Corporate Valuation: A Guide for Brokers, Managers and Investors

Corporate Valuation: A Guide for Brokers, Managers and Investors
Dr. Mounther Barakat Al Omari Securities and Commodities Authority Abu Dhabi - UAE December

تحليل الشركات وتسعير الاسهم دليل للوسطاء والمدراء والمستثمرين
د. منذر بركات العمري هيئة الاوراق المالية والسلع – ابو ظبي دولة الامارات العربية المتحدة 2006

فيما يلي مقدمة هامة للمحللين الماليين ولمسعري الشركات
Introduction مقدمة The following is an important introduction for stock analysts and evaluators. This introduction is intended to provide stock analysts with the tools they need to carryout their analysis. فيما يلي مقدمة هامة للمحللين الماليين ولمسعري الشركات تحوي هذه المقدمة على ادوات هامة لا يستطيع المحلل المالي ان يقوم بوظيفته بدونها

Financial Goals of the Corporation هدف الشركة
The primary financial goal is shareholder wealth maximization, which translates to maximizing stock price. Do firms have any responsibilities to society at large? Is stock price maximization good or bad for society? Should firms behave ethically?

Is stock price maximization the same as profit maximization
No, despite a generally high correlation amongst stock price, EPS, and cash flow. Current stock price relies upon current earnings, as well as future earnings and cash flow. Some actions may cause an increase in earnings, yet cause the stock price to decrease (and vice versa).

Factors that affect stock price العوامل التي تؤثر بسعر السهم
Projected cash flows to shareholders Timing of the cash flow stream Riskiness of the cash flows

Basic Valuation Model نموذج التسعير الاولي
To estimate an asset’s value, one estimates the cash flow for each period t (CFt), the life of the asset (n), and the appropriate discount rate (k) Throughout the course, we discuss how to estimate the inputs and how financial management is used to improve them and thus maximize a firm’s value.

Decisions made by financial managers:
Factors that Affect the Level and Riskiness of Cash Flows العوامل المؤثرة بقيمة وخطورة وتوقيت التدفقات النقدية Decisions made by financial managers: Investment decisions Financing decisions (the relative use of debt financing) Dividend policy decisions The external environment

Financial Statements, Cash Flow, and Taxes القوائم المالية، التدفقات النقدية والضرائب
Balance sheet Income statement Statement of cash flows Accounting income vs. cash flow MVA and EVA The tax system

The Annual Report التقرير السنوي
Balance sheet – provides a snapshot of a firm’s financial position at one point in time. Income statement – summarizes a firm’s revenues and expenses over a given period of time. Statement of retained earnings – shows how much of the firm’s earnings were retained, rather than paid out as dividends. Statement of cash flows – reports the impact of a firm’s activities on cash flows over a given period of time.

Balance Sheet: Assets قائمة المركز المالي - الاصول
Cash A/R Inventories Total CA Gross FA Less: Dep. Net FA Total Assets 2002 7,282 632,160 1,287,360 1,926,802 1,202,950 263,160 939,790 2,866,592 2001 57,600 351,200 715,200 1,124,000 491,000 146,200 344,800 1,468,800

Balance sheet: Liabilities and Equity قائمة المركز المالي – الخصوم وحقوق الملكية
Accts payable Notes payable Accruals Total CL Long-term debt Common stock Retained earnings Total Equity Total L & E 2002 524,160 636,808 489,600 1,650,568 723,432 460,000 32,592 492,592 2,866,592 2001 145,600 200,000 136,000 481,600 323,432 203,768 663,768 1,468,800

Income statement قائمة الدخل
Sales COGS Other expenses EBITDA Depr. & Amort. EBIT Interest Exp. EBT Taxes Net income 2002 6,034,000 5,528,000 519,988 (13,988) 116,960 (130,948) 136,012 (266,960) (106,784) (160,176) 2001 3,432,000 2,864,000 358,672 209,328 18,900 190,428 43,828 146,600 58,640 87,960

Other data معلومات أخرى
No. of shares EPS DPS Stock price 2002 100,000 -$1.602 $0.11 $2.25 2001 $0.88 $0.22 $8.50

