DCF WACC Simplified

This calculates the Free Cash Flow to the Firm for each forecast period, being:

FCF= Free Cash Flow

EBIT = Earnings before Interest and Taxes

Tax = EBIT * Tax Rate

D&A = Depreciation and Amortization

Capex = Capital Expenditure

NWC = Change in Net Working Capital

For information on the components of free cash flow, please refer to the article on Valuation Relevant Cashflows.

The Free Cash Flow for each forecast year is then discounted using the WACC as the discount rate. The terminal value is calculated using the Gordon Growth Model.

FCF = Free Cash Flow

gTY = Terminal Year Growth Rate

t = Time Period

TY = Terminal Year

The discounted free cash flows and terminal value are added together to arrive at the Enterprise Value. Net Debt (as well as any other adjustments included in the EV-EqV Bridge) is deducted to arrive at the Equity Value.

DCF APV

The value of the business is calculated as the sum of two components:

Operations of the business (Free Cash Flow to Firm); and
Tax shield created by the use of debt.

Free cash flows are discounted using the unlevered Cost of Equity instead of the WACC, which provides the unlevered Enterprise Value.

UEV = Unlevered Enterprise Value

FCF = Free Cash Flow

g = Perpetual Growth Rate

t = Time Period

TY = Terminal Year

CoE = Cost of Equity (unlevered)

Unlevered Cost of Equity is calculated the same way as regular Cost of Equity, except for using the unlevered Beta instead of Levered Beta.

β_u is the unlevered beta (asset beta)

β_l is the levered beta (equity beta)

T is the corporate tax rate

D/E is target debt-equity ratio

The Tax Shield in each period, being the reduction in tax payable as a result of the interest expense, is discounted using the unlevered Cost of Equity to arrive at the present value of the Tax Shield.

TS = Tax Shield on interest

D = Debt

I = Interest Rate

T = Tax Rate

Discounted Total Shareholder Return (DTS)

DTS = Discounted Tax Shield on interest

g = Perpetual Growth Rate

t = Time Period

TY = Terminal Year

CoE = Cost of Equity (unlevered)

Bankruptcy Cost (due to the increased gearing) could also be calculated and deducted from the sum of the unlevered Enterprise Value and the present value of the Tax Shield to arrive at the (levered) Enterprise Value.

EV = Enterprise Value

PD = Probability of Default

LGD = Loss given default (Bankruptcy cost as % of EV)

The inputs of the bankruptcy cost can be set via the ‘Change Parameters’ tab.

Enterprise Value (EV)

EV = Enterprise Value

DFCF = Discounted Free Cash Flow

DTS = Discounted Tax Shield on Interest

Dividend Discount Model (DDM)

This methodology simply takes the forecasted dividends from the business plan (based on a dividend payout ratio as a % of the net income) and discounts them at the Cost of Equity to arrive at the Equity Value.

d = Dividend

CoE = Cost of Equity

g = Perpetual Growth Rate

t = Time Period

TY = Terminal Year

EqV = Equity Value

Net Debt is added to Equity Value to arrive at Enterprise Value.

Capitalized Earnings

The Capitalized Earnings Method is an income-based approach best suited for stable companies with expected growth in line with inflation and stable margins. It assumes that the current, normalized benefit stream (earnings, dividends, free cash flow to firm or free cash flow to equity) can be maintained in future and capitalizes it using the capitalization rate (either WACC or Cost of Equity less perpetual growth rate).

This approach is theoretically equivalent to performing a discounted cash flow analysis with the assumption that forecast growth equals the perpetual growth rate and margins remain constant. The current benefit stream can be normalized or adjusted to arrive at a sustainable benefit stream (e.g. Seller's Discretionary Earnings or short SDE).

The Capitalized Earnings Method can be applied to four different benefit streams—earnings, dividends, free cash flow to firm, and free cash flow to equity—each representing a distinct method in the Valuation Overview. The respective benefit stream can also be normalized by entering the desired adjustment (positive numbers will increase the benefit stream, negative numbers will decrease it) in the ‘Change Parameters’ tab.

