MONETARY FLOW - the difference between income and expenses economic entity, expressed as the difference between payments received and payments made.
The cash flow for equity is formed based on:
1) from an analysis of the terms, amounts and conditions of payments and receipts provided for by the already concluded enterprise procurement, marketing, labor, construction, rental and loan agreements and contracts;
2) from the future projected profitability of the enterprise and the future need for investment.
Based on the cash flow for equity is determined market price own funds companies.
The market value of a business largely depends on its prospects. When determining the market value of a business, only that part of its capital that can generate income in one form or another in the future is taken into account. At the same time, it is very important when exactly the owner will receive these incomes, and with what risk their receipt is associated. These factors that affect the valuation of the business, allows you to take into account the discounted cash flow method (DCF method). Using the discounted cash flow method, it is possible to operate in the calculations either with the so-called cash flow for equity or cash flow for the entire invested capital. Regardless of the type of cash flow, if the procedures of the method and the appropriate discount rates are applied correctly and consistently, the results of the calculations should match. The cash flow for equity (total cash flow), working with which, you can directly assess the market value of the company's equity (which is the market value of the latter), reflects in its structure the planned method of financing start-up and subsequent investments that ensure the life cycle of the product ( business line). In other words, this indicator makes it possible to determine how much and under what conditions will be attracted to finance the investment process. borrowed money. For each future period, it takes into account the expected increase in the long-term debt of the enterprise (the inflow of newly borrowed credit funds), the decrease in the obligations of the enterprise (the outflow of funds due to the planned current future period repayment of part of the principal debt on previously taken loans), payment of interest on loans in the order of their current servicing. Since the share and cost of borrowed funds in business financing ( investment project) are already taken into account in the forecasted cash flow itself, then the discounting of the expected cash flows (if these are “full cash flows”) can occur at a discount rate equal to the return required by the investor (taking into account the risks) of investing only his own funds, i.e. at the so-called discount rate for equity, which will hereinafter (by default) be referred to simply as the "discount rate". Applying cash flow model for total invested capital, we conditionally do not distinguish between the equity and borrowed capital of the enterprise and consider the total cash flow. Based on this, we add to the cash flow interest payments on debt, which are not included in the net profit of the enterprise. Since the interest on the debt was deducted from profit before taxes, returning them back reduces their amount by the amount of income tax. The result of the calculation according to this model is the market value of the entire invested capital of the enterprise. Thus, according to the discounted cash flow method, the value of the enterprise is determined on the basis of future rather than past cash flows. Therefore, the main task of the valuation is to make a cash flow forecast (based on forecast cash flow reports). Money) for some future time period, starting from the current year.
This section contains a glossary in the same wording as on the website of the Ministry of Economics.
CAPM
Capital asset pricing model.
CAPM = Risk Free Rate + Beta× market premium+ risk premiums (for small companies, company-specific).
CFF
Cash flow from financial activities(Cash from financing activities).
CFF = Flow from share issuance - Share repurchases + New borrowings - Loan repayments - Dividend payments (simplified)
CFI
Cash flow from investment activity(Cash from investing activities).
CFI = Sales Flow financial assets and OS - Investments in OS - Purchase of financial assets (simplified)
CFO
Cash from operating activities.
CFO = net cash flow from operations after taxes and interest = net income + depreciation - change in working capital (simplified)
EBIT
Earnings before interest and tax.
EBIT = Revenue - Cost of sales - Selling and administrative expenses
EBITDA
Earnings before interest, tax, depreciation and amortization.
EBITDA = EBIT + Depreciation
EPS
Net income per share (Earnings per share).
EPS = (Net income - Dividends on preferred shares) / Weighted average ordinary shares in circulation
EV/EBITDA
Business enterprise value to Earnings before interest, tax, depreciation and amortization.
Multiplier of the market value of invested capital to earnings before interest, income tax and depreciation
EV/Sales
EV / Revenue (Enterprise value to Sales).
Multiplier of the market value of invested capital to revenue
EV/Inventory
Multiplier of the ratio of the market value of the business to the volume of reserves in physical terms.
IRR
Internal rate of return (Internal rate of return).
NOPAT
Net operating profit after taxes (Net operating profit after tax).
NOPAT = EBIT*(1-Income Tax)
NPV
Net Present Value.
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P/BV
Price to Book Value Multiple. Multiplier of the ratio of the market value of equity to the book value of equity, Price / Book value of equity.
P/E
Price to Earnings Multiple. Multiplier of the market value of equity to net profit, Price / net profit.