Did the expansion create additional net operating after taxes (NOPAT)
NOPAT = EBIT (1 – Tax rate) NOPAT02 = -$130,948(1 – 0.4) = -$130,948(0.6) = -$78,569 NOPAT01 = $114,257

NOWC = Current - Non-interest
What effect did the expansion have on net operating working capital? حسابات صافي رأس المال العمل NOWC = Current Non-interest assets bearing CL NOWC02 = ($7,282 + $632,160 + $1,287,360) – ( $524,160 + $489,600) = $913,042 NOWC01 = $842,400

What effect did the expansion have on operating capital
Operating capital = NOWC + Net Fixed Assets Operating Capital02 = $913,042 + $939,790 = $1,852,832 Operating Capital01 = $1,187,200

What is your assessment of the expansion’s effect on operations
Sales NOPAT NOWC Operating capital Net Income 2002 $6,034,000 -$78,569 $913,042 $1,852,832 -$160,176 2001 $3,432,000 $114,257 $842,400 $1,187,200 $87,960

What effect did the expansion have on net cash flow and operating cash flow? حسابات التدفقات النقدية
NCF02 = NI + Dep = ($160,176) + $116,960 = -$43,216 NCF01 = $87,960 + $18,900 = $106,860 OCF02 = NOPAT + Dep = ($78,569) + $116,960 = $38,391 OCF01 = $114,257 + $18,900 = $133,157

What was the free cash flow (FCF) for 2002? حساب التدفق النقدي الحر
FCF = OCF – Gross capital investment - OR - FCF02 = NOPAT – Net capital investment = -$78,569 – ($1,852,832 - $1,187,200) = -$744,201 Is negative free cash flow always a bad sign?

Economic Value Added (EVA) حساب القيمة المضافة
EVA = After-tax __ After-tax Operating Income Capital costs = Funds Available __ Cost of to Investors Capital Used = NOPAT – After-tax Cost of Capital

EVA Concepts مفهوم القيمة الاقتصادية المضافة
In order to generate positive EVA, a firm has to more than just cover operating costs. It must also provide a return to those who have provided the firm with capital. EVA takes into account the total cost of capital, which includes the cost of equity.

EVA02 = NOPAT – (A-T cost of capital) (Capital)
What is the firm’s EVA? Assume the firm’s after-tax percentage cost of capital was 10% in 2000 and 13% in حساب القيمة الاقتصادية المضافة EVA02 = NOPAT – (A-T cost of capital) (Capital) = -$78,569 – (0.13)($1,852,832) = -$78,569 - $240,868 = -$319,437 EVA01 = $114,257 – (0.10)($1,187,200) = $114,257 - $118,720 = -$4,463

MVA = Market value __ Equity capital of equity supplied
Did the expansion increase or decrease MVA? حساب القيمة السوقية المضافة MVA = Market value __ Equity capital of equity supplied During the last year, the stock price has decreased 73%. As a consequence, the market value of equity has declined, and therefore MVA has declined, as well.

Corporate and Personal Taxes ضرائب الشركات والافراد وأثرها على قيمة الشركة وأسهمها
Have a progressive structure (the higher the income, the higher the marginal tax rate). Corporations Rates are at 0% unless there are special provisions for certain companies like Oil and foreign ones. Individuals Rates 0% for individuals, again unless there are special provisions. Inexistence of taxes does not change the mechanics of our work, it will change the results.

Tax treatment of various uses and sources of funds أثر الضرائب على التدفقات النقدية الداخلة والخارجة
Interest paid – tax deductible for corporations (paid out of pre-tax income), but usually not for individuals. Interest earned - taxable Dividends paid – paid out of after-tax income. Dividends received – not taxed individuals (“double taxation”). Capital gains not taxable

Calculating Key Multipliers حساب المضاعفات - مثال
P/E = Price / Earnings per share = $12.17 / $1.014 = 12.0x P/CF = Price / Cash flow per share = $12.17 / [($ $117.0) ÷ 250] = 8.21x

