Cash flow and cost of capital pdf

1. Cash Flow and Cost of Capital

2. Learning Objec-ves 2 ¨  Cash flow to invested capital ¤  ¨  Rate cost of capital ¤  ¨  Includes all costs of capital Value of the firm ¤  ¨  Weighted average cost of capital Economic profit ¤  ¨  Free cash flow Fair value of invested capital Financial decision criterion over mul-ple periods $4,000.00 $3,500.00 $3,000.00 $2,500.00 NIBCL NOA NOA NIBCL $2,000.00 $1,500.00 $1,000.00 C IC OA $500.00 $-‐ roic > k FCFi V=∑ i i (1 + k) N IC

3. 3 State-‐ ment of Cash Flows

4. Statement of Cash Flows 4 ¨  ¨  ¨  This financial statement details the change in the balance sheet cash and equivalents accounts, CE, during an accoun-ng period. CEi = CEi-‐1 + CFOi + CFIi + CFFi = CEi-‐1 + ∆CE ∆CE = CFO + CFI + CFF ¤  ¤  ¤  CFO is the cash flow from opera-ng ac-vi-es CFI is the cash flow from inves-ng ac-vi-es CFF is cash flow from financing ac-vi-es

5. Statement of Cash Flows 5 Statement of Cash Flows Balance Sheet CFO Net cash from opera-ng ac-vi-es Assets Liability & Equity From OA CE Opera-ng ΔCE From NOA Current Liabili-es Net cash used by inves-ng ac-vi-es ‘Non-‐opera-ng For OA Capital’ For NOA Invested Capital Net cash from ﬁnancing ac-vi-es Investors ∆CE = CFO + CFI + CFF

6. Cash Flow from Opera-ng Ac-vi-es 6 ¨  CFO = NP + DX + ∆T – ∆NWC -‐ DG = $200 + $120 + $5 -‐ $77 -‐ $20 = $228.00 Net cash flow from operating activites NP $ 200 DX $ 120 ΔT $ 5 (ΔNWC) $ (77) Δ AR $ (87) Δ INV $ (47) Δ AP $ 56 Δ ITP $ 1 (DG) $ (20) CFO $ 228

7. Working Capital: Reference 7 $2,000 $1,500 CE $1,000 AR $500 INV $0 $1,500 $1,250 $500 $250 $0 STD AP ITP $1,500 OCE $1,000 $750 WC AR WC ≡ CA – CL ≡ AR + INV + CE – AP – ITP – SD OWC ≡ OCA – OCL ≡ AR + INV + OCE – AP – ITP NWC ≡ AR + INV – AP – ITP OWC = NWC + OCE $1,250 OWC $1,000 $750 INV AR NWC INV $500 AP ITP $250 $0 AP ITP

8. Cash Flow from Inves-ng and Financing Ac-vi-es 8 ¨  ¨  Cash flows from investing activitites CFI = -‐CX + ΔIS + CS CX $ (500) = -‐$500 + $50 + $20 CS $ 20 ΔIS $ 50 = -‐$430.00 CFI $ (430) CFF = ΔSD + ΔLD + ΔPAR + ΔAPC – DIV = -‐$21 + $335 + $10 + $34 -‐$60 = $298.00 Cash flows from financing activities ΔSD $ (21) ΔLD $ 335 ΔAPC $ 34 ΔPAR DIV CFF $ 10 $ (60) $ 298

9. Free Cash Flow 9 ¨  FCF ¤  ¤  ¤  ¨  ¨  Cash flow from opera-ng ac-vi-es and opera-ng assets, CFO*, plus the cash flow from investments in opera-ng assets, CFI* FCF = CFO* + CFI* FCF is the cash flow available (accrued or paid out) to the capital providers ( investors ) Also referred to as ¤  free cash flow to the firm or ¤  un-‐leveraged free cash flow