ROE
Return on equity (Return on Equity).
ROE = (Net Profit) / (Equity)
ROE = (Net profit) / ( Total assets) × (Total assets) / (Equity)
ROA
Return on Assets.
ROA = (Net Profit) / (Total Assets)
risk free rate
risk free rate. The interest rate of return that an investor can receive on his capital when investing in the most liquid assets, characterized by the absence or minimum possible risk non-return of invested funds.
Beta asset i
measure of risk. Covariance of asset i with the market portfolio/Dispersion of the market portfolio.
Beta leverless
Beta without leverage, beta without taking into account financial leverage, debt-free beta (Beta unlevered).
Beta Leverless = Beta Lever /
Beta lever
Leverage beta, leveraged beta, debt beta (Beta (re)levered).
Levered Beta = Leverless Beta ×
Gross profit
The difference between revenue and cost products sold or services.
Interdependent Assets
contributory assets. Assets (tangible and intangible) involved in the formation of cash flow.
Cash flow on invested capital
Cash flow to the firm, Cash flow for all invested capital (Free cash flows to firm (FCFF)).
FCFF = EBIT*(1-tax rate) + Depreciation - Capital cost - Change in non-cash working capital.
FCFF = CFO – Capital cost + Interest expense*(1-tax rate)
Cash flow to equity
Free cash flows to equity (FCFE).
FCFE = Net Income + Depreciation - Capital Costs - Change in Non-Cash Working Capital + ( New debt- Amortization)
Discounting at the end of the period
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Discounting at the beginning of the period
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Mid-period discounting
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Discount multiplier (discount factor)
Discount coefficient. The coefficient by which the value of the cash flow of the future period is multiplied to give it present value.
Interval multipliers
income multipliers.
Absolute liquidity ratio
Coefficient absolute liquidity= (cash + short-term financial investments) / Short-term liabilities.
Customer base churn rate
Retirement rate (Сhurn rate).
The share of clients leaving the client base for the period (to the total number of clients at the beginning of the period).
Retirement rate = Number of units retired during the period / Number of active units at the beginning of the period
Coverage ratio
Current liquidity ratio, total liquidity ratio, total coverage ratio.
Coverage Ratio = Current Assets / Current Liabilities
Licensor
The party transferring the right to use the object of the license to the licensee in accordance with the license agreement.
Licensee
A party in a license agreement that acquires from the right holder (Licensor) a limited right to use the results of intellectual activity and means of individualization equated to them.
Discounted cash flow method
The discounted cash flow method is based on the assumption that the value of the business (enterprise) is equal to the present value of future cash flows that will be received in the face of changing income streams.
Cost = The sum of the present values of the cash flows of the forecast period + the present value of the cash flows of the post-forecast period
Income capitalization method
The income capitalization method is based on the premise that the value of the business (enterprise) is equal to the present value of future income that will be received under conditions of a stable income stream.
Cost = Income / Capitalization Rate
Salvage value method
Net proceeds received after the sale of the organization's assets, taking into account the repayment of existing debt and costs associated with the sale of assets and the termination of the activity of the organization conducting business.
Capital market(s) method
Based on information about the prices of shares of similar public companies in the global stock markets.
Adjusted Net Asset Method
Within the method net assets value is defined as the difference between the market value of assets and liabilities.
Method of comparable transactions
Deal method. Based on information about the sale of blocks of shares or the company as a whole (mergers / acquisitions).
Royalty exemption method
Based on the analysis of the income stream in the case of a license agreement.
Cost advantage method
Based on the analysis of the amount of cost savings resulting from the use of intangible assets.
excess returns method
Excess profits to the enterprise bring unrecorded on the balance sheet intangible assets providing profitability above the industry average.
Replacement cost method (IA)
Accounting for the cost of creating intangible assets at replacement cost.
Replacement cost method (IA)
Accounting for the cost of creating intangible assets at the cost of reproduction.
Gordon Model
The Gordon model is used to evaluate a firm that is in a steady state.
The cost calculation is based on the capitalization of income in the last year of the forecast period or in the first year of the post-forecast period.
As a rule, the equality of the amount of capital investments and depreciation is observed when constructing the cash flow
Instant multipliers
balance multipliers.
Asset turnover
Asset turnover ratio \u003d Revenue / Average annual value of assets (value of assets at the end of the period)
Operating profit
Revenue from sales.
