237 lines
8.1 KiB
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Executable file
237 lines
8.1 KiB
Org Mode
Executable file
#+title: Section 11 | Lesson 60 - How to value public firms the easy way
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#+HTML_HEAD: <link rel="stylesheet" type="text/css" href="../_share/media/css/org-media-sass/categories/business.css" />
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#+OPTIONS: H:6
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* Links
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- [[./../mba-main.org][TOC | Business]]
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- [[https://www.udemy.com/course/an-entire-mba-in-1-courseaward-winning-business-school-prof/learn/lecture/4310022#overview][S11:L60 course video]]
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- file:../_data/section_11/microsoft_valuation.numbers
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- file:../_data/section_11/course_notes.pdf
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* notes
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** final cash flow explanation
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The "final cash flow" refers to the cash flow in the **last year of your explicit forecast** — typically Year 10 in a 10-year DCF model.
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It is used as the base to calculate the **terminal value**, which estimates all future cash flows from Year 11 to infinity.
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*** How to Determine the Expected Cash Flow
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This is the process to forecast expected cash flow for a future year:
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**** 1. Start with Historical Financials
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- Gather at least 3–5 years of historical data
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- Use sources like: Yahoo Finance, Google Finance, EDGAR (SEC), or company filings
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**** 2. Choose the Right Cash Flow Metric
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Use either:
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- **Free Cash Flow (FCF)** = Operating Cash Flow – Capital Expenditures
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- Or estimate **Free Cash Flow to Firm (FCFF)** with:
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#+BEGIN_SRC text
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FCFF = EBIT × (1 - Tax Rate) + Depreciation - CapEx - ΔWorking Capital
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#+END_SRC
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***** What the Components Mean
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- EBIT (Earnings Before Interest and Taxes) :: Profit from the company’s core operations before interest and taxes are deducted.
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- Depreciation (Non-cash expense) :: A way to spread out the cost of physical assets over their useful life; it reduces taxable income but doesn't reduce actual cash.
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- CapEx (Capital Expenditures) :: Cash spent to buy or upgrade physical assets like equipment, property, or infrastructure.
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- Working Capital (Current Assets - Current Liabilities) :: Measures short-term liquidity; changes in it reflect how much cash is tied up in day-to-day operations.
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**** 3. Project Revenue Growth
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- Estimate growth rate based on:
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- Past performance
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- Industry benchmarks
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- Market conditions
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- Company guidance
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**** 4. Forecast Expenses
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- Express expenses as a **percentage of revenue** (e.g., COGS, SG&A)
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- Estimate EBIT, taxes, CapEx, depreciation, and working capital changes
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**** 5. Project for 5–10 Years
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- Do this for each year individually
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- The last year's result is your **final cash flow**
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*** Example Forecast
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| Year | Revenue | EBIT Margin | EBIT | Taxes (20%) | FCFF |
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|------|---------|-------------|--------|-------------|---------|
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| 2024 | 100000 | 20% | 20000 | 4000 | 16000 |
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| 2025 | 110000 | 21% | 23100 | 4620 | 18480 |
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| 2026 | 120000 | 22% | 26400 | 5280 | 21120 |
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🧠 The FCFF in the final projected year (e.g., $21,120 in 2026) is what you use in the **terminal value formula**.
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*** Summary
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- The final cash flow is not the end of the business; it’s the **bridge** to estimating future value
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- It should reflect the company’s stable, mature cash-generating potential
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- Accuracy here has a **big impact** on the total DCF valuation
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** how to calculate the beta
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Beta measures a stock's volatility relative to the market (typically the S&P 500). A beta of:
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- **1.0** → moves in line with the market
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- **>1.0** → more volatile than the market
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- **<1.0** → less volatile than the market
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Here’s how to find or calculate it:
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*** 1. Google Finance (Quick and Easy)
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1. Go to https://www.google.com/finance
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2. Search for the company (e.g., Microsoft)
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3. Scroll to the "Performance" section
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4. Look for **"Beta"**
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🧠 Example: Microsoft’s beta may be listed as **0.78**, meaning it is 22% less volatile than the market.
