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stockholders
distribution.
Valuing FCFF
The FCFF valuation approach estimates the value of
FCFFt
Firm Value
t
Discounting FCFF at the WACC
gives
the
total value of all of
(1
WACC)
t 1
the firms capital. The value of equity is the value of the firm
minus the market value of the firms debt
Valuing FCFF
Equity Value = Firm Value Market
Value of Debt
Dividing the total value of equity by the
Calculating a WACC
The cost of capital is the required rate of
Calculating a WACC
If the suppliers of capital are creditors and stockholders, the
required rates of return for debt and equity are the after-tax
required rates of return for the firm under current market
conditions. The weights that are used are the proportions of the
total market value of the firm that are from each source, debt and
equity.
WACC
MV (debt )
MV (equity )
rd (1 Tax rate)
re
MV (debt ) MV (equity )
MV ( debt ) MV (equity )
and equity, not their book or accounting values. The weights will
sum to 1.0.
Valuing FCFE
The value of equity can also be found by discounting FCFE
Equity Value
t 1
FCFE t
(1 r )t
Single-stage constant-growth
FCFF valuation model
FCFF in any period is equal to FCFF in
at a constant rate is
FCFF0 (1 g )
FCFF1
Firm Value
WACC g
WACC g
Single-stage, constant-growth
FCFE valuation model
FCFE in any period will be equal to FCFE in the
rate is
FCFE1 FCFE 0 (1 g )
Equity Value
rg
rg
Non-cash charges
The best place to find historical non-cash charges is to
Non-cash charges
Deferred taxes result from a difference in
Non-cash charges
If the analysts purpose is forecasting and he seeks to
Int(1
in
FCFF = EBITDA(1 Tax rate) + Dep(Tax rate)
Inv(FC) Inv(WC)
Forecasting FCFF
One approach recognizes that capital
Forecasting FCFF
When forecasting FCFE, analysts often simplify the
which is equivalent to
FCFF = EBIT (1 Tax rate)
Forecasting FCFE
If the firm finances a fixed percentage of its capital spending
(1 DR)Inv(WC)
When building FCFE valuation models, the logic, that debt
rate could be the growth rate for FCFF or FCFE, or the growth rate
for income (such as net income), or the growth rate could be the
growth rate for sales. If the growth rate were for net income, the
changes in FCFF or FCFE would also depend on investments in
operating assets and financing of these investments. When the
growth rate in income declines, such as between stage one and
stage two, investments in operating assets will probably decline at
the same time. If the growth rate is for sales, changes in net profit
margins as well as investments in operating assets and financing
policies will determine FCFF and FCFE.
model is
Firm Value=
t 1
FCFFt
FCFFn 1
1
+
(1+WACC)t (WACC-g ) (1+WACC) n
model is
Equity
t 1
FCFE t FCFE n 1
1
t
r g (1 r ) n
(1 r )
from these assets could be combined with the cash flows of the
operating assets, often making it difficult to find the cash flows of
the operating assets. For example, interest and dividend income
and capital gains from an investment portfolio could mask the fact
that the companys operating profitability is poor. The value of the
firm should be the value of its operating and non-operating assets:
Value of firm = Value of operating assets
+ Value of non-operating assets.
Value(Operating)
FCFF0 (1 g )
22(1.05)
23.1
CD 385
WACC g
0.11 0.05 0.06
Firm
45.475
WACC g
WACC g
0.11 0.07 0.04
The market value of equity is the value of the firm minus the
value of debt:
Equity = 45.475 15 = $30.475 billion.
B. Using the FCFE valuation approach, the present value of
FCFE, discounted at the required rate of return on equity,
is
FCFE1 FCFE 0 (1 g )
1.3(1.075)
1.3975
PV The value
of equity using
this approach
25.409billion.
is $25.409
rg
rg
0.13 0.075 0.055
Taiwan Semiconductor
solution
The required rate of return found with the CAPM is:
r = E(Ri) = RF + bi[E(RM) RF] = 6.4% + 2.1 (5.0%) = 16.9%.
The table below shows the values of Sales, Net income, Capital expenditures less
Depreciation, and Investments in working capital. The free cash flow to equity is
equal to net income less the investments financed with equity, which is:
FCFE = Net income (1 DR)(Capital expenditures Depreciation)
(1 DR)(Investment in working capital)
Since 20 percent of new investments are financed with debt, 80 percent of the
investments are financed with equity, reducing FCFE by 80 percent of (Capital
expenditures Depreciation) and 80 percent of the investment in working capital.
Taiwan Semiconductor
solution
Taiwan Semiconductor
solution
The terminal stock value is 18.0 times the
earnings in year 2006, or 18 4.724 =
$85.04 billion.
The present value of the terminal value
($38.95 billion) plus the present value of
the first five years FCFE ($1.82 billion) is
$40.77 billion.
Since there are 17 billion outstanding
shares, the value per share is $2.398.
Net income is currently $600 million. Net income will grow by 20 percent annually for the next three
years.
The net investment in operating assets (capital expenditures less depreciation plus investment in
working capital) will be $1,150 million next year and grow at 15 percent for the following two years.
Forty percent of the net investment in operating assets will be financed with net new debt
financing.
Alcans beta is 1.3, the risk-free bond rate is 7 percent, and the market risk premium is 4 percent.
After three years, the growth rate of net income will be 8 percent and the net investment in
operating assets (Capital expenditures minus Depreciation plus Increase in working capital) each
year will drop to 30 percent of net income. Debt financing will continue to fund 40 percent of the net
investment in operating assets.
There are 318 million outstanding shares.
FCFE
918.19
g
0value
.122 of
0.08
equity, ther present
the first three years FCFE plus the present value of P 3, is
4
ThePpresent
value
at 12.2 percent is $15,477.64 million. The total value of
of P3 discounted
$21,861.67
3
$15,648.36 million. Dividing by the number of outstanding shares (318 million) gives a
price per share of $49.21. For the first three years, Alcan has a small FCFE because of the
high investments it is making during the high growth phase.
Bron (#12)
Bron has earnings per share of $3.00 in 2002 and expects earnings per share to increase by
21 percent in 2003. Earnings per share are going to grow at a decreasing rate for the following
five years, as shown in the table below. In 2008, the growth rate will be 6 percent and is
expected to stay at that rate thereafter. Net capital expenditures (Capital expenditures minus
depreciation) will be $5.00 per share in 2002, and then follow the pattern predicted in the table.
In 2008, net capital expenditures are expected to be $1.50, and then to grow at 6 percent
annually after that. The investment in working capital parallels the increase in net capital
expenditures and is predicted to equal 25 percent of net capital expenditures each year. In
2008, investment in working capital will be $0.375 and is predicted to grow at 6 percent
thereafter. Bron will use debt financing to fund 40 percent of net capital expenditures and 40
percent of the investment in working capital.
Year
2003
2004
2005
2006
2007
2008
Growth rate eps
21%
18%
15%
12%
9%
6%
Net capex per share5.00
5.00
4.50
4.00
3.50
1.50
The required rate of return for Bron is 12 percent. Find the value per share using a two-stage
FCFE valuation approach.
Bron solution
FCFE is shown in this table:
Bron solution
The present values of FCFE from 2003 through 2007 are given in
the bottom row of the table. The sum of these five present values is
$4.944. Since the FCFE from 2008 onward will be growing at a
constant 6 percent, the constant growth model can be used to value
these cash flows.
FCFE
5.249
P2007
2008
rg
0.12 0.06
$87.483
2007) plus the present value of the FCFE after 2007, or $4.944 +
$49.640 = $54.58.