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An overview
✦ Comparable multiples
■ P/E multiple
◆ WACC method
◆ APV method
◆ CF to Equity method
©2001 M. P.
University of Michigan 2
Narayanan
FIN Valuation: P/E multiple
■ firms in the industry have similar growth (more likely for “mature”
industries)
■ firms in the industry have similar capital structure
©2001 M. P.
University of Michigan 3
Narayanan
FIN Valuation: Price to book multiple
©2001 M. P.
University of Michigan 4
Narayanan
FIN
Valuation: Value to EBITDA
multiple
✦ This multiple measures the enterprise value, that is
the value of the business operations (as opposed to
the value of the equity).
✦ In calculating enterprise value, only the operational
value of the business is included.
✦ Value from investment activities, such as investment in
treasury bills or bonds, or investment in stocks of other
companies, is excluded.
✦ The following economic value balance sheet clarifies
the notion of enterprise value.
©2001 M. P.
University of Michigan 5
Narayanan
FIN Enterprise Value
$1850 $1850
Enterprise Value
©2001 M. P.
University of Michigan 6
Narayanan
FIN
Value to EBITDA multiple:
Example
✦ Suppose you wish to value a target company using the
following data:
■ Enterprise Value to EBITDA (business operations only)
multiple of 5 recent transactions in this industry: 10.1, 9.8, 9.2,
10.5, 10.3.
■ Recent EBITDA of target company = $20 million
■ Cash in hand of target company = $5 million
■ Marketable securities held by target company = $45 million
■ Interest rate received on marketable securities = 6%.
■ Sum of long-term and short-term debt held by target = $75
million
©2001 M. P.
University of Michigan 7
Narayanan
FIN
Value to EBITDA multiple:
Example
✦ Average (Value/ EBITDA) of recent transactions
■ (10.1+9.8+9.2+10.5+10.3)/5 = 9.98
©2001 M. P.
University of Michigan 8
Narayanan
FIN
Valuation: Value to EBITDA
multiple
✦ Since this method measures enterprise value it
accounts for different
■ capital structures
■ cash and security holdings
✦ By evaluating cash flows prior to discretionary capital
investments, this method provides a better estimate of
value.
✦ Appropriate for valuing companies with large debt
burden: while earnings might be negative, EBIT is likely
to be positive.
✦ Gives a measure of cash flows that can be used to
support debt payments in leveraged companies.
©2001 M. P.
University of Michigan 9
Narayanan
FIN Heuristic methods: drawbacks
©2001 M. P.
University of Michigan 10
Narayanan
FIN Valuation: DCF method
©2001 M. P.
University of Michigan 11
Narayanan
FIN DCF methods: Starting data
©2001 M. P.
University of Michigan 12
Narayanan
FIN Template for Free Cash Flow
Working capital
Year 0 1 2
Revenue
“Income Statement”
Costs
Depreciation of equipment Noncash item
Profit/Loss from asset sales Noncash item
Taxable income
Tax
Net oper proft after tax (NOPAT)
Depreciation Adjustment for
Profit/Loss from asset sales for non-cash
Operating cash flow
Change in working capital
Capital Expenditure Capital items
Salvage of assets
Free cash flow
©2001 M. P.
University of Michigan 13
Narayanan
FIN Template for Free Cash Flow
©2001 M. P.
University of Michigan 14
Narayanan
FIN Template for Free Cash Flow
©2001 M. P.
University of Michigan 16
Narayanan
FIN Template for Free Cash Flow
©2001 M. P.
University of Michigan 17
Narayanan
FIN Estimating Horizon
perpetuity model.
■ Use a Enterprise value to EBIT multiple, or some such multiple
©2001 M. P.
University of Michigan 18
Narayanan
FIN Costs of debt and equity
©2001 M. P.
University of Michigan 19
Narayanan
FIN Model of a Firm
DEBT and
other EQUITY
liabilities
©2001 M. P.
University of Michigan 20
Narayanan
FIN Value of equity
✦ Value of equity
= Enterprise value
+ Value of cash and investments
- Value of debt and other liabilities
©2001 M. P.
University of Michigan 21
Narayanan