10. Free Cash Flow 10 Statement of Cash Flows Net cash from opera-ng ac-vi-es CFO From OA From NOA Net cash used by inves-ng ac-vi-es For OA CFI* For NOA Net cash from ﬁnancing ac-vi-es ΔCE Assets CE FCF ∆CE = CFO + CFI + CFF FCF = CFO* + CFI* Balance Sheet Liability & Equity Opera-ng Current Liabili-es ‘Non-‐opera-ng Capital’ Invested Capital Investors

11. Free Cash Flow 11 ¨  FCF used for ¤  Interest and coupon payments ¤  Return of short and long term debt principal n  Return of debt capital ¤  Dividends to equity holders ¤  Buy back of equity shares n  Return of equity capital

12. Free Cash Flow 12 FCF = CFO* + CFI* CFO* = CFO -‐ IDI·∙(1-‐τ) + IX·∙(1-‐τ) From CFO: Remove effec-ve non-‐ opera-ng cash flow and add back effec-ve cash flow to debt providers. = NP + DX + ∆T –ΔNWC -‐ DG -‐ IDI·∙(1-‐τ) + IX·∙(1-‐τ) = (EBIT – IX)·∙(1 – τ) + DX + ∆T-‐ (∆OWC -‐ ΔOCE) -‐ CS + CC -‐ IDI·∙(1-‐τ) + IX·∙(1-‐τ) = (EBIT – IDI)·∙(1 – τ) + ∆T + DX -‐ (CS – CC) -‐ (∆OWC -‐ ΔOCE) = NOPAT + DX -‐ CS + CC -‐ ∆OWC + ΔOCE From CFI: Remove non-‐opera-ng cash flow, ΔIS, and add cash needed CFI* = CFI -‐ ΔIS + ΔOCE for business opera-ons, ΔOCE = -‐CX + ΔIS + CS -‐ ΔIS -‐ ΔOCE = -‐ CX + CS -‐ ΔOCE At Fairway at IDI and IX transac-ons are cash

13. Free Cash Flow 13 FCF = CFO* + CFI* = NOPAT + DX -‐ CS + CC -‐ ∆OWC + ΔOCE -‐ CX + CS -‐ ΔOCE = NOPAT – (CX -‐ DX – CC) -‐ ∆OWC = NOPAT – ΔNC – ΔOWC = 236.68 -‐ 380.00 -‐ 117.32 = -‐$260.64 = NOPAT – ΔIC

14. Free Cash Flow: Summary 14 FCF = NOPAT – ΔNC – ΔOWC NOPAT = EBIT·∙(1 – τ) +ΔT ΔNC = CX – DX -‐ CC ΔOWC = ΔAR + ΔINV + ΔOCE – ΔAP – ΔITP If ΔT =0 and CC = 0 FCF = EBIT·∙(1 – τ) + DX – CX – ΔAR – ΔINV – ΔOCE + ΔAP + ΔITP = EBIT·∙(1 – τ) + DX – CX – ΔOWC •  •  •  This formula is for a ﬁrm with the same accounts as Fairway Corp It is not a complete general formula (nearly impossible) Note the symbol descrip-ons on the following slide

15. Free Cash Flow: Summary 15 Symbol Description FCF Free cash flow NOPAT Net operating profit after fax OWC Operating working capital NC Net capital assets (~PPE) DX Depreciation expense CX Capital expense (capex) CC Cash received for capital assets sold off AR Accounts receivable INV Inventory AP Accounts payable OCE Operating cash and equivalents EBIT Earnings before interest and tax expenses t Average income tax rate T Deferred tax ITP Income tax payable

16. Free Cash Flow: Note 16 Damodaran defines (p. 79) Free cash flow to firm = Operating income(1-Tax rate) - (Capital expenditures – Depreciation) - Change in non-cash working capital In our notation we write FCF = EBIT·∙(1 – τ) – CX + DX – ΔOWC But is non-‐cash working capital equal to ΔOWC ? Remember working capital, WC = OCE+NOCE+AR+INV-‐ITP-‐AP-‐SD We understand that cash for opera-ons (OCE) is not available to capital providers – same for accounts receivable (AR) and inventory (INV), but ‘excess cash’ or ‘non-‐opera-ng cash’ (NOCE) is available to capital providers. Damodaran explains short term debt (SD) must be “backed out … from current liabili-es… This debt will be considered when compu-ng cost of capital and it would be inappropriate to count it twice.” p. 107 OWC=OCE+AR+INV-‐ITP-‐AP So, the answer is YES!

