net

income-interest ROIC: five sources of price premium: Employee stock options -> holder can buy a
ROA =
total assets 1. innovative products Cost of capital certain amount of shares (use Black-
net income- interest 2. quality D E Scholes or exercise value approach; creates
ROE = WACC = ×k f × 1 − t + ×k g
total equity 3. brand V V extra equity when exercised)
NOPLAT 4. customer lock-in k g = rh + β(E(rj -rh ) Convertible bonds -> bonds that can be
ROIC =
Invested Capital 5. rational price discipline: one Approp. market risk premium: 4.5-5.5% exchanged for common equity (does not
EBIT competitor acts as the leader and Beta create additional equity if exercised)
operating margin = D(1 − t)
Sales others replicate price moves
βg = βk (1 + )
cost eff. – selling products at a cost lower E Forecasting approaches:
Deconstructed ROIC βl
than competition βk = Top-down: estimate revenues by sizing the
op. earnings revenues D 1−t
= × ×(1 − t) capital eff. – selling more products/$ of IC 1+ whole market and forecasting prices
revenues Av. IC than competitors E Bottom-up: use company’s forecasts of
basis points: 100 bp = 1%
After-tax cost of debt: demand from existing customers
Net income = (Revenues – operating exp) x
Four sources of competitive advantages Use YTM
(1-tax)
deriving from cost and capital efficiencies: Promised CF Multiples
Price =
1. innovative business method Forward-looking
NOPLAT = (revenues – operating expenses 1 + YTM
2. unique resources Preferable for three reasons:
– depreciation) * (1- tax)
3. economies of scale Equity value: - historical may include extraordinary items
FCF = NOPLAT + noncash operating
4. scalable product/process g - better aligns with the numerator which is
expenses – Investment in invested capital Eq. Earnings 1 −
= ROE also future based
k g -g
Continuing Value - less variance in peer-group multiples for
Noncash op. expenses = depreciation 𝑔 𝑔
𝑁𝑂𝑃𝐿𝐴𝑇YZP 1 − 𝐸𝑎𝑟𝑛𝑖𝑛𝑔𝑠 1 − forward than backward
Investments in IC: 𝑅𝑂𝑁𝐼𝐶 𝑘q = 𝑅𝑂𝐸 + 𝑔
𝐶𝑉 =
∆ in operating WC 𝑊𝐴𝐶𝐶 − 𝑔 𝐸𝑞𝑢𝑖𝑡𝑦 𝑉𝑎𝑙𝑢𝑒
Price to Book Ratio:
∆ in capex (∆PP&E + depreciation) 𝑃𝑟𝑖𝑐𝑒 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
∆ capitalised op. leases Need to discount CV to the PV: cost of equity from PE Ratio: =
𝐶𝑉 1 g 𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑒𝑞𝑢𝑖𝑡𝑦 𝑝𝑒𝑟 𝑠ℎ𝑎𝑟𝑒
kg = 1− + g
𝑃𝑉 𝑜𝑓 𝐶𝑉 = Can also substitute market value of equity
WC = current assets – current liabilities 1 + 𝑊𝐴𝐶𝐶 Y P/E ROE
into the numerator
IC = op. assets – op. liabilities CV for economic profit
Enterprise DCF Model
= equity + debt 𝐶𝑉
𝑔 Steps: Value of equity in a stable growth dividend
cost method: investment stays on BS as 𝑁𝑂𝑃𝐿𝐴𝑇YZP 𝑅𝑂𝑁𝐼𝐶 − 𝑊𝐴𝐶𝐶
𝑅𝑂𝑁𝐼𝐶 1.value operations using FCF then discount discount model:
original cost and dividends are treated as =
𝑊𝐴𝐶𝐶 𝐷𝑃𝑆P
revenues by WACC 𝑃M =
PV discount factor = (WACC-g) 𝑘q − 𝑔•
market method: periodically adjust BS to 2.value non-operating assets and other
Enterprise Value 𝑅𝑂𝐸 − 𝑔•
reflect market changes assets not included in FCF 𝑃𝐵𝑉 =
= Debt + Equity + non-equity claims 𝑘q − 𝑔•
eg: non-controlling interests, excess
= PV of FCF + PV of CV 𝑅𝑂𝐸 𝑃𝑎𝑦𝑜𝑢𝑡 𝑅𝑎𝑡𝑖𝑜
Economic profit = Av. IC x (ROIC – WACC) cash (2% rule) 𝑃𝐵𝑉 =
= value of ops + non-operating assets 𝑘q − 𝑔•
𝐹𝐶𝐹P 3.value debt and non-equity claims and
𝑉𝑎𝑙𝑢𝑒M = 𝑔 = (1 − 𝑃𝑎𝑦𝑜𝑢𝑡 𝑟𝑎𝑡𝑖𝑜)×𝑅𝑂𝐸
𝑊𝐴𝐶𝐶 − 𝑔 subtract from EV
Apply midyear adjustment factor after
Long term growth drivers: (1) changes in 4.estimate price/share
calculating enterprise value
currency value (2) M&A (3) changes in
Midyear Adjustment
accounting procedures Valuing non-operating assets:
= 𝐸𝑉× 1 + 𝑊𝐴𝐶𝐶 M.a

 ‚ƒ‚ 1. Portfolio momentum – organic
For FCF: replace P/O ratio with Types: mergers, consolidation, tender offer,
„…†•‡•ˆ‰ revenue growth from expansion in the Factors associated with price movements:
purchase of assets, management/leverage
Missing part under (1+g)^n is (1+r)^n market segments represented in the 1. Momentum – earnings momentum and price
buyouts
r = WACC firm’s portfolio trends
Four Steps:
Payout ratio = dividend / earnings/share 2. Market share performance 2. Growth & potential for new investments
(1) Acquisition rationale & strategy
3. Mergers and acquisition Compare growth in relation to ROIC
- Acquiring undervalued firms Growing through acquisitions: Genuine growth: good ROIC, RONIC,
- Firm’s ability to earn excess returns = ROE
- Diversification 1. Bolt on -> incremental changes competitive advantage, capital stingy expansion
– rate of return
- Operating/financial synergy- 2. Large acquisitions – half the size or Invest in companies that are done spending but
- Overvalued firms -> high PBV; low equity
Operating synergies: economies of scale; more of the acquiring – tends to before they realise the benefits
return spread
greater pricing power; combine functional create less value 3. Macroeconomic cycles
- Undervalued firms -> low PBV; high equity Portfolio treadmill effect -> for each product What does the market expect and how is it
strengths; higher growth in markets
return spread that matures and declines in revenues, a new priced?
