DCF FCFF VALUATION

2008 1 Sales 45,000 (41,700) 3,300 300 3,600

8.00%

2009 2 50,075 (46,571) 3,504 376 3,880

7.75% 7.78% 6.91% 9.84% 11.28%

2010 3 54,624 (50,988) 3,637 463 4,099

7.50% 5.65% 6.96% 9.81% 9.09%

2011 4 58,622 (54,921) 3,701 560 4,261

7.27% 3.94% 6.81% 5.04% 7.32%

2012 2013 5 6 Visible cash flow period 62,078 (58,377) 3,702 669 4,370
7.04% 2.56% 6.72% 4.49% 5.90%

2014 7 67,514 (63,915) 3,600 924 4,524

6.70% 2.02% 6.52% 2.79% 3.83%

2015 8 69,595 (66,006) 3,589 1,074 4,663

6.70% 3.08% 6.60% 4.30% 3.08%

2016 9 71,323 (67,785) 3,538 1,241 4,779

6.70% 2.48% 6.64% 3.17% 2.48%

2017 10 72,750 (69,324) 3,426 1,427 4,852

6.67% 1.54% 6.66% 2.19% 2.00%

Operating costs EBITA Depreciation EBITDA Changes in NWC Operating cash flow
EBITDA margin EBITDA growth

Sales growth

65,027 (61,382) 3,644 789 4,434

6.82% 1.45% 6.59% 2.72% 4.75%

Operating cash flow margin Operating cash flow growth Capex to depn FCFF growth

7.00%

(450) 3,150 (756) (900) 1,494 1,494 0.930 1,390

3.00x

(420) 3,460

(300) 3,799

(270) 3,991

(200) 4,170

(150) 4,284

(120) 4,404

(70) 4,593

(40) 4,739

(10) 4,842

Operating model assumptions: The visible cash flow period forecasts should be trending down to achieve the long run growth rates assumed within the perpetuity calculation. The assumptions should also be reviewed for consistency with the business model, the market and with each other e.g. sales growth may need to be supported by capex growth.

Unlevered tax on operations Capex Free cash flow to firm Terminal value FCFF to be discounted Discount factors PV of FCFF PV of visible period PV of terminal value Implied firm value Net debt Minority interest JV and associates Implied equity value Number of shares Implied equity value per share
Equity value breakdown: Ideally the equity value breakdown should use market values for net debt, minority interest and joint ventures & associates, using the latest available financial information. However, if the reconciling items are immaterial to the overall valuation, book values are often used as an approximation to market value. Additional adjustments can be included in this breakdown for pension scheme deficits and operating lease commitments as long as the treatment on the cashflows is consistent.

(830) (1,002)
8.97%

1,628 1,628 0.866 1,410

2.66x

(912) (1,093)
10.25%

1,795 1,795 0.806 1,446

2.36x

(958) (1,172)
3.66%

1,861 1,861 0.749 1,395

2.09x

(1,001) (1,242)
3.61%

1,928 1,928 0.697 1,344

1.86x

(1,028) (1,301)
1.42%

1,955 1,955 0.649 1,269

1.65x

(1,057) (1,350)
2.11%

1,996 1,996 0.604 1,205

1.46x

(1,102) (1,392)
5.13%

2,099 2,099 0.562 1,179

1.30x

(1,137) (1,427)
3.63%

2,175 2,175 0.523 1,137

1.15x

(1,162) (1,455)
2.31%

2,225

1.02x

Capex/Depn multiples drivers: Capex / depn multiples normally will trend towards 1.00x FCFF drivers: Review the FCFF drivers for exceptional trends, spikes and troughs make sure that these can be supported by the business model and market expectations.

57,928 60,154 0.486 29,252

12,857 28,170 41,027 (5,000) (64) 476 36,438 7,889 4.62

31.34% 68.66% 100.00%

WACC calculation Risk free rate Credit risk premium Tax rate Cost of debt Risk free rate Equity market risk premium Beta Cost of equity Target capital structure WACC
WACC calculation: Sources of data: Risk free rates UK/US 10 yr govt bonds Credit risk premium DCM can advise Alternatively: Credit ratings can give an indication of spreads Recent company bond issues (spreads) Comparable bond yields (similar duration & yields) Tax rates use an appropriate marginal

4.50% 1.20% 30.00% 3.99% 4.50% 5.00% 1.10 10.00% 42.00% 7.48%

Terminal value Terminal free cash flow Perpetuity growth rate WACC Terminal value

2,225 3.50% 7.48% 57,928

Terminal value split calculation: As a rough guide (for a mature company) the split of firm value generated by the visible cash flow period and the terminal value should be in the region of 30% - 70%. Material deviations from this split may suggest issues such as: Inconsistent terminal value assumptions Inconsistent visible period assumptions High growth companies

tax rate Equity market premiums historic premium analysis (Premiums currently ranging between 3.25% to 5.5%) Beta can be sourced from a number of providers (Bloomberg, LBS and Barra). Normally will range between 0.6 to 1.40 Weighting WACC is a weighted average normally using market values of debt and equity and often assuming a long run target capital structure

Terminal value calculation: Cash flow growth perpetuities should reflect the long run growth rate of the free cash flow to firm beyond the visible period. Estimating this number will involve comparison to long economic growth rates (economy and/or sector). Return on capital: If a fully integrated model is used, compare the return on capital figures over the years as a check on the integrity of the inputs and the model. Enormous growth may suggest that growth is being derived without the necessary investment. Additionally, Gordons Growth Model suggests that the terminal growth can be derived from the return on capital and the reinvestment rate (g = rb, where g =growth, r = return on capital and b = reinvestment rate)

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VALUATION

DCF FUNDAMENTALS
Free Cash Flow for Firm or Enterprise Value calculation EBIT Add Add EBITDA Deduct Deduct Deduct Capital expenditure Tax paid (pre interest) Increase in working capital Depreciation Amortisation X X X X (X) (X) (X) X

DCF ADVANCED
Gordons growth model
rxb=g r = return on equity b = proportion of earnings retained g = growth g=

Implied growth rate FV EBIT in exit multiple

FV x EBIT x WACC FCF EBIT FV x EBIT + FCF EBIT

Delevering beta
u = L

Relevering beta
L = u 1 + (1 Tc) D E

Free Cash Flow

1 + (1 Tc) D E

WACC =
equity value debt value Ke x + Kd (post tax) x firm value firm value

Terminal value
FCF (in final forecast year) x (1 + g) TV = (WACC g)

D/E current leverage ratio Assumes debt beta is zero

D/E new target leverage ratio Assumes debt beta is zero

Standard perpetuity growth method

Ke =
Rf + x (EMP) [CAPM]

TV =

NOPAT x (1 g/ROIC) (WACC g)

This is the value driver approach per Valuation, Koller, Goedhart and Wessels, 4th edition, McKinsey and Company Wiley. NOPAT = net operating profit after tax (in period T + 1) (T = last forecast time period) ROIC = return on invested capital The TV calculated in both formulae above will need to be discounted to establish its Present Value.

Kd =
Rf + CRP (use post tax in WACC calculation) CRP = credit risk premium

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