17. Free Cash Flow: Check 17 Reconcile ΔCE and FCF ΔCE FCF = CFO + CFI + CFF = (CFO-‐CFO*) + (CFI-‐CFI*) + CFF + CFO* + CFI* = (CFO-‐CFO*) + (CFI-‐CFI*) + CFF + FCF = (CFO*-‐ CFO) + (CFI*-‐ CFI) – CFF + ΔCE Cash ﬂow from opera<ng ac-vi-es associated with non-‐opera<ng assets FCF Cash ﬂow from inves<ng ac-vi-es associated with non-‐opera<ng assets = (CFO*-‐ CFO) + (CFI*-‐ CFI) – CFF + ΔCE = (259.68 -‐ 228.00) + (-‐520.32 +430.00) – 298.00 + 96.00 = 31.68 – 90.32 – 298.00 + 96.00 = -‐$260.64 If no non-‐opera-ng assets, NOA=0, then ΔCE = FCF + CFF

18. Fairway Corp 18 ¨  Does Fairway Corp have a problem? ¤  ¤  ¤  ¨  Nega-ve free cash flow, FCF = -‐$260.64 Posi-ve net profit, NP = $200.00 Posi-ve opera-ng cash flow, CFO = $228.00 Yes, at least in the short term ¤  ¤  Rela-vely high inves-ng cash ourlow: CFI=-‐$430.00 Requiring a rela-vely high financing cash inflow: CFF=$298.00

19. Free Cash Flow To Equity 19 ¨  Free cash flow, FCF, is the cash flow to invested capital ¤  ¨  Accrued and cash paid out The levered free cash flow or free cash flow to equity, FCFE, is the free cash flow to equity ¤  FCFE = FCF -‐ IX(1-‐ τ) + ∆DB n  n  The effec-ve interest paid to debt providers is deducted The increase in debt is added since its available to equity providers

20. Rate Cost of Capital 20 ¨  ¨  ¨  ¨  ¨  The cost of capital to the ﬁrm is the capital provider’s expected return on the capital Its useful to work with rate costs of capital and rates of return The rates are forward looking and based on expected market condi-ons The rate of return is rela-ve to the market value of the ﬁrm’s capital The rate cost of capital is a weighted average of the rate costs for debt and equity capital, kD and kE ¤  ¤  ¤  kD weighted average cost of debt kE weighted average cost of equity k weighted average cost of capital n  Osen denoted WACC ‘weighted average cost of capital’

21. Rate Cost of Capital 21

22. Rate Cost of Capital 22 ¨  Cost of debt, kD ¤  ¤  ¨  Interest to banks and note holders Coupons to bondholders Cost of equity, kE ¤  ¤  Dividends to shareholders Share price apprecia-on n  n  Increased earnings Increased u-lity of earnings to equity providers n  n  Increased share price to earning ra-o Share buyback n  Shares become treasury stock n  Increased earnings per share for remaining shareholders

23. Cost of Equity 23 ¨  Applies to all common equity accounts, EB ¤  ¨  ¨  RE, APC, and PAR Applies to deferred taxes, T Share price apprecia-on is obviously a return to shareholders, but how is it a cost to the ﬁrm? ¤  ¤  ¤  ¤  The ﬁrm’s cost of equity was an ‘opportunity’ cost Think of the founder’s posi-on in the VC example The cost of equity to the founders was the VC’s expected return on equity The equity apprecia-on would have otherwise accrued to the founders