Calculating Key Multipliers حساب المضاعفات - مثال
M/B = Mkt price per share / Book value per share = $12.17 / ($1,952 / 250) = 1.56x 2003 2002 2001 Ind. P/E 12.0x -1.4x 9.7x 14.2x P/CF 8.21x -5.2x 8.0x 11.0x M/B 1.56x 0.5x 1.3x 2.4x

Analyzing the multipliers تحليل المضاعفات
P/E: How much investors are willing to pay for $1 of earnings. P/CF: How much investors are willing to pay for $1 of cash flow. M/B: How much investors are willing to pay for $1 of book value equity. For each ratio, the higher the number, the better. P/E and M/B are high if ROE is high and risk is low.

Trend analysis تحليل النمطية
Analyzes a firm’s financial ratios over time Can be used to estimate the likelihood of improvement or deterioration in financial condition.

Potential uses of freed up cash استخدامات التدفق النقدي الحر
Repurchase stock Expand business Reduce debt All these actions would likely improve the stock price.

The Financial Environment: البيئة المالية للشركة المراد تحليلها وتقييمها
Financial markets Types of financial institutions Determinants of interest rates Yield curves

What is a market? ما هو السوق
A market is a venue where goods and services are exchanged. A financial market is a place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds.

Types of financial markets أنواع الاسواق المالية
Physical assets vs. Financial assets Money vs. Capital Primary vs. Secondary Spot vs. Futures Public vs. Private

How is capital transferred between savers and borrowers
Direct transfers Investment banking house Financial intermediaries

Types of financial intermediaries أنواع الوسطاء الماليين
Commercial banks Savings and loan associations Mutual savings banks Credit unions Pension funds Life insurance companies Mutual funds

Physical location stock exchanges vs
Physical location stock exchanges vs. Electronic dealer-based markets الفرق بين السوق المنظمة والغير منظمة Auction market vs. Dealer market (Exchanges vs. OTC) Differences are narrowing

The cost of money تكلفة رأس المال
The price, or cost, of debt capital is the interest rate. The price, or cost, of equity capital is the required return. The required return investors expect is composed of compensation in the form of dividends and capital gains.

What four factors affect the cost of money
Production opportunities Time preferences for consumption Risk Expected inflation

“Nominal” vs. “Real” rates العائد الاسمي والحقيقي
k = represents any nominal rate k* = represents the “real” risk-free rate of interest, if there was no inflation. Typically ranges from 1% to 4% per year. kRF = represents the rate of interest on Treasury securities.

Determinants of interest rates محددات سعر الفائدة (العائد)
k = k* + IP + DRP + LP + MRP k = required return on a debt security k* = real risk-free rate of interest IP = inflation premium DRP = default risk premium LP = liquidity premium MRP = maturity risk premium

Premiums added to k* for different types of debt مقارنة علاوات المخاطر المختلفة
IP MRP DRP LP S-T Treasury  L-T Treasury S-T Corporate L-T Corporate

Yield curve and the term structure of interest rates منحنى العائد وعلاقة الفائدة بالاستحقاق
Term structure – relationship between interest rates (or yields) and maturities. The yield curve is a graph of the term structure.

Hypothetical yield curve منحنى عائد افتراضي
Years to Maturity Real risk-free rate 5 10 15 Interest Rate (%) Maturity risk premium Inflation premium An upward sloping yield curve. Upward slope due to an increase in expected inflation and increasing maturity risk premium.

The Yield Curve منحنى العائد
Corporate yield curves are higher than that of Treasury securities, though not necessarily parallel to the Treasury curve. The spread between corporate and Treasury yield curves widens as the corporate bond rating decreases.

The Yield Curve منحنى العائد
Interest Rate (%) 15 BB-Rated 10 AAA-Rated Treasury Yield Curve 6.0% 5 5.9% 5.2% Years to Maturity 1 5 10 15 20

Risk and Rates of Return المخاطر والعائد
Stand-alone risk Portfolio risk Risk & return: CAPM / SML

Investment returns العائد على الاستثمار
The rate of return on an investment can be calculated as follows: (Amount received – Amount invested) Return = ________________________ Amount invested For example, if $1,000 is invested and $1,100 is returned after one year, the rate of return for this investment is: ($1,100 - $1,000) / $1,000 = 10%.