B = Normalized Benefit Stream selected by the User.

g = Perpetual Growth Rate

CoC = Cost of Capital; depending on the selected Benefit Stream either Cost of Equity (Net Income, Dividends or Free Cash Flow to Equity) or WACC (Free Cash Flow to Firm).

Trading Comparables

The median of the observed trading multiples (EV/Sales, EV/EBITDA, EV/EBIT, EV/ P/E or P/B) of the peer group is used as the starting point of the calculation. A discount or premium (derived from the Qualitative Assessment by default, but which can be overwritten by the user) is applied to the observed median multiple to arrive at the Applied Multiple.

The Applied Metric is then multiplied by the appropriate financial result of the target company, being Sales, EBITDA, EBIT, Earnings or Book Value to arrive at the Enterprise Value (in the case of Sales, EBITDA and EBIT) or the Equity Value (in case of P/E or P/B).

This result is then adjusted by the net debt to arrive at the final Equity Value or Enterprise Value.

EV/Sales Ratio

EV/EBITDA Ratio

EV/EBIT Ratio

Price-to-Earnings (P/E) Ratio

Price-to-Book (P/B) Ratio

By default, Valutico shows multiples for the current year (based on the valuation date) and the next year.

Transaction Comparables

This works exactly the same as the Trading Comparables, except that the medians EV/Sales, EV/EBITDA, EV/EBIT, P/E of the set of selected Transactions are used instead of observed trading multiples.

Venture Capital Method (VC Method)

The VC Method is most commonly used in the venture capital industry and for valuing startups. An investor will seek to exit their investment at some future date at a price that is consistent with valuation multiples observable in the markets today.

We start by determining the exit price (based on an exit time horizon, t, and suitable multiple, m. The default exit multiple is the average of the current year’s applied trading multiple and the transaction multiple. The exit multiple is applied to the forecast financial result in time t, which is then discounted at the target Internal Rate of Return (IRR) of the investor to calculate what the entry price needs to be today for an investor to achieve the stated IRR or money multiple target.

The formulas behind the VC Method are (using EV/Sales multiple as an example):

Equity Value at Exit (EqV_EXIT)

EqVEXIT = Equity Value at Exit

S = Sales

m = Exit Multiple

ND = Net Debt

t = Exit Time Horizon

Internal Rate of Return (IRR)

IRRe = Expected Internal Rate of Return

m = Suitable Multiple

t = Exit Time Horizon

Equity Value at Entry (EqV_ENTRY)

EqVENTRY = Implied Entry Equity Value

IRR = Internal Rate of Return

The exact relationship between time horizon and target money multiple for calculating the IRR can also be seen in detail below and by following this link.

Leveraged Buy-Out (LBO)

The premise of the LBO model is that instead of the acquirer of a business providing all the capital themselves, they make use of debt to finance a portion of the acquisition price. This debt is incurred not by the acquirer but by the company being acquired. An important assumption to the LBO method is thus that the target company has the ability to gear itself fairly aggressively.

The steps in the LBO method are:

Assumption of a hypothetical Purchase Price
Valutico does this by assuming an entry EV/EBIT multiple (default is the median of listed peers). This is not the outcome of the valuation but a first step in running the iterative LBO method to achieve the target IRR and establish the target leverage. The actual entry EV/EBIT multiple that is assumed here does not impact the final valuation result as it is merely used to establish the parameters within which the target IRR will be sought.
Creating the sources and uses of the funds to make up the assumed entry Purchase Price
The debt portion is calculated based on the target leverage assumption (default of 3x EBITDA), with the equity portion being the balance. The LBO model assumes that no dividends are paid during the forecast period and that any excess cash is used to pay down debt.
Exit, based on forecast cash flows in the final year of the forecast period
An exit is calculated in the final year of the forecast period based on the EV/EBIT exit multiple assumption (default is the same multiple as the entry multiple)
Calculating the implied Purchase Price based on the required investor IRR assumption
The implied Purchase Price is calculated by discounting the exit at the target IRR.