Firm Risk

(Beta)

Cost of Equity Formula

[[



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The cost of equity increases as debt is added to the capital structure

Suppose that you own 50% of a business:

Value = $100

Your Ownership:

Your Risk:

Your Volatility:

100% Equity Financing

+/- $10

Your Stake50% Equity

Other’s Stake50% Equity

$50

+/- $5

10%

If some owners are insulated from risks (e.g., debt holders) the other owners (e.g., shareholders) must face increased risk.

50% Debt Financing

+/- $10

Your Stake100% Equity

Other’s Stake

100% Debt

$50

+/- $10

20%



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Therefore, if you are using a peer group approach to calculate the cost of equity,and the peers have different leverage than the business being valued, their betas

must be “relevered”

0%

2%

4%

6%

8%10%

12%

14%

16%

18%

20%

0 % 8 % 1 6 %

2 4 %

3 2 %

4 0 %

4 8 %

5 6 %

6 4 %

7 2 %

Debt / Total Capital

R a t e o f

R e t u r n

Cost of Equity

Pre-Tax Cost of DebtCost of Capital

Cost of Capital as a Function of Leverage

PeersTargetLeverage



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You can use the “Peer Group Beta” sheet to perform this calculation


Peer Group Beta Analysis

Peers for: Acme Corporation

Peers

Peer

(Levered)

Beta

Peer Debt to

Equity %

Peer

Operating

Cash Tax

Rate %

Unlevered

Beta

Target Debt

to Equity %

Company

Operating

Cash Tax

Rate %

Relevered

Beta Weight

Peer 1 0.93 15.4% 35.0% 0.84 9.8% 35.0% 0.90 1.00Peer 2 1.29 124.0% 37.2% 0.73 9.8% 35.0% 0.77 1.00

Peer 3 1.20 5.8% 36.0% 1.16 9.8% 35.0% 1.23 1.00

Peer 4 1.33 45.1% 38.0% 1.04 9.8% 35.0% 1.11 1.00

Peer Group Weighted Average

Relevered Beta: 1.00

Peer Information Company Information


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To calculate residual value, use the model that corresponds to the economics of the firm after the forecast period

RESIDUAL VALUE (B)

Valuation Model

Net Asset

ComparableTransaction Multiple

DCF Perpetuity

Economic Assumption at the End of the Forecast Period

All assets sold, and all liabilities retired

The business will be sold at the current average premium

No value is created after the forecast period (i.e. all new

investments return the cost of capital)

Value is either created or destroyed indefinitely into the future DCF Perpetuity withGrowth


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The straight perpetuity method implies that value is neither created nor destroyed after the forecast period

RESIDUAL VALUE (B)

The economic assumption is that companies earning rates of return in excess of thecost of capital will attract competition that will eventually drive investment returnsdown to the cost of capital

This implies that the average rate of return on new investments will equal the cost of capital, hence no incremental value is created for investments made beyond theforecast period. There may be growth in the business, but not in value

Forecast Period Residual Period

Cost of Capital

EconomicReturns

Time


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If value is neither created nor destroyed in the residual value period, then NOPAT is the basis for calculating a perpetuity residual value

Last Forecast Year:Sales

- Operating Expenses- Economic Depletion of Assets (Depreciation)- Cash Taxes on Operating Profit

Net Operating Profit After Tax (NOPAT)

+ Economic Depletion of Assets- Fixed Capital Investment- Working Capital Investment

Operating Cash Flow

Since incremental investments in residual period yield NPV=0, the straight perpetuityvalues a perpetual stream of the last forecast period’s NOPAT using the formula:

Straight Perpetuity NOPATResidual Value = Cost of Capital

Adjustments to last forecast year NOPAT may be required if it is not representative of future levels

RESIDUAL VALUE (B)

Investments madein residual periodhave no value impact


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When using the straight perpetuity method, the forecast period must be chosen tocoincide with the period of time investors believe a company will create value with

their current strategy - the value growth duration (VGD)

This can be different than standard forecast periods, or management's assessment of their competitive advantage period

Factors to consider when estimating the forecast period

- Proprietary technologies- Patented products- Product life cycles- Established brands

- Distribution channels- Company strategy

FORECAST PERIOD (C)

Source: APT!, Value Line 1Q/2000, L.E.K. Analysis

Industry Value Growth Durations

Value Growth DurationIndustry (Using Straight Perpetuity)

Banking 1-5 yearsFood Products 3-10 yearsFast Foods 3-15 yearsPharmaceutical 15+ yearsBeer and Wine 2-20 yearsAirlines 3-10 years