Profit from the main (ordinary) activity, equal to the difference between revenue and expenses for the main activity (the latter includes direct and operating expenses); difference between gross profit and operating expenses
Control Award
Control premium. The value of the advantage associated with owning a controlling stake
Equity risk premium
Equity risk premium
Profit before tax
Profit before tax = EBIT - Finance costs
Profitability of sales
Sales margin.
Return on sales = Profit from sales / Revenue
Return on sales based on net profit
Net profitability (Net income margin).
Return on sales based on net profit = Net profit/Revenue
Market capitalization
Market capitalization (MC).
The market value of all outstanding shares of the company, calculated on the basis of quotations
Market value of invested capital
business enterprise value.
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Market value of equity
equity value.
Discount for lack of liquidity
Discount for the lack of liquidity. The amount by which the value is reduced to reflect the lack of liquidity of the subject property.
Discount for the non-controlling nature of the package
DLOC (Discount for Lack of Control).
DLOC = 1 - (1 / (1 + Control Bonus))
Own working capital
Net working capital.
Working Capital Equity = Accounts Receivable + Inventory - Accounts payable
Weighted average cost of capital
Cost of invested capital (WACC).
WACC = Cost of Equity × [Equity /(Debt + Equity)] + Cost of Debt × [Debt /(Debt + Equity)] × (1 - Income Tax Rate)
Discount rate
discount rate. The interest rate used to bring projected cash flows (income and expenses) down to a given point in time, such as the valuation date.
The cost of debt
The cost of borrowed capital. Cost of debt
Cost of equity
Cost of equity.
Returns that investors expect from equity investments
Terminal cost
Terminal Value (TV). Reversion, post-forecast cost.
The cost of cash flow in the post-forecast period
Terminal period
Post-forecast period (Terminal period).
The period following the last forecast period when the company's activity stabilizes
terminal stream
Cash flow in the post-forecast period (Terminal Cash Flow).
Working capital cycle
Turnover period (Working capital cycle).
Turnover ratio accounts receivable= Revenue / Average balance of receivables (value of receivables at the end of the period)
Inventory Turnover Ratio = Cost/Average Inventory (end-of-period inventory)
Accounts payable turnover ratio \u003d Cost / Average balance of accounts payable (value of accounts payable at the end of the period)
Turnover in days = 365 (360) / Turnover ratio
Net profit
Net income = Profit before tax - Income tax
Net assets
The amount determined by subtracting from the amount of the organization's assets, the amount of its liabilities.
According to the order of the Ministry of Finance of Russia dated August 28, 2014 No. 84n "On approval of the procedure for determining the value of net assets"
net debt
net debt.
Net debt = Long-term and current liabilities - Cash and cash equivalents,
If the business being valued can exist indefinitely. long, forecasting for enough long term even with a stable economy is difficult.
Therefore, the entire life of the company is divided into two periods: forecast, when the appraiser determines the dynamics of the company's development with sufficient accuracy, and post-forecast (residual), when a certain average is calculated moderate pace growth.
It is important to correctly determine the length of the forecast period, while taking into account the possibility of making a realistic forecast of cash flows and the dynamics of income in the early years.
2nd stage. Choice of cash flow model.
When valuing a business, either the cash flow model for equity or the cash flow model for invested capital is applied.
Cash flow (CF) for equity is calculated as follows:
DP \u003d Net profit + Depreciation + (-) Decrease (increase) in own working capital - Capital investments + (-) Increment (decrease) in long-term debt.
The calculation, which is based on the cash flow for invested capital, allows you to determine the total market value of equity and long-term debt.
The cash flow for invested capital is determined by the formula
DP \u003d Profit after tax + Depreciation charges + (-) Decrease (increase) in own working capital - Capital investments.
It should be noted that when calculating the cash flow for the entire capital, it is necessary to add interest on debt service, adjusted for the income tax rate, to the net profit, since invested capital works not only to create profits, but also to pay interest on loans.
Cash flow can be predicted both on a nominal basis (in current prices), and taking into account the inflation factor.
3rd stage. Cash flow calculation for each forecast year.
At this stage, information is analyzed on the plans of the management for the development of the company in the coming years and on the dynamics of cost and natural indicators operation of the enterprise for two to four years preceding the date of assessment. This information is compared with industry trends to determine the feasibility of plans and the stage life cycle companies.
There are two main approaches to cash flow forecasting: element-by-element and holistic. The element-by-element approach allows forecasting each component of the cash flow. A holistic approach involves calculating the amount of cash flow in the retrospective period and its further extrapolation, which can be carried out two or three years ahead.
