Week 11 Equity Valuation SEE THE IS/BS MODEL & FLOW DIAGRAM TABS -YOU ARE NO READ: VIDEOS: CASE CFW on Valuation, Chapter 6 The "Big Daddy" Valuation Formula links to videos on Week 11 Bb page A Swinging Attitude for Equity Valuation Success Monmouth, Inc. do not confuse Monmouth and Robertson Tool; examine titles of case exhib Learning Objectives - Apply financial analysis techniques learned so far to size-up a business - Learn how to use and not abuse the Free Cash Flow Equity Valuation Model - Learn how to use and not abuse the Market Multiples Equity Valuation Model - Become aware of the proposition that "equity valuation is an opinion" - Become aware that successful equity analysts know how to "swing it" Assignment Questions ANSWER IN THE TABS 1 Prepare a succinct statement describing Robertson Tool's business risk, making critical j HINT: Consider the volatility of its revenues and operating expenses, therefore appraisin based on the green color-coded parts of the IS-BS Model. 2 What does the Free Cash Flow Equity Valuation model on Q2 tab suggest about the valu HINT: Note that Case Exhibit 4 provides data inputs for the FCF valuation. 3 What does the Market Multiples Valuation model on Q3 tab suggest about the value of M HINT: Case Exhibit 6 provides data inputs for the MM valuation. 4 Considering all of the above, Q1-3, recommend and justify a price for this deal. This is not easy to do. Put yourself in the shoes of the Robertson managers. Who wants it more? The buyer-Monmouth? The seller-Robertson? Who has the strongest negotiating position? Use case facts to guide you. REMEMBER: THERE IS NO SINGLE CORRECT ANSWER IN FINANCIAL ANALYSIS AND DECISION MAKING. THE QUALITY OF YOUR WORK DEPENDS ON THE INTERPRETATION OF MODEL RESULTS COMBINED WITH INFORMATION FROM THE CASE… AND JUDGMENT. DON'T BE AFRAID TO EXERCISE YOUR JUDGMENT! THUMBNAIL SKETCH: BRIEF ANALYSIS DUPONT RATIOS HISTORICAL RATIOS I/S & B/S FORECAST TIE NORMAL DEBT RATIOWORKING CAPITAL I/S, B/S, & RATIOS STOCK PRICE MKT CAP EXTENDED ANALYSIS FULL RATIOS LIQUIDITY LEVERAGE ASSET USE PROFITABILITY VALUATION GROWTH CAPITAL BUDGETING OP & CAP NATCF, NPV, IRR, PAYBACK FINANCING EFN ANALYSIS STEPS: 1-HISTORICAL RATIOS 2-K-WACC 3-CAPITAL BUDGETING 4-FORECAST & EFN 5-EQUITY VALUATION 6-FINANCING VALUATION DEBT EQUITY DEBT EQUITY EBIT CHART income risk control mktblty flexblty timing K-WACC ENTERPRISE VALUE USING FREE CASH FLOW MARKET MULTIPLES: P/E, MV/BV, REV, EBIT INCOME STATEMENT BALANCE SHEET Revenue ASSETS LIABILITIES AND EQUITY Cost of sales Current assets Current liabilities Gross profit Cash Trade payables Other operating income Investments Other accruals Other operating expenses Trade receivables Tax liabilities Total cost and expenses Inventories Short-term loans, leases Operating profit (EBIT) Non-current assets Non-current liabilities Interest, finance costs Property, plant & equipment Loans, debt, leases due after 1 year Profit before tax Investment property Retirement benefit obligation Income tax Goodwill Deferred tax liabilities Net profit after tax Total non-current liabilities Dividends Reinvested in the business Stockholder's equity (Net worth) Preferred stock OPERATING LEVERAGE Common stock Additional paid-in-capital FINANCIAL LEVERAGE Retained earnings Total assets Total liabilities & equity WORKING CAPITAL changes spontaneously with revenue ?what levels of ca, cl, s-t loans? CAPITAL BUDGETING ?which projects to accept? FINANCING ?how much debt capacity? COST OF DEBT K-WACC COST OF EQUITY VALUATION CASH FLOW COST OF CAPITAL Cost of Capital A 1 WEIGHTED AVERAGE COST OF CAPITAL 2 3 4 COST OF DEBT: 5 Coupon Rate 6 Marginal Tax Rate 7 Cost of Debt 8 weight of debt 9 10 COST OF EQUITY: 11 12 13 Risk-Free Rate Equity Risk Premium Beta Cost of Equity weight of equity 14 15 16 17 Weighted-Average Cost of Capital B C D E F G H I CONSIDER THIS AS GIVEN Formula 6.67% given 40.0% given 4.00% b5*(1-b6) 30% 4.10% 6.00% 1.00 10.10% 70% given given given b11+(b13*b12) 1-b8 Equation BB Corporate,Ex 7 k-d = I x (1- t) d ÷ d+e judgment guided by case facts 30-yr Treasury, Ex 7 given, Ex 7 avg Accutant,Snap-On,Stanley equity beta; Ex 6 k-e = R-f + [ß x (R-m - R-f)] e ÷ d+e R-m - R-f 8.27% (b8*b7)+(b15*b14)(k-d x wt-d)+(k-e x wt-e) Page 5 J Prepare a succinct statement describing Robertson Tool's business risk, making critical judgments. Consider the volatility of its revenues and operating expenses, therefore appraising the