Financial synergies: higher CFs/lower
- PBV is a proxy for risk -> low PBV firms are similar sized replacement must be found to 4.Themes
WACC; debt capacity can increase, tax
risker than high PBV firms maintain revenue and continue growing 5. Investment flows
benefits
SOTP: what individual assets within a Three types of investment: Go the opposite way of investment flow – buy
(2) Choosing and valuing target 1.capacity expansion (CAUTION!) when everyone is selling
company are worth when sold in parts
- Choose target based on motive 2.creation of new products/markets 6. Reaction to ‘news flow’
- consider sunk costs
(3) Valuing the target 3.efficiency enhancing (more reliable)
Cash Flow Multiples: Price per share / CF
-Status quo valuation Five archetypes for value-creating acq. Special Topics
per share
-Value of control is the value of the firm Improve target’s performance Cross border valuation- valuing foreign CFs
Cashflow -> earnings, depreciation, amort. Consolidate to remove capacity
optimally managed Methods:
Dividend yield: divided per share / price Accelerate market access to new product (1) spot rate: converting income using ex rate
-Value synergies (difference between with
Value to book ratio: Access to skills and tach (not forward looking)
𝑀𝑎𝑟𝑘𝑒𝑡 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡 𝑎𝑛𝑑 𝑒𝑞𝑢𝑖𝑡𝑦 and without)
Pick winners and develop their business (2) forward rate: using forward rate to convert
= -Value of combined firm w/ no synergies
𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡 𝑎𝑛𝑑 𝑒𝑞𝑢𝑖𝑡𝑦 CFs and discount at local WACC
(sum of the two firms)
Sensitivity & Scenario Analysis (3) local currency (4) explicit forecasts
-Value of combined firm w/ synergy Used to gauge the distribution of share price
Enterprise value multiple:
-Need new beta -> calculate unlevered calculated in the model Valuing high growth companies
Enterprise Value
= betas individually then weigh the betas by Sensitivity analysis Use DCF valuation to forecast a future point
EBITA the firm values and use D/E ratio to 1. Checking internal consistency where performance stabilises
Enterprise value -> subtract non-operating
estimate new levered beta and WACC 2. Understanding sensitivity to key Considerations:
assets, include financial claims such as
(4) Making the acquisition work assumptions 1. Size of market
minority interest etc Scenario Analysis 2. Reasonable market share for the firm
𝑔
1− Structuring the acquisition: Form scenarios - “what could also be?” 3. Competitive situation
𝐸𝑛𝑡. 𝑉𝑎𝑙𝑢𝑒 = 𝑁𝑂𝑃𝐿𝐴𝑇( 𝑅𝑂𝐼𝐶 ) Ideas: industry structure (competition), tech Look at multiple different scenarios
𝑊𝐴𝐶𝐶 − 𝑔 1. Acquisition price – value of the
changes, growth, funding
P/E Ratio firm with control and synergy is Use probability-weighted valuation Agency issues
= company value/ company earnings the price ceiling Reward good management and punish bad
= equity value / NOPLAT 2. Payment for target firm – debt or The investment decision management in the valuation
1 𝑃𝑉𝐺𝑂 equity? Expectations treadmill Alignment of shareholder interests with
= +
𝑘 𝐸 Exchange ratio = value/share (target)/ Outperforming total return to shareholders (TRS) management
PVGO = present value of growth opp. value/share (acquirer) requires increasing performance improvement
PEG: differing growth rates across firms – managers have to run faster and faster to WACC as a controllable variable
𝐸𝑉𝑀 Growth maintain new stock prices and improve it Balancing the benefits of the tax shield with the
= further – speed = expectations of a company’s risk of overleveraging and bankruptcy
100×𝐸𝑥𝑝𝑒𝑐𝑡𝑒𝑑 𝐸𝐵𝐼𝑇𝐴 𝐺𝑟𝑜𝑤𝑡ℎ 𝑅𝑎𝑡𝑒 Three main components:
Acquisition share price