An Integrated Market-Based Approach To order this title, and for more information, click here
By Joseph Tham, Visiting Assistant Professor, Duke Center for International Development(DCID), Sanford Institute of Public Policy, Duke University Ignacio Vélez-Pareja, Politécnico Grancolombiano, Bogotá, Colombia
Description The valuation of assets, both tangible and intangible, is an important element of corporate finance. Putting a price tag on ideas is
almost impossible, and in the new economy, where companies grow dependent on intangible assets all the time, market volatility can be
attributed in large part to our collective ignorance of their value. There are two basic approaches to valuation: from financial statements
to cash flows, and from cash flows to financial statements. The former projects historical financial statements into the future and the
latter attempts to construct cash flow statements and use them in forecasting future financial statements. Established companies use
the first method and start-ups the second. In Principles of Cash Flow Valuation, the authors strive to "close the gap" between these
two approaches by presenting the principles of cash flow valuation and cost of capital in a clear and systematic fashion.
Audience
Finance professionals; MBA and other graduate students in finance
Contents Chapter One Basic concepts in market-based cash flow valuation
1.1 Introduction
1.1.1 Finite streams of cash flows
1.1.2 Content and
organization of the chapters
1.2 Market-based procedure for valuation
1.2.1 Integrated valuation framework with complete financial
statements
1.3 Steps in cash flow valuation
1.3.1 Why invest?
1.3.2 The role of information and expectations
1.4 Present value (PV)
1.4.1 Perfect capital markets and arbitrage opportunities
1.4.2 Valuation in an imperfect but real world
1.4.3 Perfect capital markets
1.4.4 Replicating portfolio strategy
1.4.5 Traded firms in the U.S. stock market
1.4.6 Traded firms in an emerging market
1.5 The
standard after-tax Weighted Average Cost of Capital (WACC)
1.6 Types of cash flows
1.6.1 What is FCF?
1.6.2 What is cash flow to (existing)
debt?
1.6.3 What is cash flow to equity (CFE)?
1.7 The WACC in a Modigliani and Miller (M & M) world
1.7.1 WACC in an M & M world
without taxes
1.7.2 An unlevered company versus a levered company
1.7.3 The no-arbitrage argument
1.7.4 Slicing the cake
1.7.5 Debt
and equity financing
1.7.6 Formula for the WACC without taxes
1.7.7 Equality of the unlevered and levered returns
1.8 WACC in an M & M world with taxes
1.8.1 The expanding cake
1.8.2 Why firms do not have 100% debt?
1.9 The fundamental FCF relationship
1.10 The
main valuation methods and formulas for cost of capital
1.10.1 The tax shield (TS)
1.10.2 After-tax WACC applied to the FCF
1.10.3
Alternative expression for the WACC applied to the FCF
1.10.4 The WACC with the CCF method
1.10.5 Losses carried forward (LCF)
1.10.6
The FCF WACC versus the CCF WACC
1.11 The CFE approach
1.12 Estimating the cost of capital
1.13 The Adjusted Present Value (APV) approach
1.14 Various formulations for the cost of capital 1.15 Summary and concluding remarks
KEY CONCEPTS AND IDEAS
Chapter Two
Time Value
of Money (TVM) and introduction to cost of capital
2.1 Introduction
Section One
2.1.1 The expected inflation rate
2.1.2 Relationship
between the real rate of return and the nominal rate of return
2.1.3 Expression for the cost of capital
2.2 Nominal prices, constant
prices and real prices
2.2.1 Expected real increase is 2% and expected inflation rate is 3%
2.2.2 Expected real increase is 2% and expected
inflation rate is 0%
2.2.3 Expected real increase is 0% and expected inflation rate is 3%
2.2.4 Real increase is 0% and expected inflation
rate is 0%
2.2.5 The use of nominal prices versus real prices
2.2.6 Multi-period example with nominal and real prices
2.3 Risk premium
with CAPM
2.4 Calculating (present) value with a finite stream of cash flows
2.4.1 Future value with the nominal risk-free rate: single
period case
2.4.2 Time value of money (TVM)
2.4.3 Variable rates of return
2.4.4 The discounting process
2.4.5 Variable discount
rates
2.4.6 Single and multi-period cash flows
2.4.7 Assessing an investment opportunity with the PV concept
Section Two
2.5 Valuation
with a finite stream of cash flows
2.5.1 Unlevered values
2.5.2 Debt financing with constant leverage
2.5.3 (Present) Value of TS
2.5.4 The corrected return to levered equity and WACC
2.5.4 Alternative formulation for the WACC with circularity
2.5.5 After-tax WACC
applied to the FCF
2.6 Summary and concluding remarks
KEY CONCEPTS AND IDEAS
APPENDIX A for Chapter Two
A2.1 Calculating the present
value (PV) with cash flow in perpetuity (without growth)
A2.1.1 WACC in an M & M world without taxes
A2.1.2 Unlevered value
A2.1.3
Value of the cash flow to debt (CFD)
A2.1.4 Value of the cash flow to equity (CFE)
A2.1.5 Formula for the return to levered equity
e
A2.1.6 Deriving the Weighted Average Cost of Capital (WACC) without taxes
A2.1.7 Numerical example
A2.2 WACC in an M & M world with
taxes
A2.2.1 Annual tax shield
A2.2.2 Capital cash flow
A2.2.3 (Present) value of the annual tax shield
A2.2.4 The levered value
VL in the presence of corporate tax
A2.3.1 Value of levered equity
A2.3.2 Cash flow to equity
A2.3.3 Return to levered equity with
taxes
A2.3.4 Formula for the return to levered equity
A2.4.1 Traditional after-tax WACC with the FCF
A2.4.2 Alternative expression
for the WACC with the FCF
A2.4.3 WACC with the Capital Cash Flow (CCF)
A2.4.4 Another WACC formulation with the Capital Cash Flow (CCF)
A2.5 FCF in perpetuity with growth
A2.5.1 Unlevered value
A2.5.2 Value of the debt
A2.5.3 The annual tax shield
A2.5.4 (Present)