Industry Value Growth Durations

Value Growth DurationIndustry (Using Straight Perpetuity)

Banking 1-5 yearsFood Products 3-10 yearsFast Foods 3-15 yearsPharmaceutical 15+ yearsBeer and Wine 2-20 yearsAirlines 3-10 years


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The DCF framework discounts free operating cash flows to estimate Acme’sshareholder value

THE DISCOUNTED CASH FLOW FRAMEWORK

Market Valueof Debt and Other

Obligations$10.8

Shareholder ValueTotal

$100.0

(C)

Forecast PeriodResidual Period

CumulativePresent Valueof Cash Flow

$32.1

+

+

=

- =

Present Valueof Residual

Value

$77.6

Non OperatingAssets

$1.0

Corporate Value$110.8

2003 2004 2005 2006 2007 2008 - - - - - - - -

Residual Value$127.7

CF CF CF CF CF1 2 3 4 5(A)

(B)

(D)

(E)

($000)


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You can calculate a business’ value using the “Shareholder Value” sheet


Shareholder Value Calculator

Company Name: Acme CorporationScenario: Base CaseUnits: $ millions

Shareholder Value $100.0Shareholder Value Per Share $10.00

Value Growth Duration (Years) 5Residual Value Approach or Value NOPAT/K

Value Drivers: 2002 2003 2004 2005 2006 2007

Historical Sales $250.0Sales Growth (G) 12.00% 12.00% 11.00% 10.00% 9.00%

Operating Profit Margin (P) 6.00% 7 .00% 7.00% 6 .00% 5.00%

Operating Cash Tax Rate (T) 36.00% 36.00% 36.00% 36.00% 36.00%Incremental Fixed Capital Investment (F) 5.00% 5.00% 5.00% 5.00% 5.00%

Incremental Working Capital Investment (W) 10.00% 10.00% 10.00% 10.00% 10.00%

Cost of Capital (K) 10.46% 10.46% 10.46% 10.46% 10.46%Non-Operating Assets $1.00 $1.00 $ 1.00 $1.00 $ 1.00Market Value of Debt $10.80 $10.80 $10.80 $10.80 $10.80

Number of Shares Outstanding 10.000 10.000 10.000 10.000 10.000

Operating Cash Flows & Value:

Sales $250.0 280.0 313.6 348.1 382.9 417.4Operating Costs 263.2 291.6 323.7 359.9 396.5

Operating Profit 16.8 22.0 24.4 23.0 20.9

Cash Taxes 6.0 7.9 8.8 8.3 7.5Net Operating Profit After Taxes (NOPAT) 10.8 14.0 15.6 14.7 13.4

Fixed Capital Investment 1.5 1.7 1.7 1.7 1.7

Working Capital Investment 3.0 3.4 3.4 3.5 3.4

Cash Flow (CF) 6.3 9.0 10.4 9.5 8.2

Discount Factor 0.9053 0 .8196 0.7420 0.6717 0 .6081

Present Value (PV) of CF 5.7 7.4 7.7 6.4 5.0

Cumulative PV of CF 5.7 13.0 20.8 27.1 32.1

Residual Value (NOPAT Perpetuity Method) 127.7

PV of Residual Value 77.6Non-Operating Assets 1.0

Corporate Value 110.8Market Value of Debt 10.8

Shareholder Value (SHV) $100.0

Share Price $10.00

THE DISCOUNTED CASH F OW FRAMEWORK


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What long-term expectations explain Acme’s $100 per share stock price?

Acme Corporation

Value Driver

2002 Sales

Forecast Period

Sales Growth

Profit Margins

Cash Tax Rate

Incremental FixedCapital Investment

Incremental WorkingCapital Investment

Cost of Capital

Cash Flows

$25.4M

84.4M

1.0M

(10.8M)

$100.0M

PV Operating

Cash Flows

PV Residual Value

PV Investments

Debt and Obligations

Shareholder Value

$11.00

$10.00

Shareholder Value

Per Share

Stock Price

$250.0M

5 years

10.8%

5.4%

36.0%

5.0%

10.0%

10.5%




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The “Sensitivity Analysis” sheet identifies the value drivers with the greatest impact on value


Sensitivity Analysis

Company Name: Acme Corporation

Scenario: Value Line

Value Driver Value Multiplicative Modifier

Additive

Modifier Low Range High Range

Sales Growth (G) 10.8% 10.0% 1.0% 9.8% 11.8%Operating Profit Margin (P) 5.4% 10.0% 1.0% 4.4% 6.4%Operating Cash Tax Rate (T) 36.0% 10.0% 1.0% 35.0% 37.0%

