1. BU Finance & Investment Club Joseph McNiff & Xun Yao Chen Spring 2013 Introduction to Valuation

2. 2 Meeting Schedule Apple Trees & Valuation [ Xun ] 4 Valuation Methods [ Joe ]  Basic example of how to value an apple tree, basic concepts of valuation used for equity investments  Overview of the 4 valuation methods used to derive a projected share price

3. Valuation

4. Apple Tree OR

5. Where is Your Apple? Your APPLES TIME Your APPLES NOT your APPLES

6. Opportunity Cost Lost of Apple Received = Opportunity Cost Time is Money Discount on future cash = discount rate (interest rate / year)

7. How much cash can you make? Free cash flow – Free: something that is not tied up to any use Revenues: Apples Expenses or costs: Water, grooming, chemical to shoo the bugs away, land to plant your apple tree, labor fee, Any capital expenditures to fund your business growth or maintain your business FREE Cash Flows to the Firm (FCFF)

8. So much should you pay? TIME How much should you pay? Discount

9. How s

10. How do you measure opportunity cost? For now, just assume 10% because economic average ROE Next TOPIC

11. What Else is On Balance Sheet? Cash that are not used for main business Investments that are not core of the company’s business

12. 12 Meeting Schedule Apple Trees & Valuation [ Xun ] 4 Valuation Methods [ Joe ]  Basic example of how to value an apple tree, basic concepts of valuation used for equity investments  Overview of the 4 valuation methods used to derive a projected share price

13. 13 4 Ways to Value a Company 1.Precedent Transactions 2.Discounted Cash Flow (DCF) 3.Trading Multiples 4.LBO  In order of Highest Valuation to Lowest

14. 14 EBITDA  Earnings Before: Interest Taxes Depreciation (tangible assets) Amortization (intangible assets) - EBITDA is a cash-adjusted (D&A) measurement of the income generated by a company before making distributions to debt holders, the government and the remainder being left for equity holders. EBITDA is widely used in precedent transaction and trading multiple valuation

15. 15 Precedent Transactions (Previous Purchases of Competitors)  Highest Valuation due to Premiums  Companies make transactions due to Synergies –Cost Synergies from transaction/operating costs –Revenue Synergies from sales and distribution  Willing to pay Control Premium to gain synergies  Pay X times for transaction related to EV/EBITDA or other multiple –Can use this metric from similar transactions to value a company

16. 16 Discounted Cash Flow Analysis  5-step process 1.Investment Horizon 2.Forecast Financial Statements 3.FCF 4.WACC 5.TV

17. 17 DCF – Investment Horizon  Determine length of time you want to calculate cash flows (point of stabilization)  Determine how long till terminal value  For BUFC –5 year forecast, 1 year target price

18. 18 DCF – Forecast Financial Statements  Input past data (10-K’s)  Forecast future data (from trends & opportunities, Industry Analysis)  Historical Data gives benchmark for future data

19. 19 DCF – Calculating Free Cash Flow  To calculate 1.EBIT x (1-tax rate) = NOPAT Tax adjustment 2.Net Operating Profit After Tax + D/A – CAPEX – Net working capital [increases = – ] = Free Cash Flow Free Cash Flow represents the cash that a company is able to generate after laying out the money required to maintain or expand its asset base.

20. 20 DCF – Weighted Average Cost of Capital  (Cost of Debt x Weight of Debt) + (Cost of Equity x Weight of Equity) = WACC Cost of Debt = After Tax Cost of Equity = CAPM = R f + B(R m -R f ) This represents the discount rate (time value of money) used to get the present value of the FCF’s calculated and forecasted. SAMPLE FCF

21. 21 DCF – Terminal Value  Time when cash flows stabilize  Two Methods 1.Exit Multiple Method TV = EBITDA x PTm (precedent transaction multiple) 2.Perpetuity Growth Model FCF / (r-g) R = Discount Rate [WACC] G = Anticipated Growth Rate of Company Forever

22. 22 Trading Multiples  Comparable multiples focus on how the company’s stock is currently trading in relation to a measurement of company earning ability  If a company’s multiple is value lower than industry, considered undervalued  Expected Value = EPS x Mean/Median Multiple A forward multiple uses the anticipate earnings for example (P/E) and uses that as the divisor for current price. Gives an idea of how much current investors are willing to pay for future earnings.

23. 23 Leveraged Buyout Analysis The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. Typical example is a private equity firm purchasing a company through raising large amounts of debt and uses the Cash Flow of the company to pay off the periodic payments; ultimately reselling the company in either a primary or secondary market.