Value of the tax shield
A2.6 Cash flow to equity
A2.6.1 Value of levered equity
A2.6.2 Return to levered equity
APPENDIX B
B2 Using
CAPM to find the cost of capital
B2.1 Discount rate for the tax shield is the cost of debt d
B2.2 Discount rate for the tax shield
is the return to unlevered equity r
Basic Review of Financial Statements and Accounting Concepts
3.1 Financial statements and accounting
concepts
SECTION ONE
3.1.1 Pro-forma financial statements
3.1.2 Integrated framework
3.2 Balance sheet
3.2.1 Assets
3.2.2 Current
assets
3.2.3 Liabilities
3.2.4 Current liabilities
3.3 Working capital
3.4 (Book) Value of equity
3.5 Income statement
3.5.1 Line
items in the income statement
3.5.2 Gross profit
3.5.3 Earnings before Interest and Taxes (EBIT)
3.5.4 EBT
3.5.5 Taxes
3.5.6 Net
income
3.5.7 Dividends
3.5.8 Retained and accumulated retained earnings
3.6 Cash flow statement
3.6.1 Cash flow from operating activities
3.6.2 Cash flow from investing activities
3.6.3 Cash flow from financing activities
3.7 Cash budget statement
3.7.1 Annual cash budget
statement
3.7.2 NCB before financing and reinvestment
3.7.3 NCB after debt financing
3.7.4 NCB after equity financing
3.7.5 Reinvestment
of surplus funds
3.7.6 Final NCB after reinvestment
3.7.7 Cumulative Cash balance
3.8 Differences between the CFS according to GAAP
and the CB statement
3.9 Integration of the financial statements
SECTION TWO
3.10 Preliminary tables
3.10.1 Depreciation schedule
3.10.2 Loan schedule
3.10.3 Quantity sold, inventories and purchases
3.10.4 Cost of Goods Sold (COGS)
3.10.5 Adjustments for credit
sales and purchases
3.10.6 Accounts Receivable (A.R.)
3.10.7 Accounts Payable (A.P.)
3.11 Summary and concluding remarks
Appendix
A
APPENDIX B
Sample Balance Sheet
Sample Income Statement
Chapter Four
Constructing Integrated Pro-forma Financial Statements, Part
One
4.1 Basic financial statements
4.2 Simple numerical example
4.2.1 Basic data for the simple example
4.2.2 Cash Required for Operations
(CRO)
4.2.3 Reinvestment of surplus funds
4.2.4 Terminal value calculation
4.3 Goals and policies for selected variables
4.4 Depreciation
schedule
4.5 Estimated target variables
4.5.1 Annual sales volume
4.5.2 Annual sales revenues
4.5.3 Selling and administrative expenses
4.6 Preliminary tables for the simple example
4.6.1 Initial cash budget statement for year 0
4.6.2 Loan schedule
4.6.3 Inventory
and purchases
4.6.4 Final inventory in year 1
4.6.5 Purchases (units)
4.6.6 Cost of goods sold (COGS)
4.6.7 Receivables and payables
4.6.8 Accounts receivable
4.6.9 Accounts payable
4.6.10 Cash receipts and cash expenditures
4.7 Constructing the financial statements
for the simple example
4.7.1 Cash budget statement in year 0 revisited
4.7.2 Cash budget statement for year 1
4.7.3 Income statement
for year 2
4.7.4 Iterations between the income statement and cash budget statement
4.7.5 Cash budget statement for year 2
4.7.6 Completed
income statement for all years