What is investment risk? مخاطر الاستثمار
Two types of investment risk Stand-alone risk Portfolio risk Investment risk is related to the probability of earning a low or negative actual return. The greater the chance of lower than expected or negative returns, the riskier the investment.

Probability distributions التوزيع الاحتمالي
A listing of all possible outcomes, and the probability of each occurrence. Can be shown graphically. Expected Rate of Return Rate of Return (%) 100 15 -70 Firm X Firm Y

Risk: Calculating the standard deviation حساب المخاطر باستخدام الانحراف المعياري

Standard deviation as a measure of risk الانحراف المعياري كمقياس للخطورة
Standard deviation (σi) measures total, or stand-alone, risk. The larger σi is, the lower the probability that actual returns will be closer to expected returns. Larger σi is associated with a wider probability distribution of returns.

Coefficient of Variation (CV) معامل التشتت كمقياس للخطورة
A standardized measure of dispersion about the expected value, that shows the risk per unit of return.

Investor attitude towards risk درجة تحمل المستثمرين للمخاطر
Risk aversion – assumes investors dislike risk and require higher rates of return to encourage them to hold riskier securities. Risk premium – the difference between the return on a risky asset and less risky asset, which serves as compensation for investors to hold riskier securities.

Company-Specific Risk
Illustrating diversification effects of a stock portfolio اثر التنويع على المخاطر # Stocks in Portfolio ,000+ Company-Specific Risk Market Risk 20 Stand-Alone Risk, sp sp (%) 35

Breaking down sources of risk مصادر المخاطر
Stand-alone risk = Market risk + Firm-specific risk Market risk – portion of a security’s stand-alone risk that cannot be eliminated through diversification. Measured by beta. Firm-specific risk – portion of a security’s stand-alone risk that can be eliminated through proper diversification.

Capital Asset Pricing Model نموذج تسعير الاصول الرأسمالية
Model based upon concept that a stock’s required rate of return is equal to the risk-free rate of return plus a risk premium that reflects the riskiness of the stock after diversification. Primary conclusion: The relevant riskiness of a stock is its contribution to the riskiness of a well-diversified portfolio.

Beta معامل بيتا كمقياس للخطورة
Measures a stock’s market risk, and shows a stock’s volatility relative to the market. Indicates how risky a stock is if the stock is held in a well-diversified portfolio.

Calculating betas حساب معامل بيتا باستخدام Excel
Run a regression of past returns of a security against past returns on the market. The slope of the regression line (sometimes called the security’s characteristic line) is defined as the beta coefficient for the security.

Illustrating the calculation of beta مثال - حساب معامل بيتا باستخدام Excel
See PADICO-PALTEL.XLS

Comments on beta ملاحظات على معامل بيتا
If beta = 1.0, the security is just as risky as the average stock. If beta > 1.0, the security is riskier than average. If beta < 1.0, the security is less risky than average. Most stocks have betas in the range of 0.5 to 1.5.

Can the beta of a security be negative? معامل بيتا قد يكون سالبا
Yes, if the correlation between Stock i and the market is negative (i.e., ρi,m < 0). If the correlation is negative, the regression line would slope downward, and the beta would be negative. However, a negative beta is highly unlikely.

Beta coefficients مقارنة معامل بيتا
ki _ kM 40 20 -20 Firm X: β = 1.30 T-bills: β = 0 Firm Y: β = -0.87

The Security Market Line (SML): خط السوق
SML: ki = kRF + (kM – kRF) βi Assume kRF = 8% and kM = 15%. The market (or equity) risk premium is RPM = kM – kRF = 15% – 8% = 7%.

What is the market risk premium? ما هي علاوة مخاطر السوق
Additional return over the risk-free rate needed to compensate investors for assuming an average amount of risk. Its size depends on the perceived risk of the stock market and investors’ degree of risk aversion. Varies from year to year, but most estimates suggest that it ranges between 4% and 8% per year.

