Download Value of firm`s shares

Valuing the Enterprise: Free Cash Flow
Valuation
Value of firm’s shares
VS = VF– VD - VP
Discount estimates of free cash flow that the firm
Discount
will generate in the future.
• VS = value of firm’s common shares
• VF = total enterprise value
• VD = value of firm’s debt
Use weighted average cost of capital (WACC) to
discount the free cash flows.
WACC: after-tax weighted average required return
on all types of securities that firm issues.
We have an estimate of total value of the firm.
How can we use this to value the firm’s shares?
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An Example: YUM! Brands
YUM
An example....
Recently trading between $48
and $50 per share
Yum! Brands
We can use the free cash flow approach to estimate
the value of YUM shares.
2
An Example: Yum! ($millions)
• YUMs debt market value is $1860
million.
• No preferred stock
• 285 million shares outstanding
• End of 2005 Free cash flow is $647
million.
Assume that Yum will experience 15% FCF growth
for 2006 and 11% the following 2 years and 10.5%
annual growth thereafter.
YUM’s WACC is approximately 15%.
• VP = value of firm’s preferred stock
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End of Year Growth
Status
Growth
Rate (%)
FCF Calculation
0
Historic
Given
1
Variable
15
$647 x (1.15) = $744
2
Variable
11
$744 x (1.11) = $826
3
Variable
11
$826 x (1.11) = $917
4
Stable
10.5
$647
$917 x (1.105) = $1013
Use variable growth equation to estimate
YUM!s enterprise value.
4
1
An Example: YUM! Enterprise Value ($millions)
VF =
An Example: YUM!’s Total Stock Value and
Value per Share
VF =
FCF0 (1 + g1 ) FCF1 (1 + g 2 )
FCFN −1 (1 + g N )
+
+ ...
+
(1 + r )1
(1 + r ) 2
(1 + r ) N
VD = $1860
VP = $0
⎡ 1
FCFN (1 + g CorS ) ⎤
+⎢
×
⎥, where N = # of yrs of var. growth
N
r − g CorS
⎣ (1 + r )
⎦
VS = VF - VD - VP =
Divide total share value by 285 million shares
outstanding to obtain per-share value:
5
Common Stock Valuation
Other Options
Book value
• The value shown on the balance
sheet of the assets of the firm, net of
liabilities shown on the balance sheet
Liquidation
value
• Actual net amount per share likely to
be realized upon liquidation and
payment of liabilities
P/E
multiples
• Reflects the amount investors will
pay for each dollar of earnings per
share
• P / E multiples differ between and
within industries.
• Especially helpful for privately-held
7
firms.
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Stock Valuation Summary
zLooked at Dividend Discount Model:
Value = PV of future expected dividends.
All else equal:
{Higher interest rates yields lower stock prices
(inverse relationship)
{Higher growth rate yields higher stock price.
zOther Stock Valuation Methods
{PE Ratio x expected EPS
{PV of all expected future cash flows available to
stockholders
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