4.7.7 Complete budget statement for all years
4.7.8 Calculation of the new loan in year 4
4.8 Detailed
cash budget statement in year 5
4.8.1 NCB before financing and reinvestment in year 5
4.8.2 NCB after debt financing in year 5
4.8.3
NCB after debt and equity financing in year 5
4.8.4 Reinvestment of surplus funds in year 5
4.8.5 Final NCB after reinvestment in year
5
4.8.6 Cumulative cash balance in year 5
4.8.7 Adjustments in the cash budget statement
4.9 Balance sheet
4.10 Cash Flow Statement
according to GAAP
4.11 Summary and concluding remarks
Key Concepts and Ideas
Appendix A:
A4.12 Detailed income statement for year
1
A4.12.1 Gross profits in year 1
A4.12.2 EBIT in year 1
A4.12.3 EBT in year 1
A4.12.4 Net income in year 1
A4.12.5 Dividends declared
in year 1
A4.12.6 Retained earnings in year 1
A4.13 Detailed cash budget statement for year 1
A4.13.1 NCB before financing and reinvestment
A4.13.2 NCB after debt financing
A4.13.3 NCB after equity financing
A4.13.4 Reinvestment of surplus funds in year 1
A4.13.5 Final
NCB after reinvestment
A4.13.6 Cash balance after reinvestment in year 1
A4.14 Detailed cash budget statement for year 2
A4.14.1 NCB
before financing and reinvestment
A4.14.2 NCB after debt financing
A4.14.3 NCB after equity financing
A4.14.4 Reinvestment of surplus
funds
A4.14.5 Final NCB after reinvestment
A4.14.6 Cumulative cash balance in year 1
Chapter Five
5.1 Constructing Financial Statements
(continued), Part Two
5.1.1 The construction of the financial statements
5.1.2 A complex example
5.1.3 Model assumptions
5.1.4 Goals
and policies for selected variables
5.1.5 Relationship between the quantity purchased and the purchase price
5.1.6 Simulation of market
demand
5.2 Impact on demand of changes in price and of expenditures on advertising and promotion
5.2.1 Annual Sales
5.2.2 Impact on
demand of change in price
5.2.3 Impact on demand of expenditures on advertising and promotion
5.2.4 Preliminary tables for the complex
example
5.2.5 Annual increase in the volume of sales
5.2.6 Annual expenditures on advertising and promotion
5.2.7 Cash Requirements
for Operations (CRO)
5.2.8 Expected domestic inflation rate
5.2.9 Annual sales volume
5.2.10 Annual sales revenue
5.3 Real rate of
interest, the risk-premium for debt and the reinvestment return: Interest rates estimation
5.4 Depreciation Schedule
5.4 Initial cash
budget for year 0
5.5 Loan schedule
5.6 Inventory and quantity purchased
5.7 Relationship between the quantity purchased and the purchase
price
5.8 Cost of goods sold (COGS)
5.9 Selling and administrative expenses
5.10 Receivables and payables
5.11 The logic of the model
5.12 Constructing the financial statements for the complex example
5.12.1 Income Statement
5.12.2 Cash budget statement
5.12.3 Balance
Sheet
5.12.4 The Cash flow statement
5.13 Summary and concluding remarks
Key concepts and ideas
Appendix A
A Brief Introduction
to Price-Demand Elasticity
A1.1 Own Price.