volatility of its HINT: Consider the volatility of its revenues and operating expenses, therefore appraising the volatility Answer Q1 here: Q1 refore appraising the volatility of its EBIT. es, therefore appraising the volatility of its EBIT, Q2 A B C D 1 FREE-CASH-FLOW VALUATION OF EQUITY E F G H I J USE ANSWER BOX BELOW AT ROW 57 2 Assumptions: PERIOD YEAR 3 4 5 Profit from operations (EBIT) 6 Income tax rate 2002 0 3 7 Depreciation & amortization expense 8 Net working capital from balance sheet forecast 24.0 9 Capital expenditures 2003 1 4.2 40.0% 2.3 25.4 4.0 2004 2 5.6 40.0% 2.5 27.0 3.5 2005 3 7.2 40.0% 2.7 28.6 3.6 2006 4 8.2 40.0% 2.9 30.3 3.8 10 Long-term growth rate 11 Wt-Avg. C of C (K-wacc) 8.27% 12.0 0.584 0.0 12 Market Value of Debt 13 Number of Shares 14 Redundant Assets 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 2007 5 8.2 40.0% 2.9 30.3 2.9 1.5% PERIOD YEAR 2002 0 EBIT after tax (EBIAT) + Depreciation =Cash Flow from Operations (CFFO) +/- Change in Net Working Capital +/- Capital Expenditures =Free Cash Flow (FCF) +Terminal Value (TV) =Sum of FCF + TV Present Value - Market Value of Debt = Valuation of Equity +Redundant assets =Adjusted Value of Equity / Number of Shares Value of Equity per Share GIVEN IN EX 4 JUDGMENT GIVEN IN EX 1 NONE MENTIONED IN THE CASE 2003 1 2.5 2.3 4.8 (1.4) (4.0) (0.6) 2004 2 3.4 2.5 5.9 (1.6) (3.5) 0.8 2005 3 4.3 2.7 7.0 (1.6) (3.6) 1.8 2006 4 4.9 2.9 7.8 (1.7) (3.8) 2.3 (0.6) 0.8 1.8 2.3 2007 5 4.9 2.9 7.8 0.0 (2.9) 4.9 73.8 78.7 56.1 12.0 44.1 0.0 44.1 0.584 $75.55 2003 58.6 39.8 2004 62.1 41.6 2005 65.9 43.5 2006 69.8 45.4 2007 69.8 45.4 sales per day cost of goods per day 0.152 0.104 0.161 0.109 0.170 0.114 0.181 0.119 0.191 0.124 0.191 0.124 25.4 27.0 28.6 30.3 30.3 53 173 8 18 2 24 43.4% CALCULATED IN ROW 50 BELOW GIVEN IN EX 2 2002 55.3 37.9 rec invn pay NWC NWC/Sales GIVEN IN EX 4 FROM COST OF CAPITAL TAB FORECAST NWC AS % OF SALES IN ROW 8 sales cost of goods days receivables days inventory days payables GIVEN IN EX 4 GIVEN IN EX 4 -STATUATORY RATE, NOT TRUE RATE Q2 What does the Free Cash Flow Equity Valuation model on Q2 tab suggest about the value of Monmouth? HINT: Note that Case Exhibit 4 provides data inputs for the FCF valuation. Answer Q2 here: Page 8 Q3 A B C D E F G H USE ANSWER BOX BELOW AT ROW 30 1 2 3 4 5 6 7 8 9 MARKET MULTIPLES (COMPARABLES) VALUATION OF EQUITY Acutant Snap On Market Multiples of Peers Peer A Peer B Price /revenue market multiple of peer company 0.0 0.0 Price/EBITDA market multiple of peer company 12.8 14.4 Price /Earnings market multiple of peer company 15.0 14.4 Mkt Val of Eq/Book Val mkt mult of Equity of peer co 0.0 0.0 10 11 Target company data 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 Target company revenue Target company EBITDA Target company earnings (net income) Target company book value of equity Target company number of shares Stanley Peer C 0.0 12.9 11.6 0.0 Peer D 0.0 0.0 0.0 0.0 Average Peer E Mkt Mult 0.0 0.0 0.0 13.4 0.0 13.7 0.0 0.0 adjust function if less than 5 peers FROM ACTUAL 2002 DATA 55.3 1.8 CHANGED TO EBIAT TO FIT EXHIBIT 6 1.3 31.0 0.584 from col B from Col G BxC C/B55 Target Co Average Aggregate Per Share Valuation Calculations Data Mkt Mult Valuation Valuation Valuation based on avg revenue market multiple 55.3 0.0 0.00 $0.00 NO DATA IN EXHIBIT 6 - DISREGARD Valuation based on avg EBITDA market multiple 1.8 13.4 24.06 $41.20 CHANGED TO EBIAT TO FIT EXHIBIT 6 Valuation based on avg earnings market multiple 1.3 13.7 17.77 $30.42 Valuation based on avg book value market multiple 31.0 0.0 0.00 $0.00 NO DATA IN EXHIBIT 6 - DISREGARD Q3 What does the Market Multiples Valuation model on Q3 tab suggest about the value of Monmouth? HINT: Case Exhibit 6 provides data inputs for the MM valuation. Answer Q3 here Page 9 I J K L Summary map FREE CASH FLOW MODEL REVENUE MARKET MULTIPLE EBITDA MARKET MULTIPLE EARNINGS MARKET MULTIPLE BOOK VALUE MARKET MULTIPLE CURRENT MARKET PRICE $10.00 $20.00 $30.00 $41.20 $30.42 Q4 Considering all of the above, Q1-3, recommend and justify a price for this deal. This is not easy to do. Put yourself in the shoes of the Robertson managers. Who wants it more? The buyer-Monmouth? The seller-Robertson? Who has the strongest negotiating position? Use case facts to guide you. Answer Q4 here: $40.00 $23-32 $50.00 $60.00 $75.55 recent closing price $44 influenced by news of possible deal
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