The element-by-element approach is more complex, but gives more accurate results. Typically, the following methods can be used to determine the size of cash flow elements:
Fixation at a certain level;
Extrapolation with simple trend correction;
Element planning;
Binding to a specific financial indicator(the amount of debt, revenue, etc.).
Forecasting cash flows can be done in different ways - it depends primarily on the amount of information that the appraiser has. Usually when element-by-element planning all elements of the cash flow are closely interconnected: for example, the amount of profit is largely determined by the amount of depreciation and interest payments on loans; in turn, depreciation deductions depend on the volume capital investments; the cost of long-term loans depends on the amount of long-term debt.
Thus, the forecasts of revenue, cost, depreciation make it possible to calculate the amount of balance sheet profit, which will be reduced by the income tax rate, and as a result, the appraiser will receive the amount of net profit.
Consider the procedure for assessing changes in own working capital. Working capital is sums of money invested in working capital enterprises, they are defined as the difference between current assets and liabilities. The value of current assets is largely determined by the size of the company's revenue and is directly dependent on it. In turn, the amount of current liabilities to a certain extent depends on current assets, since they are used to purchase inventory and pay off receivables. Consequently, both current assets and current liabilities depend on the amount of revenue, so the forecast value of own working capital can be determined as a percentage of revenue.
4th stage. Calculation of the discount rate.
The discount rate is the rate used to convert future earnings into present value (value at the valuation date). Its main purpose is to take into account the possible risks that an investor may face when investing in the business being valued. Investment risk is understood as the probability that the actual income of the enterprise in the future will not coincide with the forecast. The methodology for calculating the discount rate is based on the identification and adequate assessment of the risks inherent in a particular business. At the same time, all risks are traditionally divided into systematic, or inherent in all elements of the economy (inflation, political and economic instability etc.), and non-systematic, or specific to a specific type of business (for example, aluminum production is more dependent on electricity tariffs than potato cultivation).
The choice of discount rate is determined by the type of forecasted cash flow.
When using cash flow for equity, the discount rate must be determined for
equity or according to the valuation model capital assets, or by the method of cumulative construction. If a cash flow forecast is made for invested capital, then the rate is determined using the weighted average cost of capital method.
The Capital Asset Pricing Model (CAPM) was developed on a number of assumptions, the main of which is the assumption of an efficient capital market and perfect competition of investors. The main premise of the model is that an investor accepts risk only if in the future he receives an additional return on invested capital compared to a risk-free investment.
The capital asset valuation model equation is as follows:
I \u003d Yag + B (Yat - I) + Ya1 + 52 + C,
where L is the rate of return required by the investor; Щ - risk-free rate of return; P - coefficient "beta"; Kt - the overall profitability of the market as a whole; ^ - premium for the risk of investing in small company; ?2 - premium for risk specific to a particular company; C is the country risk premium.
The risk-free rate of return is calculated on investments with a guaranteed rate of return and a high degree of liquidity. Such investments usually include investments in public securities (debentures). AT developed countries they are usually referred to debt bonds government with a maturity of 5-10 years.
In Russian practice, as a risk-free rate, for example, the rate on foreign currency deposits Sberbank, Eurobond yield or risk-free rate of other countries with the addition of a country risk premium.
Systematic risk arises as a result of the impact of macroeconomic and political factors on the company's activities and stock market. These factors affect all business entities, so their influence cannot be completely eliminated through diversification. The coefficient "beta" (P) allows you to take into account the systematic risk factor. This coefficient represents a measure of the sensitivity of the company's shares to systematic risk, reflecting the volatility of the prices of the shares of this company relative to the movement of the stock market as a whole.
As a rule, p is calculated based on retrospective information stock market over the past 5-10 years. However, the history of the Russian stock market (represented, for example, by the RTS) is only 5 years old, so when calculating p it is necessary
consider the dynamics of the stock market for the entire period of its existence.
It should be noted that there is a calculation of p based on fundamental indicators. At the same time, a set of risks is considered and determined: factors financial risk(liquidity, income stability, long-term and current debt, market share, customer and product diversification, territorial diversification), industry risk factors ( state regulation, cyclical nature of production, barriers to entry into the industry), general economic risk factors (inflation, interest rates, exchange rates, changes public policy). The application of this method is largely subjective, depends on the analyst using this method, and requires deep knowledge and experience from him.