A1.2 Consumption.
A1.3 Income.
A1.4 Substitutability.
A1.5 Kind of goods.
A1.6 Habits
and time.
A1.7 Taste.
A1.8 Determinants of quantity sold
A1.9 An expression for the Quantity demanded
APPENDIX B
A Detailed Spreadsheet
Example
6.1 Derivation of the free cash flows
6.2 The fundamental free cash flow (FCF) relationship
6.2.1 CB statement versus free
cash flow
6.2.2 Operational cash flow
6.2.3 Inflation adjustments for financial statements
6.2.4 Treatment of tax savings
6.3 Deriving
the FCF from the CB statement
6.3.1 Cash flow to equity (CFE)
6.3.2 Cash Flow to Debt
6.3.3 Tax shields
6.3.4 Deferred taxes
6.3.5
Total Free Cash Flow
6.3.6 Capital cash flow
6.4 Total CCF versus operational CCF
6.4.1 Total capital cash flow
6.4.2 Operational
CCF
6.4.3 Non-operational CCF
6.4.4 Other relationships for operational cash flows
6.5 Deriving the FCF from the CF statement according
to GAAP
6.6 Deriving the FCF from the EBIT in the income statement
6.6.1 Adjustments to the income statement
6.6.2 Depreciation charges
and amortization
6.6.3 Working capital adjustment
6.6.4 Deriving the FCF from the EBIT
6.7 Deriving the CFE from the Net Income, NI
6.8 Advantages of using the CB Approach
6.9 Summary and concluding remarks
APPENDIX A
A1: Calculating the excess cash from the Income
Statement and the Balance Sheet
APPENDIX B
B1: Deriving the FCF from NI
B2: Deriving the CCF from NI
Chapter Seven
Using the WACC
in theory and in practice
Section One: Introduction
7.1 Approaches to the cost of capital
7.2 Review of basic ideas
7.2.1 Impact
of taxes
7.2.2 Cash flow relationships
7.2.3 Relationships between values and cash flows
7.2.4 Two period example
7.2.5 Discount rate
for the tax shield
7.2.6 Return to levered equity ei
7.3 Three simple expressions for the cost of capital
7.3.1 Standard after-tax
WACC applied to the FCF
7.3.2 Adjusted WACC applied to the FCF
7.3.3 WACC applied to the CCF
7.4 General framework
7.4.1 First dimension
7.4.2 Second dimension
7.4.3 Third dimension
7.4.4 Matrix for the WACC applied to the FCF
7.4.5 Matrix for the WACC applied to the
CCF
7.4.6 How do we estimate the cost of capital? Practical issues.
7.5 Numerical examples with the complex example
7.5.1 Standard
WACC applied to the FCF
7.5.2 Adjusted WACC applied to the FCF
7.5.3 WACC applied to the CCF
7.5.4 Cash flow to equity (CFE) approach
7.6 Summary and concluding remarks
APPENDIX A
A.1 Algebraic approach
A.1.1 General expression for the return to levered equity ei
A.1.2 Standard WACC applied to the FCF
A.1.3 Adjusted WACC applied to the FCF
A.1.4 Standard WACC applied to the CCF
A.1.5 Adjusted
WACC applied to the CCF
APPENDIX B:
Using the Capital Asset Pricing Model (CAPM) to find the cost of capital
Appendix C
The Calculation