Incremental Fixed Capital Investment (F) 5.0% 10.0% 1.0% 4.0% 6.0%Incremental Working Capital Investment (W) 10.0% 10.0% 1.0% 9 .0% 11.0%Cost of Capital (K) 10.5% 10.0% 1.0% 9 .5% 11.5%

$ millions

Low High Low High Low High

Sales Growth (G) ($2.7) $3.1 ($2.7) $2.8 ($3.2) $2.3

Op. Profit Margin (P) ($11.7) $12.8 ($23.7) $23.7 ($5.1) $42.3

Cash Tax Rate (T) $6.6 ($7.2) $2.0 ($2.0) $2.0 ($2.0)

Incr. Fixed Cap. (F) $0.6 ($0.6) $1.2 ($1.2) $1.2 ($1.2)

Incr. Working Cap. (W) $1.1 ($1.2) $1.2 ($1.2) $1.2 ($1.2)

Cost of Capital (K) $12.4 ($11.2) $13.1 ($10.7) $13.1 ($10.7)

Multiplicative

Sensitivity Analysis Results

Additive Range

Range

Change in Shareholder Value

Multiplicative Sensitivity

Cost of

Capital (K)

Incr. Working

Cap. (W)

Incr. Fixed

Cap. (F)

Cash Tax

Rate (T)

Op. Profit

Margin (P)

Sales Growth

(G)

-$15 -$10 -$5 $0 $5 $10 $15


Additive Sensitivity

Cost of

Capital (K)

Incr. Working

Cap. (W)

Incr. Fixed

Cap. (F)

Cash Tax

Rate (T)

Op. Profit

Margin (P)

Sales

Growth (G)

-$30 -$20 -$10 $0 $10 $20 $30


Range Sensitivity

Cost of

Capital (K)

Incr. Working

Cap. (W)

Incr. Fixed

Cap. (F)

Cash Tax

Rate (T)

Op. Profit

Margin (P)

Sales

Growth (G)

-$20 -$10 $0 $10 $20 $30 $40 $50


SUMMARY


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Valuation Techniques Review

The goal of mergers and all other strategies is to create value

Creating value with acquisitions is difficult

The fundamental principle behind all acquisitions and divestitures is:

The best way to determine whether an acquisition will add value is to ask, "Why is thistarget worth more to us than to any other bidder?”

Only unique synergies can be reliably saved for the buyer's shareholders

Don’t confuse valuation techniques that calculate prices with those that calculatevalues

- Value is what something is worth to you

- Price is what someone pays for it

DCF acquisition value is the best way to ascertain an acquisition’s unique value to your company

SUMMARY

Find the Highest Valued Usefor All Assets


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Appendices:

Value Driver Reference Sheets

Net Asset Valuation Example

Current Multiples Example

Transaction Multiples Example

Proof of the Equivalence of Perpetuity Residual Value Approaches

VALUE DRIVER REFERENCE SHEET


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Value Driver Description Formula Hints

Sales Growth(G)

Sales growth rateanticipated during theforecast period

Where: N = # years

Calculate this rate using % Growth,exponent, or PV, FV keys on acalculator

OperatingProfit Margin(P)

Pre-Tax Operating profitsas a percent of Sales

Sales – Op. ExpensesSales

Subtract economic depletion of assets in OP. Exp. (or useDepreciation as a proxy).

Cash Tax Rate(T)

Cash Taxes that wouldhave been paid if the firmhad no debt as a percent of Operating Profits

T = Cash Taxes / Op. Profit

Where Cash Taxes =+ Book Taxes- Non. Operating Taxes+ Interest Tax Shield- Incr. In Deferred Tax Liability

Interest Tax Shield is the tax savingsresulting from Debt(Interest Expense x Tax Rate)

The tax advantage of debt will beincluded in valuations by using theafter-tax cost of debt in the weighted

average cost of capital. Not in cashflows.

Incremental FixedCapital Investment(F)

The addition to fixedcapital, over and abovemaintenance capitalexpenditure, as a percentof change in sales

F =

Depreciation can be used as a proxyfor Economic Depletion of Assets.

IncrementalWorking CapitalInvestment(W)

The addition to workingcapital as a percentage of change in sales

Ch. In Working CapitalChange in Sales

Where Working Capital =Operating Current Assets (-)Operating Current Liabilities

Exclude cash not necessary for operations (add it to non-operatingassets).