Time Value of Money القيمة الزمنية للنقود
Future value Present value Annuities Rates of return

Time lines خط الزمن – اين انت؟
1 2 3 i% CF0 CF1 CF2 CF3 Show the timing of cash flows. Tick marks occur at the end of periods, so Time 0 is today; Time 1 is the end of the first period (year, month, etc.) or the beginning of the second period.

Time lines خط الزمن – مثال
100 1 2 i% $100 lump sum due in 2 years 100 1 2 3 i% 3 year $100 ordinary annuity

Time lines خط الزمن – مثال
100 50 75 1 2 3 i% -50 Uneven cash flow stream

Future value (FV) القيمة المستقبلية
Finding the FV of a cash flow or series of cash flows when compound interest is applied is called compounding. FV can be solved by using the arithmetic, financial calculator, and spreadsheet methods. FV = ? 1 2 3 10% 100

Future value (FV) القيمة المستقبلية
After 1 year: FV1 = PV ( 1 + i ) = $100 (1.10) = $110.00 After 2 years: FV2 = PV ( 1 + i )2 = $100 (1.10) =$121.00 After 3 years: FV3 = PV ( 1 + i )3 = $100 (1.10) =$133.10 After n years (general case): FVn = PV ( 1 + i )n

Present value (PV) القيمة الحالية
Finding the PV of a cash flow or series of cash flows when compound interest is applied is called discounting (the reverse of compounding). The PV shows the value of cash flows in terms of today’s purchasing power. 1 2 3 10% PV = ? 100

Present value (PV) القيمة الحالية
Solve the general FV equation for PV: PV = FVn / ( 1 + i )n PV = FV3 / ( 1 + i )3 = $100 / ( 1.10 )3 = $75.13

Ordinary annuity and an annuity due الدفعات المنتظمة اول الفترة وآخرها
PMT 1 2 3 i% PMT 1 2 3 i% Annuity Due

PV of uneven cash flow stream? القيمة الحالية لدفعات غير منتظمة
100 1 300 2 3 10% -50 4 90.91 247.93 225.39 -34.15 = PV

Bonds and Their Valuation السندات وتسعيرها
Key features of bonds Bond valuation Measuring yield Assessing risk

What is a bond? ما هو السند؟
A long-term debt instrument in which a borrower agrees to make payments of principal and interest, on specific dates, to the holders of the bond.

What is a bond? ما هو السند؟
Par value – face amount of the bond, which is paid at maturity (assume $1,000). Coupon interest rate – stated interest rate (generally fixed) paid by the issuer. Multiply by par to get dollar payment of interest. Maturity date – years until the bond must be repaid. Issue date – when the bond was issued. Yield to maturity - rate of return earned on a bond held until maturity (also called the “promised yield”).

The value of financial assets قيمة (سعر) الاصول المالية
1 2 n k CF1 CFn CF2 Value ...

What is the opportunity cost of debt capital? حساب تكلفة السندات
The discount rate (ki ) is the opportunity cost of capital, and is the rate that could be earned on alternative investments of equal risk. ki = k* + IP + MRP + DRP + LP

Bond valuation – an example تسعير السندات - مثال
1 2 n k 100 ,000 VB = ? ...

What is the YTM on a bond? حساب العائد المطلوب على سند
Must find the kd that solves this model.

Definitions تعريفات

An example: Current and capital gains yield حساب العائد على سند - مثال
Find the current yield and the capital gains yield for a 10-year, 9% annual coupon bond that sells for $887, and has a face value of $1,000. Current yield = $90 / $887 = = 10.15%

An example: Current and capital gains yield حساب العائد على سند - مثال
YTM = Current yield + Capital gains yield CGY = YTM – CY = 10.91% % = 0.76% Could also find the expected price one year from now and divide the change in price by the beginning price, which gives the same answer.

Evaluating default risk: Bond ratings تصنيف السندات حسب خطورتها
Investment Grade Junk Bonds Moody’s Aaa Aa A Baa Ba B Caa C S & P AAA AA A BBB BB B CCC D Bond ratings are designed to reflect the probability of a bond issue going into default.