of Levered Values with Operational Cash Flows
Operating CFD, CFE, TS, FCF and CCF
7.5.1 Standard WACC applied to the FCF
7.5.2 Adjusted
WACC applied to the FCF
7.5.3 WACC applied to the CCF
7.5.4 Cash flow to equity (CFE) approach
Chapter Eight
Estimating the WACC
for Non Traded firms
Introduction
8.1 Practical Approaches to the Cost of Capital for Traded and Non Traded Firms
8.2 Finding the
Relationship between Levered and Unlevered b?s
8.3 Valuation for Traded Firms
8.3.1 Estimating the Return to Levered Equity e for a
Traded Firm
8.3.2 Using CAPM to find the Cost of Capital
8.3.3 Adjusted WACC applied to the FCF
8.3.4 WACC applied to the CCF
8.4
Valuation for Non-Traded Firms
8.4.1 Valuing Firms, both Traded and Non-traded, in Emerging Markets
8.4.2 Systematic Risk and Total
Risk
8.4.3 The Estimation of the Cost of Levered Equity with Systematic Risk
8.4.3.1 Using a Proxy Traded Firm
8.4.3.2 Accounting
Betas
8.4.4 The Estimation of the Unlevered Return to Equity, r with Systematic Risk
8.5 Summary and Concluding Remarks
APPENDIX A
A.1 The Estimation with Total Risk
A.1.1 The Estimation of the Levered Cost of Equity, e with Total Risk
A.1.2 The Estimation of the
Unlevered Return to Equity, r with Total Risk
APPENDIX B
Appendix C
Chapter Nine
Beyond the planning period: calculating the terminal
value
9.1 Introduction
9.2 Operation versus liquidation
9.3 Calculating the salvage (or liquidation) value
9.4 Terminal value versus
salvage value
9.5 The standard approach for estimating the terminal value
9.5.1 Assumptions in the model
9.5.2 Simple numerical example
9.5.3 Estimating the key parameters
9.5.4 Growth in the steady state
9.5.5 Estimating the growth rate of the NOPLAT, g
9.6 Terminal
Value is Calculated for Discounted Cash Flow (DCF) Method Using NOPLAT and Using Constant Leverage
9.7 Amount of reinvestment for the
growth in the Free Cash Flow
9.8 Calculating the Return on the Market Value of the Invested Capital (ROMVIC)
9.9 A Comment on constant
leverage
9.9.1 The Tax Savings with Terminal Value
9.9.2 CFE with terminal value
9.9.3 CFD with terminal value
9.9.4 CCF with terminal
value
9.10 Calculating the terminal value with the CCF and APV approaches
9.11 Summary and concluding remarks
Appendix A: Terminal
value and amount of reinvestment
A.1 Return on the Market Value of the Invested Capital
A.2 Additional reinvestment for higher growth
of NOPLAT
Appendix B: Independent Calculation of the TV Levered Value
B.1 Value of debt in the terminal period N
B.2 Value of tax
shield in the terminal year N
B.3 Levered value in terminal year N
B.4 The Terminal Value with CCF and APV
Appendix C
Pure Free Cash
Flow and non pure Free Cash Flow
Matching the RIM (Residual Income Model), EVA? and DCF (Discounted Cash Flow)
D9.1 What is value added?
