Valuing Assets

Kori Sandberg
Finance 309

As an investor, buyer, or analyst, it is crucial to be able to identify the overall value in a

firm. The need to assign a value to a company arises from the inquiry into how much money that
company is worth, or how that company values their assets. Using and identifying the similarities
and utility between book, market, and production values we can get a clearer picture of the
company worth so we can begin to understand the financial and operational health of the firm we
are inquiring into. In this evaluation we will unravel different methods of using two different
models, the continuing value model (KVD) and the free cash flow model (FCF) to derive an
enterprise value for the company.

There are several key segments of a firm to consider when attempting to assign a value to
the entire company or just specific assets. In this situation we are analyzing the three most
common methods of measuring value: Market, Book and Production.

Market value is how much a company would sell for on the stock market today, this is
calculated by taking the total number of outstanding shares and multiplying it by the price
per share, this is also known as market capital or enterprise value. Market value is commonly
used to compare one company to that of others in the same industry to arrive at a relative
value. Market value or enterprise value is used to obtain a multiple that represents the
companys value over a given period of time using: Valmult=PVDCF+PVCVmult. This is a much
simpler method of valuation but lacks the richness that the other models offer in more
specific valuations. There are advantages to using multiples in valuation such as simplicity,
convenience and quickness, however there are also disadvantages including the lack of
sensitivity to inputs and no implication of any change in growth for the company. This could
be considered one of the benefits of using a valuation model to evaluate market value.

Book value or accounting value of an asset is how much that asset is worth according to the
financial statements, specifically the balance sheet. Book value is derived by taking the cost
of the asset minus any accumulated depreciation. Additionally, book value of the entire firm
would be calculated by taking total assets and subtracting total liabilities to obtain a net asset
value. In order to truly see if book value is a good assessment of the company value it must
be compared to market value. When we begin to compare book value vs. market value we
see that book value can indicate if the stock price is over or under priced, this is the
advantage of evaluating book value. A disadvantage to only using book value to analyze the
worth of a firm is that it only represents historical data and doesnt consider any changes in
projected growth.

Production value is the value of what the company is working on now it could be the value
of the product recorded as an asset once it has been completed and before it is sold; this
allows the product to be accounted for on the financial statements and provides a way that
shareholders can be informed of these products. The production value of a company can also
be measured using several techniques based on what is it you are trying to measure, be it
operating profits, free cash flows, invested capital or return on invested capital. Usually

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 market, book, and production values are exhibit different outcomes but it is important to note
that all values are equal at the instant the asset sells.

Generally, when doing corporate valuation, investors tend to analyze production value
intently. They use the previous values, and growth rates or anticipated growth rates to forecast
future values, there are several methods and reasons for doing this. First we start with a growth
analysis, predicting future cash flows based on prior or predicted growth rates, and the
assumptions that they should remain relatively constant. By putting a value on the earning
potential for the company for some period of time in the future and then discounting the future
value back to a present value we can arrive at a present value for the continuing value. In order to
do this we must assume that the growth rate of the cash flows will remain constant in the explicit
period, and in the forecasted period. There are two methods we will be using to arrive at an
enterprise value, the FCF/DCF model and the KVD model.

One of the first steps to valuation involves using a DCF or discounted cash flow model.
In this model we choose FCF (Free cash flows) as the cash flow input. The advantage to using
FCF opposed to other alternatives in this model is that free cash flows represent the earnings a
company has generated by core operations after accounting for all capital expenditures. FCF
allows a company to pursue additional opportunities that increase value. FCF derived by
subtracting net investment from net operating profits less adjusted taxes, and can also be
obtained by multiplying NOPLAT by (1-IR). NOPLAT is equal to EBIT (earnings before
interest and taxes) multiplied by (1-tax rate) and IR is equal to g/ROIC, which is the growth on
the return on invested capital.

Another component in the FCF/DCF model is WACC (weighted average cost of capital).
WACC represents the opportunity cost that investors face when investing their funds in one
business as opposed to other companies with similar levels of risk. This is the cost of equity
multiplied by the after tax cost of debt multiplied by the cost of the companys target capital
structure. The reason we use WACC as the discount rate in the FCF model valuation is it gives a
value to how much of the companies free cash flows are leveraged by debt or risk factors.

We use the DCF model to arrive at a present value for the continuing value, then using
this and adding it to the dividend growth outcome also using FCF. This formula for the
Value(DCF/FCF) looks like this:

FCF t + PVCV
(1+WACC)^t

Arriving at this value happens in stages, the first is to find the continuing value, and this is done
by taking FCF in the next year after the explicit period and dividing it by the rate of return or in
our case we will use WACC (weighted average cost of capital) minus the growth rate (g) which
is the change in revenues; this gives us the continuing value.