Financial performance
Factors affecting default risk and bond ratings العوامل التي تؤثر على خطورة السندات Financial performance Debt ratio TIE ratio Current ratio Bond contract provisions Secured vs. Unsecured debt Senior vs. subordinated debt Guarantee and sinking fund provisions Debt maturity

Factors affecting default risk and bond ratings العوامل التي تؤثر على خطورة السندات
Earnings stability Regulatory environment Potential antitrust or product liabilities Pension liabilities Potential labor problems Accounting policies

Priority of claims in liquidation من له الاولوية عند التصفية
Secured creditors from sales of secured assets. Trustee’s costs Wages, subject to limits Taxes Unfunded pension liabilities Unsecured creditors Preferred stock Common stock

The Cost of Capital تكلفة رأس المال
Sources of capital Component costs WACC Adjusting for flotation costs Adjusting for risk

Sources of capital مصادر رأس المال

WACC = wdkd(1-T) + wpkp + wcks
Calculating the weighted average cost of capital حساب المعدل المرجح لرأس المال WACC = wdkd(1-T) + wpkp + wcks The w’s refer to the firm’s capital structure weights. The k’s refer to the cost of each component.

Should our analysis focus on before-tax or after-tax capital costs
Stockholders focus on A-T CFs. Therefore, we should focus on A-T capital costs, i.e. use A-T costs of capital in WACC. Only kd needs adjustment, because interest is tax deductible.

Should our analysis focus on historical (embedded) costs or new (marginal) costs? تحسب تكلفة رأس المال حديا (أي على الاموال الجديدة وليس القديمة) The cost of capital is used primarily to make decisions that involve raising new capital. So, focus on today’s marginal costs (for WACC).

How are the weights determined? حساب الاوزان
WACC = wdkd(1-T) + wpkp + wcks Use accounting numbers or market value (book vs. market weights)? Use actual numbers or target capital structure?

Component cost of debt حساب تكلفة الدين
WACC = wdkd(1-T) + wpkp + wcks kd is the marginal cost of debt capital. The yield to maturity on outstanding L-T debt is often used as a measure of kd. Why tax-adjust, i.e. why kd(1-T)?

Component cost of debt حساب تكلفة الدين
Interest is tax deductible, so A-T kd = B-T kd (1-T) = 10% ( ) = 6% Use nominal rate. Flotation costs are small, so ignore them.

Component cost of preferred stock حساب تكلفة الاسهم الممتازة
WACC = wdkd(1-T) + wpkp + wcks kp is the marginal cost of preferred stock. The rate of return investors require on the firm’s preferred stock.

The cost of preferred stock can be solved by using this formula: kp = Dp / Pp = $10 / $111.10 = 9%

Preferred dividends are not tax-deductible, so no tax adjustments necessary. Just use kp. Nominal kp is used. Our calculation ignores possible flotation costs.

Preferred stock risk خطورة الاسهم الممتازة
More risky; company not required to pay preferred dividend. However, firms try to pay preferred dividend. Otherwise, (1) cannot pay common dividend, (2) difficult to raise additional funds, (3) preferred stockholders may gain control of firm.

Component cost of equity حساب تكلفة الاسهم العادية
WACC = wdkd(1-T) + wpkp + wcks ks is the marginal cost of common equity using retained earnings. The rate of return investors require on the firm’s common equity using new equity is ke.

Why is there a cost for retained earnings? حساب تكلفة الارباح المحجوزة
Earnings can be reinvested or paid out as dividends. Investors could buy other securities, earn a return. If earnings are retained, there is an opportunity cost (the return that stockholders could earn on alternative investments of equal risk). Investors could buy similar stocks and earn ks. Firm could repurchase its own stock and earn ks. Therefore, ks is the cost of retained earnings.