24. Value of the Firm 24 ¨  ¨  ¨  ¨  ¨  ¨  ¨  Free cash ﬂow, FCF, discounted at the rate cost of capital, k N FCFi V = ∑ (1 + k)i i V is the fair value of the invested capital, IC The fair value of the debt capital is denoted D The fair value of the equity capital is denoted E Assume no non-‐opera-ng assets, NOA=0 V = D + E Values V, D, and E will also be used for market value ¤  The issue of fair and market value will be addressed later

25. Rate Cost of Capital 25 Cost of Capital [$M] $25 $20 kD·∙D·∙(1-‐τ) $15 k·∙V $10 kE·∙E Note kD·∙D ~ IX $5 $-‐ V = D + E V ⋅ k = k D ⋅ (1 − τ) ⋅ D + k E ⋅ E k = kD ⋅ (1 − τ) ⋅ D E + kE ⋅ V V D : market value of debt E : market value of equity V : market value of capital

26. Economic Profit 26 ¨  ¨  ¨  ¨  ¨  The difference between the return to invested capital and the cost of invested capital EP = IC·∙ (roic – k) EP = NOPAT – IC ·∙ k A posi-ve net (accoun-ng) profit, NP, does not ensure an economically viable firm whereas a posi-ve economic profit does Fairway Corp ¤  ¤  ¤  Posi-ve NP and CFO Nega-ve FCF Posi-ve EP requires roic > k

27. Investment Decisions 27 ¨  A firm’s capital investments could have the following results: ¤  ¤  ¤  ¨  roic > k: The firm’s investments increase the value of the firm roic = k: The firm’s investments sustain the value of the firm roic < k: The firm’s investments diminish the value of the firm A firm’s management is expected to increase the value of the firm ¤  ¤  Make roic > k investments N FCFi Increase V = (1 + k)i i ∑ n  Increase FCF, move FCF forward, decrease k (decrease risk)

28. Investment Decisions 28 ¨  ¨  ¨  Each of the firm’s investments may have different risk, thus a different required roic The aggregate roic must be greater than k Each investment with roic > k should be made even if they require the raising of addi-onal capital FCFi V=∑ (1 + k)i i N

29. Investment Decisions 29 Free cash flow is cash flow in excess of that required to fund all projects that have posi-ve net present values when discounted at the relevant cost of capital. Conflicts of interest between shareholders and managers over payout policies are especially severe when the organiza-on generates substan-al free cash flow. The problem is how to mo-vate managers to disgorge the cash rather than inves-ng it at below the cost of capital or was-ng it on organiza-onal inefficiencies. Jensen, Michael C., "Agency Cost Of Free Cash Flow, Corporate Finance, and Takeovers" . American Economic Review, Vol. 76, No. 2, May 1986.

30. Financial Decision Making 30 Invested Capital ΔIC true Inves-ng Business ΔN, ΔOWC Strategy Opera-ng Assets New Capital FCF roic > k NOPAT = EBIT(1-‐τ) + ΔT roic = NOPAT / IC NOPAT = FCF + ΔIC ΔIC = ΔNC + ΔOWC Opera-ons NOPAT FCFi V=∑ i i (1 + k) N

31. Further Assump-ons 31 ¨  In subsequent topics two simplifying addi-onal assump-ons are osen made ¤  No non-‐opera-ng assets, NOA=0 ¤  IC = C ¤  No interest and dividend income, IDI = 0 ¤  No deferred taxes, T=0, thus ¤  IC = C = EB + DB ¤  TA = LE = C + OCL ¤  roic = NP / C ¤  NOPAT = EBIT·∙(1 – τ) ¤  FCF = NOPAT – ΔC = EBIT·∙(1 – τ) – ΔC

32. Essen-al Points 32 ¨  ¨  ¨  ¨  ¨  Cash flow to invested capital, FCF Rate cost of capital, k Economic profit, EP Value of the firm, V Financial decision criterion over mul-ple periods $4,000.00 $3,500.00 $3,000.00 $2,500.00 NIBCL NOA NOA NIBCL $2,000.00 $1,500.00 $1,000.00 $500.00 $-‐ OA FCFi V=∑ i i (1 + k) N C IC roic > k IC