Exclude Short Term Debt.Exclude Deferred Taxes

Future SalesLast Historical Sales( )

N

1

-1

P =

( )Total CAPEX -Econ. Depl. Of AssetsChange in Sales

W =



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Cost of Capital(K)

The weightedaverage returnthat a company'sdebt and equityholders requiregiven the levelsof risk of their investments

K = [K x %Eq] + [K x (1-T) x %Debt]

Where:

K = Cost of Equity= Risk-free Rate + (Beta x MRP)

K = Cost of DebtT = Cash Tax Rate

%Eq = Equity/(Debt + Equity)%Debt = Debt/(Debt + Equity)

For public companies get Beta frompublished sources. Use peer groupanalysis for private firms/divisions.Betas may need to be relevered if thetarget capital structure of peers differsfrom that of the firm being valued.

Cost of debt is the weighted average

yield to maturity for public firms. Usecomparables or bond rating analysisfor private firms.

%Eq and %Debt should be the firm'starget capital structure for the future.

Use Market values for debt and equity.

Number of ForecastPeriods (N)(Value GrowthDuration)

The number of periods investorstoday are willingto bet the firmbeing valued willbe able to createvalue with itscurrent strategy

Estimate qualitatively by asking howlong it would take for a company to enter the industry, emulate the strategy and"compete away" the firm's advantage.

OR

Estimate quantitatively by using marketsignals analysis

Consider:

Proprietary TechnologiesDistribution ChannelsPatented ProductsProduct Life CyclesEstablished BrandsOther Competitive Advantages

e

e

d



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Residual Value(RV)

The value of afirm after theforecast period(N)

If returns = K after the fcst period:RV = NOPAT / K

If value is created in perpetuity:

If firm will be sold after fcst period:RV = After-tax Sale Price

Returns equal K is almost always thebest assumption for going concerns.

Value creation in perpetuity should onlybe used for monopolies and other instances where an advantage can never

be competed away.

Don't forget to take the present value of residual value.

Non-OperatingAssets (NOA)

Anything that hasvalue that hasnot been

included inWorking Capitalor cash flows

NOA =Marketable Securities

+ Real Estate

+ Investments in Affiliates

Use market values or recently appraisedvalues to estimate non-operating assets.

Market Value of Debt (MVD) andother obligations

Anything thatcould detractfrom the value of the firm to

shareholders notreflected in cashflows

MVD =Mkt. Value of Debt Instruments

+ Underfunded Pensions+ Environmental Liabilities

+ Litigation Liabilities

Use market values, recently appraisedvalues or expected values to estimatemarket value of debt.

Any time the yield to maturity is differentthan the coupon rate, book value willmisstate market value for debt.

RV = CFT + 1

(K - G)

VALUATION METHODS


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Asset-based valuation has several advantages:

- Asset value data is often easy to obtain- The calculation is theoretically simple

However, it is not relevant for valuing going concerns and can be difficult to apply

- Market values for illiquid assets may be difficult to ascertain- Book value accounts may be old- Foreign accounting practices may make adjustments difficult

Example: Acme

Value = Assets - Liabilities

Asset value can be used to estimate break-up values

Value = Assets - Liabilities$61,480M = $72,280M - $10,800M

COMPARABLE MULTIPLES


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Comparable multiples analysis can be used to estimate the current value of private companies

Current Multiples Analysis

Company Name: Acme CorporationUnits: $ thousands

Peer Companies Share Price

Number of

Shares

Market Equity

Value Debt

Corporate

Value Sales EBITDA Earnings

Book Equity

Value

Peer 1 $17.0 2,153.0 $36,601.0 $11,301.0 $47,902.0 $97,874.1 $7,487.4 $3,011.8 $20,148.6Peer 2 $12.0 13,670.0 $164,040.0 $45,001.0 $209,041.0 $308,334.4 $26,346.9 $14,706.2 $89,206.0Peer 3 $3.5 14,659.0 $51,306.5 $33,294.0 $84,600.5 $135,093. 3 $11,967.7 $4,720.1 $38,367.3Peer 4 $8.0 4,230.0 $33,840.0 $14,993.0 $48,833.0 $127,974. 3 $8,547.3 $3,495.3 $21,189.3Peer 5 $14.0 6,661.0 $93,254.0 $36,121.0 $129,375.0 $247,594. 1 $17,996.2 $7,288.8 $70,029.0

Peer Total $379,041.5 $140,710.0 $519,751.5 $916,870.2 $72,345.5 $33,222.3 $238,940.3