CAPM: ks = kRF + (kM – kRF) β DCF: ks = D1 / P0 + g Own-Bond-Yield-Plus-Risk Premium: ks = kd + RP

Component cost of equity حساب تكلفة الاسهم العادية - مثال
If the kRF = 7%, RPM = 6%, and the firm’s beta is 1.2, what’s the cost of common equity based upon the CAPM? ks = kRF + (kM – kRF) β = 7.0% + (6.0%)1.2 = 14.2%

If D0 = $4.19, P0 = $50, and g = 5%, what’s the cost of common equity based upon the DCF approach? D1 = D0 (1+g) D1 = $4.19 ( ) D1 = $4.3995 ks = D1 / P0 + g = $ / $ = 13.8%

What is the expected future growth rate? حساب معدل النمو
The firm has been earning 15% on equity (ROE = 15%) and retaining 35% of its earnings (dividend payout = 65%). This situation is expected to continue. g = ( 1 – Payout ) (ROE) = (0.35) (15%) = 5.25% Very close to the g that was given before.

If kd = 10% and RP = 4%, what is ks using the own-bond-yield-plus-risk-premium method? This RP is not the same as the CAPM RPM. This method produces a ballpark estimate of ks, and can serve as a useful check. ks = kd + RP ks = 10.0% + 4.0% = 14.0%

Method Estimate CAPM % DCF % kd + RP % Average %

Why is the cost of retained earnings cheaper than the cost of issuing new common stock? When a company issues new common stock they also have to pay flotation costs to the underwriter. Issuing new common stock may send a negative signal to the capital markets, which may depress the stock price.

If issuing new common stock incurs a flotation cost of 15% of the proceeds, what is ke?

Flotation costs تكاليف الاصدار
Flotation costs depend on the risk of the firm and the type of capital being raised. The flotation costs are highest for common equity. However, since most firms issue equity infrequently, the per-project cost is fairly small. We will frequently ignore flotation costs when calculating the WACC.

Ignoring floatation costs, what is the firm’s WACC
WACC = wdkd(1-T) + wpkp + wcks = 0.3(10%)(0.6) + 0.1(9%) + 0.6(14%) = 1.8% + 0.9% + 8.4% = 11.1%

The Hamada Equation معادلة العالم حمادة
βL = βU[ 1 + (1 - T) (D/E)] Suppose, the risk-free rate is 6%, as is the market risk premium. The unlevered beta of the firm is If the total assets are $2,000,000.

The Hamada Equation معادلة العالم حمادة - مثال
If D = $250, βL = 1.0 [ 1 + (0.6)($250/$1,750) ] βL = ks = kRF + (kM – kRF) βL ks = 6.0% + (6.0%) ks = 12.51%

Calculating levered betas and costs of equity علاقة استخدام الرفع المالي على معامل بيتا وتكلفة الاسهم ks 12.00% 12.51 13.20 14.16 15.60 Amount borrowed $ 250 500 750 1,000 D/A ratio 0.00% 12.50 25.00 37.50 50.00 D/E ratio 0.00% 14.29 33.33 60.00 100.00 Levered Beta 1.00 1.09 1.20 1.36 1.60

Determining the minimum WACC تحديد أقل تكلفة لرأس المال
ks 12.00% 12.51 13.20 14.16 15.60 kd (1 – T) 0.00% 4.80 5.40 6.90 8.40 Amount borrowed $ 250 500 750 1,000 D/A ratio 0.00% 12.50 25.00 37.50 50.00 E/A ratio 100.00% 87.50 75.00 62.50 50.00 WACC 12.00% 11.55 11.25 11.44 12.00 * Amount borrowed expressed in terms of thousands of dollars

Determining the stock price maximizing capital structure تحديد هيكل رأس المال الذي ينتج اعلى سعر للسهم Amount Borrowed DPS k P s $ $3.00 12.00% $25.00 250,000 3.26 12.51 26.03 500,000 3.55 13.20 26.89 750,000 3.77 14.16 26.59 1,000,000 3.90 15.60 25.00

Financial Planning and Forecasting التنبؤ والتخطيط المالي – اساسيات التسعير
Forecasting sales Projecting the assets and internally generated funds Projecting outside funds needed Deciding how to raise funds