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*** 2. Yahoo Finance
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1. Go to https://finance.yahoo.com
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2. Search for the company (e.g., MSFT)
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3. Click on **"Statistics"**
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4. Under "Stock Price History", find **"Beta (5Y Monthly)"**
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*** 3. Bloomberg Terminal / Paid Services
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These are professional tools, often used in finance:
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- Bloomberg: `MSFT <Equity> FA`
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- Also available via: Morningstar, Reuters, FactSet
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*** 4. Manual Calculation (Advanced)
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If you want to calculate beta yourself:
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Formula:
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#+BEGIN_SRC text
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Beta = Covariance(Stock Return, Market Return) / Variance(Market Return)
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#+END_SRC
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Steps:
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1. Get historical prices for the stock and a market index (e.g., S&P 500)
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2. Calculate periodic returns (daily, weekly, or monthly)
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3. Compute covariance and variance
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4. Apply the formula
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You can do this using:
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- Excel (with `COVARIANCE.P()` and `VAR.P()` functions)
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- Python (e.g., using pandas and NumPy)
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*** Summary
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- Use Google Finance or Yahoo Finance for quick lookups
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- Use Bloomberg or Morningstar for professional-level data
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- Calculate manually only if you're customizing the analysis
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** Cost of Equity Calculation
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The cost of equity is the return investors expect for owning a company's stock. It's calculated using the Capital Asset Pricing Model (CAPM):
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Formula:
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#+BEGIN_SRC text
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Cost of Equity = Risk-free rate + Beta × Market Risk Premium
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= 1% + 0.78 × 11% = 9.58%
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#+END_SRC
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- **1%**: Risk-free rate (e.g., U.S. Treasury yield)
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- **0.78**: Microsoft's beta (measures volatility relative to market)
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- **11%**: Market risk premium (extra return expected above risk-free rate)
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🧠 Interpretation:
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Investors expect a 9.58% annual return to compensate for the risk of owning Microsoft stock.
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** Discounted Cash Flow (DCF) Basics
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DCF tells us how much a company is worth today, based on future expected profits.
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Steps:
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1. Forecast future cash flows (e.g., next 10 years)
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2. Discount each cash flow using the cost of equity (e.g., 9.58%)
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3. Sum the discounted values
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Formula:
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#+BEGIN_SRC text
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Present Value = Cash Flow / (1 + r)^n
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#+END_SRC
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Example:
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- Year 1: $100 / (1 + 0.0958)^1 ≈ $91.27
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- Year 2: $100 / (1 + 0.0958)^2 ≈ $83.33
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- Year 3: $100 / (1 + 0.0958)^3 ≈ $76.07
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- Total Present Value ≈ $250.67
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🧠 Interpretation:
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A dollar in the future is worth less today. DCF converts all future profits into today’s dollars.
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** Terminal Value and Growth Limits
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What happens after the 10-year forecast? Use the Terminal Value to estimate value from Year 11 to infinity.
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Formula (Gordon Growth Model):
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#+BEGIN_SRC text
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Terminal Value = Final Year Cash Flow × (1 + g) / (r - g)
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#+END_SRC
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Assumptions:
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- Final Year Cash Flow = $20 billion
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- g = 1% (long-term growth rate)
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- r = 9.58% (discount rate)
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Example:
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#+BEGIN_SRC text
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TV = 20 × (1 + 0.01) / (0.0958 - 0.01) ≈ 235.41 billion
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#+END_SRC
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🧠 Interpretation:
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- This is the present value (as of Year 10) of all future profits beyond that year.
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- We assume **low, steady growth** because no company can grow faster than the economy forever.
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- This value must then be discounted back to today just like the other cash flows.
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** NPV in Excel
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You can calculate all the present values quickly using Excel’s `=NPV()` function.
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Steps:
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1. Enter your forecasted cash flows into cells (e.g., B2:B6)
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2. Add terminal value to the last cash flow (e.g., B6 = 14,000 + 150,000)
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3. In an empty cell, enter:
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#+BEGIN_SRC excel
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=NPV(0.0958, B2:B6)
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#+END_SRC
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🧠 Notes:
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- Excel assumes cash flows happen at the end of each period.
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- If you receive a cash flow today (Year 0), add it manually:
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#+BEGIN_SRC excel
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=InitialCashFlow + NPV(0.0958, B2:B6)
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#+END_SRC
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🧠 Interpretation:
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Excel returns the total **present value** of all the future income streams — meaning how much they are worth today, assuming a 9.58% expected return.
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** What "Present Value of Future Income Streams" Means
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"Present value of future income streams" means:
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- You're estimating how much a set of future cash payments is worth today.
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- This accounts for risk, time, and opportunity cost.
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- Future money is discounted using a rate (like 9.58%) to reflect these factors.
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🧠 Analogy:
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If someone promises to pay you $10k every year for 5 years, that’s not worth $50k **today** — because of inflation and risk. You discount those payments to find out their **real value now**.
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🧠 Summary:
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- It’s the foundation of DCF
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- It gives you today’s value of tomorrow’s profits
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- Helps investors decide if an investment is worthwhile
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