Acme Corporation $10,800.0 $250,000.0 $14,800.0 $7,105.0 $61,480.0

Value eight Value eight Value eight Value eight

Peer 1 0.5 1 6.4 1 12.2 1 1.8 1Peer 2 0.7 1 7.9 1 11.2 1 1.8 1Peer 3 0.6 1 7.1 1 10.9 1 1.3 1Peer 4 0.4 1 5.7 1 9.7 1 1.6 1Peer 5 0.5 1 7.2 1 12.8 1 1.3 1

Peer Weighted Average Average

Implied Equity Prices $98,182.2

Implied Corporate Prices $108,982.2

Peer Companies

0.54 6.86 11.33

Sales Multiple EBITDA Multiple P/E Multiple

$97,401.1

Market/Book Ratio

$134,887.2 $101,537.5 $91,302.9 $108,201.1

1.58

$124,087.2 $90,737.5 $80,502.9

TRANSACTION MULTIPLES


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Comparable transactions can be used to calculate acquisition prices of privatecompanies

Transaction Multiples Analysis

Company Name: Acme CorporationUnits: $ thousands

Target Acquirer

Transaction

Date

Market Equity

Value Debt

Corporate

Value Sales EBITDA Earnings

Book Equity

ValueTarget 1 Company 1 12/11/2002 $3,213.0 $1,344.4 $4,557.4 $6,636.9 $496.6 $228.5 $1,660.8

Target 2 Company 2 9/20/2002 $72,387.0 $56,729.7 $129,116.7 $175,096.9 $12,010.6 $4,444.5 $34,276.8

Target 3 Company 3 3/5/2002 $23,373.0 $8,678.0 $32,051.0 $47,183.7 $2,906.7 $1,338.2 $11,183.0

Target 4 Company 4 10/11/2001 $1,512.0 $703.1 $2,215.1 $3,720.3 $108.4 $2.7 $751.1

Peer Total $100,485.0 $67,455.2 $167,940.2 $232,637.9 $15,522.3 $6,013.9 $47,871.8

Acme Corporation $10,800.0 $250,000.0 $14,800.0 $7,105.0 $61,480.0

Value eight Value eight Value eight Value eightTarget 1 0.7 1 9.2 1 14.1 1 1.9 1

Target 2 0.7 1 10.8 1 16.3 1 2.1 1Target 3 0.7 1 11.0 1 17.5 1 2.1 1

Target 4 0.6 1 20.4 0 558.1 0 2.0 1

Peer Average Average

Implied Equity Prices $134,569.5

Implied Corporate

Prices $145,369.5

Market/Book Ratio

0.67 10.32 15.94 2.04

Target Sales Multiple EBITDA Multiple P/E Multiple

$157,872.6 $141,902.7 $113,245.7 $125,257.0

$168,672.6 $152,702.7 $124,045.7 $136,057.0

VALUATION METHODS


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The various proxies for Acme's value can be placed along a value spectrum

Value Spectrum for Acme

$157.8

$141.9

$125.3$124.1

$113.2

$100.0

$97.4

$90.7

$80.5

$61.4

$ - $ 2

0 . 0 $ 4

0 . 0 $ 6

0 . 0 $ 8

0 . 0

$ 1 0 0

. 0

$ 1 2 0

. 0

$ 1 4 0

. 0

$ 1 6 0

. 0

$ 1 8 0

. 0

Trans. Sales Multiple

Trans. EBITDA Multiple

Trans. Mkt/Bk MultipleCurrent Sales Multiple

Trans. P/E Multiple

DCF Stand Alone

Current Mkt/Bk Multiple

Current EBITDA Multiple

Current P/E Multiple

Asset Value

($ millions)


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Proof of the equivalence of perpetuity residual value approaches

Definitions:

CF = Cash Flow

NOPAT = Net Operating Profit After Tax

g = Growth Rate of Cash Flows

r = Percentage of Cash Flows Reinvested

(Reinvestment Rate )

ROC = Return on Capital Invested

K = Cost of Capital

Relationships:

1. Cash Flow is NOPAT minus Investment

CF = NOPAT * (1 - r)

2. The percentage growth in Cash flows isthe percentage of Cash Flow reinvestedmultiplied by the expected return on

investment

g = r x ROC

Proof:

InsertRelationship 2

InsertRelationship 1

AssumeROC = K

CFK - g

NOPAT * (1 - r)K - (r x ROC)

NOPAT * (1 - r)K * (1 - r)

NOPATK

= = =

lek - valuation techniques

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