Summary
Summary Investment Valuation, ISBN: 9781118011522 MF08FI Valuation (BM08FI)
- Course
- Institution
Summary of the Valuation box
[Show more]
Seller
Followjonasvw
Content preview
F&I ValuationLecture 1: Approaches to Valuation & Adjusting
R&D & Lease liabilities
Approaches to valuation (DCF, Multiples, Contingent Valuation)
Five incremental steps in Discounted Cash Flow Valuation
Step 1: Adjusting (accounting) earnings by:
o Capitalizing R&D expenses
o Converting (operating) lease expenses into debt
o Adjustments for non-recurring income and expenses
o Adjustments for income from investments and divestitures
Discounted Relative Contingent
Cash Flow Valuation Valuation
Valuation (DCF) (Multiple-based
valuation)
Estimate “intrinsic Estimate price or Used in conjunction
value” of an asset market value of an with DCF to value
based on its ability asset based on option-like assets or
to generate future comparable peers features
cash flows
Assumptions Market- Market is efficient in
inefficiencies may the aggregate, but
exist in the short- may be incorrect in
run valuation of
individual assets
Inputs needed Expected cash Comparable group Inputs for Black-
flows; discount rate of assets whose Scholes Model
reflecting risk pricing is known;
associated with the standardized
cash flows; terminal measure of value
value of the asset (P/E; M/B)
Advantages Allows to identify Few inputs and
assets with solid hence lesser scope
fundamentals which for discretion or
will pay off in the manipulation
long run; less
sensitive to market
moods/hype
Disadvantages Requires inputs; all Only identifies Hard top map
stocks in an relative mispricing features of real
industry may be and not absolute assets to option
over-/undervalued; mispricing pricing inputs.
cannot be used for
assets that do not
generate cash flows
(e.g. commodities
like gold,
currencies)
Best suited Long-horizon When there are When standard
investors that are large number of valuation
not affected by comparable assets techniques do not
short-run swings in with a market price. work well;
the market. Short term Firms in distress,
investors; analysts firms with negative
, who issue buy/sell earnings; valuation
recommendations of assets with
option-like features.
A)Discounted Cash Flow Valuation
The 5 incremental steps in DCF valuation:
Step 1: Calculate adjusted earnings from accounting statements
in the base year(s) (i.e., the income in the year(s) on which you
are going to apply a growth rate factor).
Step 2: Calculate the reinvestments made by the firm.
Step 3: Forecast the growth rate.
Step 4: Calculate the discount rate.
Step 5: Calculate the PV of discounted cash flows.
Step 1: Calculate the adjusted earnings
For valuation purposes, the balance sheet should contain;
- Value of assets in place (i.e. existing assets that generate cash flows and will
continue to do so in the future).
- Value of growth assets (i.e. expected cash flows which will be generated by
future investments).
Companies have three types of expenses:
- Operating expenses: generate benefits for the only in the current period
(E.g., labor cost, cost of fuel and other materials).
- Capital expenses: generate benefits over multiple periods (E.g., costs ass.
with building a manufacturing facility, developing a new drug).
- Financial expenses: costs associated with non-equity capital raised by the
firm. (E.g., interest expenses, interest liabilities on leased assets).
Accounting earnings can be misleading because some capital and financial
expenses are misclassified as operating expenses.
Major misclassifications:
- R&D expenses are treated as operating expenses
- Operating lease expenses are treated as operating expenses
B) Misclassification 1: R&D Expenses
R&D Expenses are often treated as operating expenses; outcome of R&D is
uncertain and hard to quantify. Hence, they are expensed in the period they are
incurred, which reduces operating income and results in a lower profitability
ratio.
Consequence: Assets created by research do not show up in the balance sheet
(as intangible assets) of the firm understates firm’s invested capital
For valuation purposes, one should capitalize R&D expenses: the value of the
research assets which they would create will show up in the balance sheet as
,part of invested capital.
Consequence: if the firm does not generate return on R&D spending made in a
year, its ROA/ROIC/ROE will be lower in the future years.
How to capitalize R&D Expenses?
The right way to treat R&D expenses is to capitalize them and value the (potential) research assets
they would create.
Requires that we make assumptions about the amortizable life of the research assets – i.e.,the
time it takes for R&D expenses to be converted into commercial products.
Amortizable life varies across industries. (E.g, R&D in pharamaceutical firms will take longer time
to payoff).
Recall under IFRS: Research spending is expensed while, development expenditures are capitalized.
Step 0: To capitalize the internal R&D spending of company X, lets assume an amortizable life of 3
years.
Step 1: Collect the research spending made by company X in the past 3 years:
Ye T Resea
ar rch
spend
ing ($
M)
20 0 291
19
20 -1 285
18
20 -2 276
17
20 -3 244
16
Step 2: Calculate the unamortized and amortized portion of R&D spend
Assumption; the amortization expense takes place at the end of the year. So,
the research spending for the current year (2019) just took place.
Ye T Resea Unamortized
ar rch portion ($ M)
spend
ing ($
M)
20 0 291 100% 291
19 Here, 66.67% has been
amortized already. Value
of research asset is
remaining 33.33%.
, 20 -1 285 66.67 190
18 %
20 -2 276 33.33 92
17 %
20 -3 244 0.00% 0
16
Value of the $573
research asset
The value of the research asset is the sum of the unamortized portion
of research spending over the amortizable life. This amount will be added
to the asset side of the balance sheet to “non-current intangible assets”.
On the liabilities side it will appear among “shareholder’s equity” after
adjustment for deferred tax liability.
Each year, (1/n)th of the research spending made in the past n years (where n is
amortized where n is the amortizable life of the research asset). If amortizable
life is 3 years amortizable expense is 33.33% of research spending made in
the past 3 years.
Ye T Resea Unamortized Amortiza
ar rch portion ($ M) tion in
spend current
ing ($ year ($
M)
M)
20 0 291 100% 291 0 $285M * (1/n),
19
where n = 3:
20 -1 285 66.67 190 95
18 % $95M
20 -2 276 33.33 92 92
17 %
20 -3 244 0.00% 0 81
16
Value of the $573
research asset
Amortization of $268
research asset in
current year
Impact on Income Statement:
Add back the research spending of $291 and subtract the amortization expense
on the research asset of $268 to the “Other operating income/(expense)”
account.
Impact on profit from continuing operations: ($291-$268) * (1-0.221) = $18M.
The benefits of buying summaries with Stuvia:
Guaranteed quality through customer reviews
Stuvia customers have reviewed more than 700,000 summaries. This how you know that you are buying the best documents.
Quick and easy check-out
You can quickly pay through credit card or Stuvia-credit for the summaries. There is no membership needed.
Focus on what matters
Your fellow students write the study notes themselves, which is why the documents are always reliable and up-to-date. This ensures you quickly get to the core!
Frequently asked questions
What do I get when I buy this document?
You get a PDF, available immediately after your purchase. The purchased document is accessible anytime, anywhere and indefinitely through your profile.
Satisfaction guarantee: how does it work?
Our satisfaction guarantee ensures that you always find a study document that suits you well. You fill out a form, and our customer service team takes care of the rest.
Who am I buying these notes from?
Stuvia is a marketplace, so you are not buying this document from us, but from seller jonasvw. Stuvia facilitates payment to the seller.
Will I be stuck with a subscription?
No, you only buy these notes for $9.13. You're not tied to anything after your purchase.
Can Stuvia be trusted?
4.6 stars on Google & Trustpilot (+1000 reviews)
57114 documents were sold in the last 30 days
Founded in 2010, the go-to place to buy study notes for 14 years now