33. 33 Firm Valua-on Fair value of LE and TA OCL OCL NOA NOA Book value of LE and TA OCL OCL T OCL NOA DB C IC EB PV(FCF) Value o f Value of capital invested capital Value of operating assets

34. References 34 ¨  Accoun-ng: Texts and Cases ¤  ¤  ¨  Robert Anthony , David Hawkins , Kenneth Merchant Harvard On the General Equivalence of Company Valua<on Models ¤  ¤  Joakim Levin Stockholm School of Economics

35. Appendix: Free Cash Flow 35 CFO = NP + DX + ∆T – ∆NWC -‐ DG = 200 + 120 + 5 -‐ 77 – 20 = $228.00 CFI = -‐CX + ΔIS + CS = -‐500 + 50 + 20 = -‐$430.00 CFO* = CFO -‐ IDI·∙(1-τ) + IX·∙(1-τ) CFI* = CFI -‐ ΔIS -‐ ΔOCE = -‐430 – 50 – 40.32 = -‐$520.32 = 228 – 12.54 + 44.22 = $259.68 = CFO* + CFI* = 259.68 -‐520.32 = -‐$260.64 FCF

36. Appendix: Cash Flow Statement – Direct 36 Cash and Accrual Expenses Equivalent at Fairway IX OX IDI Cash Expenses COGSC ITC Cash Revenue RC FAIRWAY CORPORATION Statement of Cash Flows For the Year Ending December 31, 2009 (in thousands) Cash flows from operating activities: RC Cash received from customers…………………………………………..………………………… $ 3,103 IDI Dividends and interest received……………………………………….……………………………………… $ 19 RC Total cash from operations …………………………………………………. + IDI $ 3,122 Cash paid to s uppliers and employees ………………………………………………………………………. $ 2,730 COGSC + OX IX Interest paid ……………………………………………………………………………………………… $ 67 ITC Income tax paid ………………………………………………………………………………………… $ 97 Cash disbursed for operating activities ……………………………………………… $ 2,894 CFO Net cash flow from operating activities ……………………………………………………. $ 228 Cash received from customers…………………………………………..………………………… $ 3,103 RC ΔAR $ 87 Cash from accounts receivable ………………………………………………………………………………………… Revenue from s ales……………………………………………………………………………………………… $ 3,190 R Dividends and interest received……………………………………….……………………………………… $ 19 IDI Total cash from operations………………………………………………………………… + IDI $ 3,122 RC $ 3,209 Total revenue from s ales, interest, and dividends……………………………………….. R + IDI

37. Appendix: Cash Flow Statement – Direct 37 Cash received from customers…………………………………………..………………………… $ 3,103 RC Δ AR $ 87 Cash from accounts receivable ………………………………………………………………………………………… ccrual Expenses Cash and A Revenue from s ales……………………………………………………………………………………………… $ 3,190 R Equivalent at Fairway Dividends and interest received……………………………………….……………………………………… $ 19 IDI IX OX Total cash from operations………………………………………………………………… + IDI IDI $ 3,122 RC $ 3,209 Total revenue from s ales, interest, and dividends……………………………………….. R + IDI Cash Expenses COGSC ITC Cost of s ales………………………………………………………… $ 2,290 COGS Increase in inventory……………………………………………………………………….. Δ INV $ 47 Δ AP $ (56) Decrease in accounts payable………………………………………………………………………….. Cash cost of s ales…………………………………………………………………….. $ 2,281 COGSC Operating expenses……………………………………………………………….. $ 449 OX Total cash expenses…………………………………………………………………… COGSC + OX $ 2,730 IT Income tax expense……………………………………………………………………. $ 103 ΔT Increase in deferred taxes……………………………………………………….. $ 5 Δ ITP $ 1 Increase in income taxes payable…………………………………………………………………… ITC Income taxes paid………………………………………………………………….. $ 97 Cash Revenue RC

