CLASS 8 FIRM VALUATION

Bridge Program 2005 Finance module

Finance, Bridge Program 2005

Contents
1 2 Valuing PSFT Final review 3 7

Finance, Bridge Program 2005

1 Valuing PSFT
Financial forecasts - automatic cash ow estimation exercise.
Time Sales Cost R&D EBIT Income WC Change in WC CF 0 2200 990 400 810 526.5 110 1 2376 1069.2 436 870.8 566.0 118.8 8.8 557.2 2 2566.1 1154.7 475.2 936.1 608.5 128.3 9.52 599.0 3 2771.4 1247.1 518.0 1006.2 654.1 138.6 10.3 643.8 4 2993.1 1346.9 564.6 1081.6 703.0 149.7 11.1 691.9 5 3232.5 1454.6 615.4 1162.4 755.6 161.6 12.0 743.6

Note: depreciation and capex cancel each other out.

Finance, Bridge Program 2005

Measuring risk
Given the time-series data on PSFT one can nd A 1.94. This would call for a discount rate of r = 5% + 1.93(5%) = 14.68% Comparable companies looked a bit more risky. Equity value SEBL CA DST 4990 15912 4032 Firm value 5590 18212 5832 Equity ratio 0.89 0.87 0.69 E 3.5 2.4 3.2 A 3.12 2.1 2.21

The average beta of the assets of these companies is A 2.48, which suggests r = 5% + 2.48(5%) = 17.4% Finance, Bridge Program 2005 4

Current valuation
If there are 364.8m shares of PSFT outstanding, and the stock is trading at $16.25, the market is valuing PSFT at about $6b. At 17% discount our projections yield a valuation for PSFT around $4.5b ($5.5b using the 14.68% rate). The rm would need to have a growth rate of sales around 15% for the rst 5 years in order for our model to reproduce the market valuation.

Finance, Bridge Program 2005

Random remarks
Note we used market values of equity (price times shares outstanding) when nding the equity ratio: book values of equity are very unreliable estimates of the (market) value of equity. Book value of debt is a decent proxy for its market value (although choose market values if you can!). Alternative valuation: steady state sales of $3b, costs at 60% of revenue. Then V = 780 EBIT(1 ) = = $5.068b rg 0.174 0.02

Arguably as accurate (or more) as what we did in class.

Finance, Bridge Program 2005

2 Final review
Example 1
Consider the following information on zero-coupon bonds with face value of $100. Maturity 1 2 3 Price 95 89 82

What is the price of a 3-year 15% coupon bond with a face value of $1m? $1.219m is the PV of future cash ows. What coupon rate would you choose so that a 3-year bond with a face value of $1m would sell for $1.2m? With a coupon of 14.28% the bond will sell for $1.2m. Finance, Bridge Program 2005 7

Example 2
E Price per share Firm A Firm B Firm C 2.5 0.8 1.5 $15 $10 $8 Shares outstanding 2m 1m 1m Book value of equity $15m $4m $2m Book value of debt $10m $5m $20m

Assume that the debt of the above is riskfree. The assets of which of the above rms are riskier?

Finance, Bridge Program 2005

Example 2
We determine the riskyness of an asset by its market risk, i.e. its beta. Note that we are given equity (stock) betas, so we need to delever to nd the asset betas. When nding rm value (debt plus equity): you should use market values of equity and not book values! Beta equity 2.5 0.8 1.5 BV debt 10 5 20 E 30 10 8 E/V 0.750 0.667 0.286 Beta Assets 1.875 0.533 0.429

Assets from rm A are the riskiest, followed by B an C.

Finance, Bridge Program 2005

Example 3
Project that generates revenues of $100m in the next 5 years. CGS at 50% of revenues. Initial investment of $125m, depreciated straight line over 5 years. Discount rate of r = 10%. Tax at 50%. What is the NPV of the project? Its IRR?

Finance, Bridge Program 2005

10

Example 3
Cash ow: EBIT(1 ) + Depr = 25(1 0.5) + 25 = 37.5 So applying NPV rule 37.5 NPV = 125 + 0.1 IRR is around 15.2%. 1 1 1.15 = 17 > 0

Finance, Bridge Program 2005

11

Example 4
SD Mortadelo Filemn o Zape 0.3 0.5 0 Price 30 20 10 Book value of equity 800 500 200 Shares outstanding 50 100 30

Mortadelo and Filemn have a correlation of 0.5. o What is the standard deviation of a portfolio that invests 50% in Mortadelo and 50% in Filemn? (35%). o How about the standard deviation of a portfolio that invests 50% in Mortadelo and 50% in Zape? (15%).

Finance, Bridge Program 2005

12

Example 4
What is the market portfolio if these companies were the only ones publicly traded? Compute the market capitalization of each of the three securities in order to get the market weights w1 = 39.47%, w2 = 52.63%, and w3 = 7.89%. What is the standard deviation of the market portfolio? The standard deviation of the market portfolio is 33.8%.

Finance, Bridge Program 2005

13