Comprehensive example مثال في التنبؤ
Balance sheet (2002), in millions of dollars Cash & sec. $ Accts. pay. & accruals $ 100 Accounts rec Notes payable Inventories Total CL $ 200 Total CA $ L-T debt 100 Common stock 500 Net fixed Retained assets earnings Total assets $1,000 Total claims $1,000

Comprehensive example مثال في التنبؤ
Income statement (2002), in millions of dollars Sales $2,000.00 Less: Var. costs (60%) 1,200.00 Fixed costs EBIT $ Interest EBT $ Taxes (40%) Net income $ Dividends (30%) $15.12 Add’n to RE $35.28

Key assumptions معطيات
Operating at full capacity in 2002. Each type of asset grows proportionally with sales. Payables and accruals grow proportionally with sales. 2002 profit margin (2.52%) and payout (30%) will be maintained. Sales are expected to increase by $500 million. (%DS = 25%)

Determining additional funds needed AFN حساب الحاجة الى تمويل اضافي
AFN = (A*/S0)ΔS – (L*/S0) ΔS – M(S1)(RR) = ($1,000/$2,000)($500) – ($100/$2,000)($500) – ($2,500)(0.7) = $180.9 million.

How shall AFN be raised? كيفية الحصول على الاموال الاضافية
The payout ratio will remain at 30 percent (d = 30%; RR = 70%). No new common stock will be issued. Any external funds needed will be raised as debt, 50% notes payable and 50% L-T debt.

Forecasted Income Statement (2003) التنبؤ بقائمة الدخل
2002 Forecast Basis 2003 Forecast Sales $2, $2,500 Less: VC 1, ,500 FC EBIT $ $ 125 Interest EBT $ $ 109 Taxes (40%) Net income $ $ Div. (30%) $15 $19 Add’n to RE $35 $46

Forecasted Balance Sheet (2003) - Assets التنبؤ بقائمة المركز المالي - الاصول
Basis 2003 1st Pass 2002 Cash $ $ Accts. rec Inventories Total CA $ $ 625 Net FA Total assets $1,000 $1,250

Forecasted Balance Sheet (2003) - Liabilities and Equity التنبؤ بقائمة المركز المالي – الخصوم وحقوق الملكية Forecast Basis 2003 1st Pass 2002 AP/accruals $ $ 125 Notes payable Total CL $ $ 225 L-T debt Common stk Ret.earnings * Total claims $1,000 $1,071 * From income statement.

What is the additional financing needed (AFN)
Required increase in assets = $ 250 Spontaneous increase in liab. = $ Increase in retained earnings = $ Total AFN = $ 179 NWC must have the assets to generate forecasted sales. The balance sheet must balance, so we must raise $179 million externally.

How will the AFN be financed? كيفية تحديد التمويل الاضافي
Additional N/P 0.5 ($179) = $89.50 Additional L-T debt But this financing will add to interest expense, which will lower NI and retained earnings. We will generally ignore financing feedbacks.

Forecasted Balance Sheet (2003) - Assets التنبؤ بقائمة المركز المالي - الاصول بعد حساب التمويل الاضافي 2003 1st Pass 2003 2nd Pass AFN Cash $ $ Accts. rec Inventories Total CA $ $ 625 Net FA Total assets $1,250 $1,250

AP/accruals $ 125 - $ 125 Notes payable 100 +89.5 190
Forecasted Balance Sheet (2003) - Liabilities and Equity التنبؤ بقائمة المركز المالي – الخصوم وحقوق الملكية بعد حساب التمويل الاضافي 2003 1st Pass 2003 2nd Pass AFN AP/accruals $ $ 125 Notes payable Total CL $ $ 315 L-T debt Common stk Ret.earnings Total claims $1,071 $1,250

Why do the AFN equation and financial statement method have different results?
Equation method assumes a constant profit margin, a constant dividend payout, and a constant capital structure. Financial statement method is more flexible. More important, it allows different items to grow at different rates.

Corporate Valuation: A Guide for Brokers, Managers and Investors

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Corporate Valuation: A Guide for Brokers, Managers and Investors

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