In cases where the stock market is not developed, and it is difficult to find an analogue enterprise, the calculation of the discount rate for cash flow for equity capital is possible based on the cumulative construction model. The model implies an assessment of certain factors that give rise to the risk of shortfall in planned income. The calculation is based on the risk-free rate of return, and then the total premium for the risks inherent in the business being assessed is added to it.
Western theory has identified a list of key factors that should be analyzed by the appraiser: the quality of management, the size of the company, financial structure, industrial and territorial diversification, customer diversification, income (profitability and predictability) and other special risks. A premium of 0 to 5% is set for each risk factor.
The use of this model assumes that the evaluator has a lot of knowledge and experience, and the use of unreasonable values of risk factors can lead to erroneous conclusions.
If the basis for calculating the company's value is the cash flows for invested capital, then the discount rate is calculated using the weighted average cost of capital model. The weighted average cost of capital is understood as the rate of return that provides for the costs associated with attracting equity and borrowed capital. The weighted average yield depends both on the cost per unit of attraction | of own and borrowed funds, and from the shares of these funds in the capital of the company. In the very general view the formula for calculating the weighted average cost of capital (K) can be represented as follows:
where (1e - the share of own funds in the invested capital; / - the rate of return on equity; dk - the share of borrowed funds in the invested capital; 1k - the cost of raising borrowed capital (interest on long-term loans); Tm - the income tax rate.
The rate of return on equity is the discount rate calculated in the CAPM and cumulative construction models. The cost of borrowings is the average rate of interest on all of the company's long-term loans.
5th stage. Residual value calculation.
This value (Р^st) can be determined by the following main methods, depending on the prospects for the development of the enterprise:
1) calculation method according to salvage value- if in the post-forecast period the possibility of liquidating the company with the subsequent sale of existing assets is considered;
2) methods for evaluating an enterprise as an operating one:
Р^ is determined according to the Gordon model - the ratio of the amount of cash flow in the post-forecast period to the capitalization rate, which, in turn, is determined as the difference between the discount rate and long-term growth rates;
It is determined by the net asset method, which is focused on the change in the value of the property. The amount of net assets at the end of the forecast period is determined by adjusting the amount of net assets at the beginning of the first year of the forecast period by the amount of cash flow received by the company for the entire forecast period. The use of this method is expedient for enterprises of capital-intensive industries;
The value of the proposed sale is forecast.
The most applicable is the Gordon model, which is based on a forecast of stable income in the residual period and assumes that depreciation and investment are equal.
The calculation formula is as follows:
where V is the cost in the post-forecast period; CP - cash flow of income for the first year of the post-forecast period; I - discount rate; g is the long-term growth rate of cash flow.
6th stage. Calculation of the total present value of income.
The market value of a business using the discounted cash flow method can be represented by the following formula:
RU = 22 /„/(1 + K) where RU is the market value of the company; 1p - cash flow in the n-th year of the forecast period; I - discount rate; Y - residual value of the company at the end of the forecast period; y is the last year of the forecast period.
It is necessary to note the peculiarity of the process: the residual value is discounted at the end of the year; if the flow is concentrated on a different date, the exponent n in the denominator of the fraction must be adjusted, for example, for the middle of the year, the indicator will look like and - 0.5.
,
senior expert of the Valuation Department of FBK LLC
In Russian appraisal practice, the value of a business, as a rule, is understood as the cost of a company's equity capital. When evaluating the business of companies income approach(capitalization method or discounted cash flow method) the cost of equity is calculated by discounting (capitalizing) the cash flows generated by the company.
You can determine the value of a business by forecasting cash flows to equity, subtracting from them the cost of servicing interest-bearing borrowed capital. alternative this method is the calculation of the cost of invested capital by predicting cash flows for the entire invested capital of the company, including interest-bearing borrowed capital. In this case, the cost of equity is the difference between the cost of invested capital and the cost of interest-bearing borrowed capital of the company.
Cost of invested capital should be used in business valuation Russian companies in two cases:
- The company's activities are financed by both equity capital and interest-bearing borrowed capital. At the same time, the amount of interest-bearing borrowed capital is significant in relation to the amount of equity capital, and this financing structure will continue in the forecast period.
- The valuation of the company's business is carried out in order to determine investments in the company being valued in the course of mergers and acquisitions.
In the first case, the value of the company is determined at current structure funding for its activities. In the second case, the cost of invested capital characterizes the feasibility of investing in the purchase of a company for a potential investor, for whom the cost of capital may be lower than the cost of capital of the company being valued, which increases investment value last. This is because the buyer can refinance the capital of the acquired company with its own, cheaper debt financing.
