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Consulting Club Finance Workshop

Consulting Club Finance Workshop. DMCC January 12 th , 2013. Contents. Net Present Value Perpetuities Free Cash Flows Valuation through multiples. Net Present Value. 1 1+i (1+i)^2 1/(1+i)^2 1/(1+i) 1. Worth the investment? Investment of $5M today

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Consulting Club Finance Workshop

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  1. Consulting Club Finance Workshop DMCC January 12th, 2013

  2. Contents • Net Present Value • Perpetuities • Free Cash Flows • Valuation through multiples

  3. Net Present Value

  4. 1 1+i (1+i)^2 1/(1+i)^2 1/(1+i) 1 Worth the investment? Investment of $5M today Return of $2.8M each year for 2 years Interest rate is 10%

  5. Investment of $5M today Return of $2.8M each year for 2 years Interest rate is 10% 1/(1.1)=0.909 or 1/(1.1)~0.9 1/(1.1)^2=0.826 or 1/(1.1)^2~0.8 NPV = -5M + 2.8M*0.9 + 2.8*0.8 = -0.24M Not a good investment -5M 2.8M 2.8M

  6. Perpetuities

  7. NPV = Cash flow / Interest rate Worth the investment? Investment of $5M today Return of $2.8M each year for the next 50 years Interest rate is 10% CF CF CF CF

  8. Investment of $5M today Return of $2.8M each year for the next 50 years Interest rate is 10% NOT a perpetuity, but can be approximated with one NPV = -5M + 2.8M/0.1 = 23M Real result = 22.76M It is worth investing

  9. Free Cash Flows

  10. Why free cash flows instead of returns? Most of the times investments have an effect on taxes as well as working capital. If you invest in a machine today, you’ll get tax returns from depreciation, but you need to save some money to maintain it. Also, the sales from the machine’s work will be taxed.

  11. Sales (Revenues from operations) - COGS (Labor + Materials + Book Depreciation) - SG&A (Selling, General and Administrative Costs) EBIT (Earnings Before Interest and Taxes= NOPBT = Net Operating Profits Before Taxes) - Taxes (Calculated on EBIT) EBIAT (Earnings Before Interest After Taxes = NOPAT = Net Operating Profits After Taxes)

  12. EBIAT (Earnings Before Interest After Taxes = NOPAT = Net Operating Profits After Taxes) + DEP (Book Depreciation) - CAPX (Capital Expenditures) - DWC (Incremental Working Capital) FCF (Free Cash Flows)

  13. Back to our example Worth the investment? • We purchase 100 trucks that will depreciate entirely (straight line) in 2 years, each truck costs $50K • There are no maintenance costs, but we need to add 0.5M to Working Capital • Operating profits are 4M each year for the following 2 years. • Taxes are 30% • Interest rate is 10%

  14. Back to our example Time 0 free cash flows No revenues, profits or taxes today, so EBIAT=0 EBIAT = 0 +DEP = + 0 -Capex = - 5M (100 trucks x $50K) -ΔWC = - 0.5M FCF = - 5.5M

  15. Back to our example Time 1 & 2 free cash flows Operating profits = 4M Depreciation = 2.5M (5M / 2) Taxable profits = 1.5M EBIAT = 1.05M (1.5M x (1-0.3)) EBIAT = 1.05M +DEP = + 2.5M -Capex = - 0 -ΔWC = . - 0 . FCF = 3.55M

  16. NPV = -5.5M + 3.55M*0.9 + 3.55*0.8 = 0.535M Real result = 0.661M It is a good investment -5.5M 3.55M 3.55M

  17. Valuation Through Multiples

  18. Most common multiples (at least for casing) P/S (Price over sales) usually startups and high- tech firms in red numbers P/E (Price over earnings) most projects/ companies use this P/BV (Price over book value) usually for financial institutions

  19. It’s all about choosing the right comparable companies Similar: • Lines of business/industry • Size • Geography • Profitability/Margins • Other (choose, it’s not a science) If possible, choose over 6 comparable companies

  20. Examples WalmartVs. Target Amazon Vs. Netflix Apple Vs. Microsoft You can make a case for or against any of these.

  21. You are looking to acquire a small silver mining company called Silver Inc. It owns three working mines in Mexico and one in Central America.

  22. Mosler Silver: P/E 50 & annual revenue* 20M Deloitte’s mining: P/E 35 & annual revenue* 80M Evil Silver Co: P/E 65 & annual revenue* 300M *Assuming each has a 50% margin Total sales are 400M P/E for Silver Inc.=50*20M/400M+35*80M/400M+ 65*300M/400M =58

  23. P/E for Silver Inc.=58 Earnings: 50M Valuation: 50M * 58 = 2,900M

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