Chapter 21 : Summary Illustration - Snap Value


You can analyze the past, but you have to design the future.

Edward de Bono

Now that the estimation procedures for the calculation of components of intrinsic value, cash flow from operations, cost of capital, terminal value, non-operating assets, and liabilities are explained, let us look at an illustration that incorporates all of the components. Consider a business 'Snap Value' with the following five-year forecast:

Assumptions for Snap value

Forecast Period 5 Years
Currency USD
Figures in Millions
Risk Free Rate 4.1%
Expected Inflation Rate 4.0%
Sales in Prior Period $150 Million
CAGR of Sales 11.0%
OPM in Prior Period 9.0%
OPM - All 5 Years 10.0%
Incremental Fixed Asset Investment Rate 25%
Incremental NWC Investment Rate 20%
Income Tax 21%

Net Operating Assets & Liabilities

Cash and Securities 30
Investment and Other Assets 10
Minority Interest and Other Liabilities 10
Debt and Obligations 30
Outstanding Shares 20
Market Capitalization 70
Debt Ratio 30%
Equity Ratio 70%
Beta 0.9
Expected Market Return 10.9%
Cost of Debt 6%
Cost of Equity 10.22%
WACC 8.576%

Terminal Period

Risk Free Rate 2.5%
Expected Inflation Rate 2.0%
Income Tax 21.0%
Debt Ratio 0.0%
Equity Ratio 100%
Expected Market Return 8.90%
Beta 0.8
Cost of Equity 7.57%

Terminal Growth

Inflationary Growth 2.0%
Real Growth 2.0%
Terminal Growth 4.0%

Computation of Expected Market Returns - Forecast Period


Inflation + Expected Return Over Inflation
= 4.00% + 6.90%
= 10.90%

Computation of Cost of Equity based on CAPM - Forecast Period


ra = rf + [ βa x ( rm - rf ) ]

= 4.10% + [ 0.90 x (10.90% - 4.10%) ]
= 10.22%

Computation of WACC in Nominal Terms

Particulars Weight Cost Tax Rate Total
Debt 30% 6% * 21% 1.422%
Equity 70% 10.22% 7.15%
WACC 8.57%

Computation of Expected Market Returns - Terminal Period


Inflation + Expected Return Over Inflation
= 2.00% + 6.90%
= 8.90%

Computation of Cost of Equity based on CAPM - Terminal Period


ra = rf + [ βa x ( rm - rf ) ]

= 2.25% + [ 0.80 x (8.90% - 2.25%) ]
= 7.57%

Computation of WACC - Terminal Period

Particulars Weight Cost Tax Rate Total
Debt 0% 0%
Equity 100% 7.57% 7.57%
WACC 7.57%

Thus, based on the above computation, the cost of capital or WACC during Terminal Period comes to 7.57%.

Terminal Growth

The Terminal Growth for Snap value is assumed at 4% (Inflationary Growth at 2% and Real Growth at 2%).

Valuation of Snap Value


The valuation of Snap Value based on above assumptions is presented in Table 16.

Table 16 - (figures in USD / Million)

Year 0 1 2 3 4 5
Sales 150 166.5 184.8 205.1 227.7 252.8
Operating Profit 16.65 18.48 20.51 22.77 25.28
Income Tax 3.50 3.88 4.31 4.78 5.31
Incremental Fixed Assets 4.13 4.58 5.08 5.64 6.26
Incremental Net Working Capital 3.30 3.66 4.07 4.51 5.01
Free Cash Flow 5.73 6.36 7.06 7.83 8.70
Discount Factor 1 0.921 0.85 0.78 0.72 0.663
Present Value of Free Cash Flow 5.28 5.39 5.51 5.64 5.76
Cumulative PV of Cash Flows 27.58
PV of Terminal Value 167.89
Cash and Securities 30
Investment and Other Assets 10
Minority Interest and Other Liabilities 10
Debt & Obligations 30
Shareholder Value 195.47
No. of Shares 20
Price Per Share 9.77

Computation of Terminal Value


The formulae for computing Terminal value is,

Free Cash flow in Target Year * (1 + Terminal Growth) / (WACC - Terminal Growth)
8.70 * ( 1 + 4%) / (7.57% - 4%) = 253

Present Value of Terminal Value is Terminal Value * Discount Factor in the last year of forecast Period
253 * 0.663 = 167.89