10. Re-Cap on Equity Value Calculation

 
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Overview

With Equity Value now calculated, let's pause and review the steps taken in the past 9 lessons to get to our company valuation.

Summary

Getting to Equity Value

1. Build 5-year or 10-year financial projections
2. Find the unlevered free cashflow for each year in your projections
3. Calculate the Weighted Average Cost of Capital (WACC) for the company
4. Discount the unlevered free cashflows for all future years in your projection
5. Estimate the terminal value of the company beyond your projection
6. Discount the terminal value and combine with your discounted cashflows to find Enterprise Value
7. Calculate Equity Value by subtracting debt and adding cash to Enterprise Value

Transcript

With our discounted cash flow valuation now calculated, let's take one lesson to recap on the stages we took to get this far. From the previous course, we had five-year projections built for the Income Statement, Balance Sheet and statement of cash flows. These projections constituted a lot of the work required to create our DCF.

Our next step was to distinguish between enterprise value and equity value, and we resolved to calculate enterprise value first and then equity value, as this is often the easier path to follow.

To find the enterprise value using the discounted cash flow method, we need to use unlevered free cash flows. To calculate unlevered free cash flows, we found NOPAT, which is net operating profit after tax, and then we adjusted for non-cash expenses, changes in operating assets and liabilities and we also subtracted capital expenditure. These unlevered free cash flow projections could then be discounted by the weighted average cost of capital, or WACC. The weighted average cost of capital for MarkerCo was calculated from the following formula. In this formula, the most challenging value to calculate was the cost of equity, and we used the Capital Asset Pricing Model to calculate the cost of equity. For MarkerCo, the risk-free rate was 2.3%, the expected market rate of return was 8% and beta was 1.3, and this gave us a cost of equity of 9.7%. Returning to our WACC formula, because MarkerCo has no debt, the WACC was simply equal to the cost of equity at 9.7%.

With the WACC now in place, we could discount the cash flows for our five-year projection and from this table, you can see the impact of discounting on our unlevered free cash flows. We now have the value of the company based on the first five years into the future, but what about the remaining years? For this, we need to calculate the terminal value. And the terminal value is calculated using two different methods, the perpetuity method, where we assume a constant growth rate for each year, and the exit multiple method, where we assumed a certain enterprise value all over EBITDA multiple at the end of the projection period. Using a growth rate of 1.5%, we achieved a terminal value of 293.9, which when discounted and combined with the first 5 years of cash flows, provided an enterprise value of 250 million. Using the exit multiple method, our terminal value is 301 million with an enterprise value of 254.5 once discounting had been taken into account. With our enterprise value now calculated, all we need to do is to calculate the equity value of the company, which I'll show you in the next lesson.