D9.2 Assumptions and financial statements for the complex example
D9.2.1 RIM for the complex example
D9.2.2 EVA for the complex example
D9.3 Conclusion
Chapter Ten
Theory for cost of capital revisited
10.1 Cost of capital with a finite stream of cash flows
10.1.1
WACC in an M & M world without taxes
10.1.2 Value relationships
10.1.3 Cash flow relationships
10.1.4 Unlevered value in year 1
10.1.5
Unlevered value in year 0
10.2 Numerical example
10.2.1 Unlevered equity schedule
10.2.2 Loan Schedule for the debt financing
10.2.3
Value of debt in year 1
10.2.4 Value of debt in year 0
10.2.5 Annual cash flow to (levered) equity
10.2.6 Debt-Equity Ratios
10.2.7
Returns to levered equity in year 1 and year 2
10.2.8 Value of (levered) equity in year 1
10.2.9 Value of (levered) equity in year
0
10.2.10 Levered equity schedule
10.2.11 Calculation of the multi-period WACC
10.3 Loan schedule with constant leverage
10.3.1 Calculation
of the multi-period WACC
10.4 Policy on debt financing and the WACC in the presence of taxes
10.4.1 Risk-free tax shields
10.4.2 Fixed
loan schedule
10.4.3 Constant leverage
10.5 The M & E WACC
10.5.1 The M & E argument in the limit
10.5.2 Relaxation of the M & E
assumptions (Optional)
10.6 WACC for a finite stream of cash flows in an M & M world with taxes
10.6.1 Fixed loan schedule
10.6.2
Option 1: WACC applied to finite FCF (fixed amount of debt) with y = r
10.6.3 Option 2: WACC applied to the finite CCF (fixed amount
of debt) with y = r
10.7 Fixed percentage of debt
10.7.1 M & E specification for the WACC applied to the FCF
10.7.2 Harris & Pringle
(H & P) specification
10.7.2.1 Option 1: WACC applied to FCF (fixed percentage of debt and y = r)
10.7.2.2 Option 2: WACC applied to
the CCF (fixed percentage of debt and y = r)
10.7.3. Standard (inaccurate) specification
10.7.3.1 Option 1: WACC applied to FCF (fixed
percentage of debt and y = d)
10.8 Theory on the cost of capital applied to finite cash flows
10.8.1 Value relationships
10.8.2 Cash
flow relationships
10.8.3 Tax shield in year 1 and year 2
10.8.5 (Present) value of the tax shield in year 0
10.9 Standard WACC applied
to the CCF
10.10 Standard after-tax WACC applied to the FCF
10.11 Return to (levered) equity
10.11.1 Case 1
10.11.2 Case 2
10.11.3
Case 3
10.12 Alternative adjusted WACC applied to the FCF (Optional)
10.12.1 Alternative adjusted WACC in year 1 applied to the FCF
10.12.2 Assuming the discount rate for the tax shield is r
10.13 Alternative WACC applied to the CCF (Optional)
10.14 Numerical example
10.14.1 Amount of the Tax Shields
10.14.2 Summary of the cash flows
10.14.3 (Present) Value of the tax shields
10.15 Adjusted Present
Value (APV) approach
10.15.1 Percent debt and percent equity in year 1
10.15.2 Percent debt and percent equity in year 2
10.15.3 Returns
to levered equity in year 1 and year 2
10.15.4 WACC applied to the CCF
10.15.5 Standard after-tax WACC applied to the FCF
10.15.6
Alternative WACC applied to the FCF
10.16 Summary and concluding remarks
KEY CONCEPTS AND IDEAS
Appendix A
A10.1 Derivation of the
M & E WACC
A10.1.1 Levered value in Year 2
A10.1.2 Levered value in Year 1
A10.1.3 Levered value in Year 0
APPENDIX B
B10.1 Numerical
example with constant leverage
B10.1.1 Leverages in year 1 and year 2
B10.1.2 Relationship between the levered and unlevered value
in year 1
B10.1.3 Relationship between the levered and unlevered value in year 0
B10.2 Basic information
B10.2.1 Levered values in
year 0 and year 1
B10.2.2 Values of debt in year 0 and year 1
B10.2.3 Tax shields in year 1 and year 2
B10.2.4 CCF in year 1 and year
2
B10.2.5 Return to levered equity
B10.3 WACC applied to the CCF
B10.4 Standard after-tax WACC applied to the FCF
B10.5 Alternative
adjusted WACC for the FCF
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