CV= FCF (t+1)

WACC-g

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Then we use the continuing value and discount it back to the present value by dividing it by the
rate of return or (WACC plus 1) raised to the last year in the explicit period in this case we will
say is a period of t years. The equation looks like this:

PVCV= CV
(1+WACC)^t

The Discounted cash flow model takes the sum of all the values of the cash flows for each year
and discounted separately to obtain the overall value for the explicit period. This series of
equations would look like this:

= FCFt + FCF (t+1) + . FCFn

(1+WACC)^t (1+WACC)^t+1 (1+WACC)^n

Once the cash flows have been discounted for each year in the explicit period we can add it to
the present value of the continuing value we calculated earlier to arrive at an overall value for the
discounted cash flow free cash flow model. This assigns a value to the company based on
projected future cash flows. The strength of this discounted cash flow model using free cash flow
as the income variable is that free cash flow is driven by revenue growth and ROIC (return on
invested capital), these estimated values are only considered to be accurate for a short period of
time, such as 5 or 10 years. Any further projections must be made using these value drivers
which would provide a more substantial idea of whether or not the company was creating more
value or destroying it. The disadvantage to using free cash flows as the cash flow for this DCF
model is that free cash flow doesnt incorporate any financing related cash flows such as interest
or dividends.

The other method of valuation we will be analyzing is the KVD model. The KVD
formula relates a companys enterprise value to the drivers of economic value. This model is
used assign a continuing value before the explicit period that needs to be discounted back to a
present value to be relevant to us. The construction of the equation is similar to the DCF model
but it includes (1-g/ROIC) in the numerator to get the value of the period before the explicit
period. It is important to identify that in the construction of FCF we see that FCF is equal to
NOPLAT multiplied by (1-g/ROIC), this appears to have the same or similar construct as the
KVD model; implying they should have relatively similar outcomes. One reason they would not
have similar outcomes is that in the KVD valuation model we use NOPLAT instead of FCF-
which have different components involving after tax implications and sensitivity to various
inputs. Another reason the outcome would be different is because the KVD model is a perpetuity
based model that is superior to other methods because it links cash flow directly to growth and
ROIC.

The KVD model is also done in two parts similar to the construction of the FCF/DCF above. An
advantage to using the KVD model we can identify where in the firm we can assign a positive or
negative growth in value, when ROIC>WACC>g there is drives the creation of value within the
company, whereas when g<WACC<ROIC the value is depleted or destroyed.

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 First step is to use the projected NOPLAT (net operating profit less adjusted taxes) in a
discounted cash flow model to assign a value during the explicit forecast period. In this equation
we use the cash flow multiplied by (1- g/ROIC) in the numerator which adds a different
perspective considering value. The equation for the value of discounted cash flows using the
KVD formula looks like this:

Value(DCF/KVD) = NOPLATt + PVCV

(1+WACC)^t

As before the PVCV is done in two parts, first we must find the continuing value to plug into the
equation as follows:

CV= NOPLAT(1-(g/ROIC)) (t+1)

WACC-g

Then we must plug in the CV to the next step to get the PVCV as follows:

PVCV= CV
(1+WACC)^t

This gives us the present value of the continuing value after the explicit period, the next step is to
assign a value for the explicit period.

Part two of the Key Driver Model that assigns a continuing value before the explicit period, this
step creates a future value that needs to be discounted back to present value. Then we add the
continuing value to the value for the explicit period to end up at an overall KVD valuation. The
KVD construction looks like this:

Value (DCF) = NOPLATt + NOPLAT (t+1) + ..NOPLATn

(1+WACC)^t (1+WACC)^t+1 (1+WACC)^n

Once this value is obtained for the value (DCF) we add on the present value of the continuing
value to arrive at an overall KVD value of the enterprise.

In conclusion there are several other methods of valuation to evaluate a companys

financial health and sustainability. Starting with analyzing a companys market, book and
production values, we can see the benefits of each independently as they each represent their
own value, interdependently where we see that one can be useful when compared to the others
such as production value or overall enterprise value compared to book value or market value, and
the importance of realizing that upon the point of purchase that all three of these values become
equal to each other. This is due to the selling price becoming the purchased price, and amount
recorded on the books in regards to the acquisition all being the same value. Through the use of
the discounted cash flow and free cash flow models as well as using the KVD model which
allows for a little more sensitivity in changing rates that continue into perpetuity opposed to
using a multiple provided, we can begin to arrive at the enterprise value and therefore determine

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the areas in which one might begin to consider possibly purchasing the business or a substantial
share and contribute to the areas that need the most work.

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Sources

Copeland, Thomas E., Tim Koller, and Jack Murrin. Valuation: Measuring and Managing the Value
of Companies. New York: Wiley, 2000. Print.

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