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Module 5: Valuation Using Forecasts of Cash Flows Patrick Noonan

Module 5: Valuation Using Forecasts of Cash Flows Patrick Noonan. Overview of Valuation Using Forecasts of Cash Flows. Value is estimated based on expected future cash flows

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Module 5: Valuation Using Forecasts of Cash Flows Patrick Noonan

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  1. Module 5: Valuation Using Forecasts of Cash Flows Patrick Noonan

  2. Overview of Valuation Using Forecasts of Cash Flows • Value is estimated based on expected future cash flows • Potential users of financial information are generally interested in the enterprise’s ability to generate favorable cash flows • Investor decisions relate to: Amounts + Timing + Uncertainties of expected cash flows • Accounting will NOT tell you how much something is worth… • …It WILL provide information helpful in estimating how much something is worth

  3. Cash-Flow Based Valuation of a Finite-Life Project Green Mountain Coffee Roasters

  4. Cash Flow-Based Valuation of a Finite-Life Project • DCF is familiar to most people • Most accounting-based valuation models are derived from DCF • Value of an investment or project is based on the expected future payoffs

  5. The Free Cash Flow Valuation Model Green Mountain Coffee Roasters

  6. The Free Cash Flow Valuation Model • Cash flows generated become available to either pay debt holders or be distributed to equity holders • “Free cash flows from operations” • FCFT is the cash flow generated by the enterprise that is distributable to debt and equity holders

  7. Relation Between Free Cash Flows and Accounting Numbers • Beginning NEA plus EPAT less FCF is equal to ending NEA: • Can be rearranged to find FCF as follows:

  8. Parsimonious Forecasts of Enterprise Operations Green Mountain Coffee Roasters

  9. Assumptions for GMCR Based on an analysis of GMCR’s financial statements in Module 4, we arrived at the following assumptions for the foreseeable future: • Sales growth rate 9.05% • Enterprise profit margin (EPM) 10% EPM = EPAT / Sales • Enterprise asset turnover (EATO) 1.65 EATO = Sales / NEA

  10. GMCR Multiyear Forecasts of Sales, EPAT & NEA

  11. Valuing GMCR

  12. Valuing GMCR • Estimated growth rate beyond 2017: 9.05% • Estimate of enterprise cost of capital: 10%

  13. Valuing GMCR

  14. Continuing Values • Can be calculated in several ways – must understand what a “base year” is an how many years to discount • I used 2017 and then also grew 2017 forward one year (2018) to get start of infinite stream. Then I discounted back four years (from 2017 to 2013). • Could also use 2017 as a base year and then discount back three years.

  15. Questions? 18

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