38. Appendix: Free Cash Flow 38 Direct CFO Method CFO = RC + IDI – COGSC– OX – IX – ITC CFI = -‐CX + ΔIS + CS = 3,103 + 19 – 2,281 – 449 – 67 – 97 = -‐500 + 50 + 20 = 228 = -‐430 CFO* = CFO -‐ IDI·∙(1-‐τ) + IX·∙(1-‐τ) CFI* = CFI -‐ ΔIS + ΔOCE = 228 – 12.54 + 44.22 = -‐430 – 50 – 40.32 = 259.68 = -‐520.32 FCF = CFO* + CFI* = 259.68 -‐ 520.32 = -‐260.64 FCF = RC – COGSC – OX – ITC + IDI·∙τ – IX·∙τ – CX + CS – ΔOCE = 3103 – 2730 -‐97 + 6.46 – 22.78 – 500 + 20 – 40.32 = -‐260.64

39. (12.54) $ 20 $ $ $ (520.32) $ (260.64) Δ IS CS -Δ IS Δ OCE CFI* FCF (50) (40.32) 50 $ (500) $ CX $ 259.68 CFO* 44.22 (22.78) $ IX·∙τ $ IX $ 67 $ 6.46 (19) IX·∙(1-τ) IDI ·∙(1-τ) IDI $ IDI·∙τ $ Direct Cash Flow R $ 3,190 Δ AR $ (87) RC $ 3,103 IDI $ 19 COGS $ (2,290) OX $ (449) Δ INV $ (47) Δ AP $ 56 COGSC + OX $ (2,730) IX $ (67) IT $ (103) ΔT $ 5 Δ ITP $ 1 ITC $ (97) CFO $ 228 (87) $ FCF CFI* -Δ IS Δ OCE CS Δ IS CX 44.22 (22.78) 50 (50) (40.32) $ (260.64) $ (520.32) $ $ $ 20 $ $ (500) $ 259.68 IX·∙τ $ IX·∙(1-τ) $ CFO* (12.54) 6.46 (19) IX $ 67 IDI ·∙(1-τ) IDI $ IDI·∙τ $ $ 228 CFO $ $ (77) 56 1 $ $ (47) $ Δ NWC Δ AR Δ INV Δ AP Δ ITP $ ΔT 5 $ (20) DG Indirect Cash Flow R $ 3,190 IDI $ 19 COGS $ (2,290) OX $ (449) DG $ 20 DX $ (120) EBIT $ 370 IX $ (67) IT $ (103) $ 200 NP $ 120 DX 236.68 CS $ $ 20 120 $ (500) $ $ (260.64) $ (497.32) Δ IC FCF $ (117.32) (40.32) Δ OWC Δ OCE $ DG $ (20) CC $ -‐ Δ AR $ (87) Δ INV $ (47) Δ AP $ 56 Δ ITP $ 1 DX CX 6.46 $ 5 (19) $ IDI IDI·∙τ ΔT NOPAT $ $ (125.78) (22.78) τ·∙EBIT IX·∙τ $ Income Statement R $ 3,190 IDI $ 19 COGS $ (2,290) OX $ (449) DG $ 20 DX $ (120) EBIT $ 370.00 IT $ (103) $ (298.00) $ (430.00) $ (520.32) $ (90.32) FCF $ (260.64) Δ CE $ 96.00 CFI CFI* CFO $ 228.00 CFO* $ 259.68 $ 31.68 CFI Cash Flow From Financing 39

Cash flow and cost of capital pdf

Du liest eine Vorschau.

Hier ansehen

Cash flow and cost of capital pdf

Weitere Verwandte Inhalte

Diashows für Sie (20)

Andere mochten auch (20)

Ähnlich wie Cash flow and cost of capital pdf (20)

Weitere von David Keck (20)

Aktuellste (20)

Cash flow and cost of capital pdf