As is known, there are different kinds the cost determined depending on the purposes and conditions of an estimation. AT this article we are talking on the calculation of the market value of the company's business. However, the described methods can be used in other cases, for example, to calculate the investment value.
When evaluating invested capital using the income approach, it is necessary to determine the discount rate or cost of capital of the company. The cost of capital in this case refers to the rate of return that reflects the risk of investing and is required by the market to finance these investments.
The company's cost of capital will include both the cost of equity and the cost of debt capital.
A company's cost of borrowing is the interest rate on loans and borrowings on an after-tax basis. Depending on how the interest rates of the company being valued and the average market interest rates correlate, we can talk about the coincidence or mismatch of the book and market values of borrowed capital. So, if interest rates are close to the average market values, the book value of debt capital (the amount of loans and borrowings of the company, reflected in its balance sheet) is approximately equal to its market value. Otherwise, the book value and market value of borrowed capital may differ.
However, since the interest rates on loans and borrowings raised by companies in most cases approximate the average market values for similar investments, it can be assumed that the book value of debt equals its market value to calculate the cost of all invested capital.
If there are preferred shares in the composition of the shares of a company - a joint-stock company, they are considered as a separate source of financing in addition to equity and borrowed capital. The cost of preferred shares is the rate dividend payments according to these securities.
The cost of equity is determined in a similar way to the discount rate when using the equity cash flow model:
- The method of cumulative construction;
- Using the Capital Asset Pricing Model (CAPM);
- Using the theory of arbitration pricing (Arbitrage Pricing Theory, ART).
The cost of all invested capital of the company is determined by the formula of the weighted average cost of capital (Weighted Average Cost of
Capital, WACC). If the invested capital includes equity (in the absence of preferred shares at joint-stock companies) and interest-bearing borrowed capital, the formula for calculating WACC is as follows:
rIC = w E r E + w D r D (1 - T) , (1)
where
rIC
- cost of invested capital according to the WACC formula;
w E
- share of own capital in the company's capital structure;
rE
- cost of own capital;
wD
- share of interest-bearing borrowed capital in the company's capital structure;
rD
- the cost of borrowed capital;
T
- Income tax rate.
Thus, to calculate the cost of invested capital of a company using the income approach, cash flows on invested capital are discounted at a rate equal to the cost of all invested capital and determined by the WACC formula. The weighted average cost of capital reflects the combined cost of debt and equity, with these funding sources weighted by their market value rather than their book value.
As already noted, the book value of debt capital, as a rule, can be considered its market value. This assumption does not apply to a company's equity, whose market value almost never matches its book value.
When evaluating companies whose shares are traded on open markets, the cost of equity to calculate the share of equity in a company's capital structure can be determined based on their market capitalization. In other cases, the appraiser needs to determine the weights of equity and debt capital himself, while not allowing a significant distortion of the value of the invested capital.
Example 1 describes the illustration of the calculation of the cost of equity of a company based on the method of capitalization of cash flow on invested capital, proposed in the book "Valuation of companies in mergers and acquisitions" 1, adapted in this paper for Russian conditions.
Example 1
Table 1. Data financial statements companies
Table 1 shows the financial statements of the proposed company whose business value (equity) is to be estimated. As can be seen from Table 2, the invested capital of this company consists of equity (E) and interest-bearing debt (D) capital. The weights of these sources by book value are 28.6% and 71.4%, respectively.
Table 2. Determination of the weights of equity and interest-bearing borrowed capital
It is also known that the net cash flow on invested capital (NCF IC) of the first forecast year will be RUB 1,000 thousand, and the long-term forecast growth rate of cash flow (g) will be 5%. The discount rate for equity (r E) will be 25%, the nominal rate on loans and borrowings (r D) - 15%, the income tax rate (T) - 24% (see Table 3).
Table 3. Initial data for calculations
The formula for calculating the cost of invested capital using the capitalization method is:
Taking into account the initial data, the cost of invested capital according to the WACC formula will be 15.3% (see Table 4). The estimated value of the company's invested capital will be RUB 9,709 thousand.
Based on the obtained values, the estimated cost of the company's equity capital will be 4,709 thousand rubles, while the cost of borrowed capital is 5,000 thousand rubles. However, the resulting structure of sources of invested capital contradicts the balance sheet data on which the calculation was based, namely, the shares of equity and interest-bearing borrowed capital are 48.5% and 51.5%, and not 28.6% and 71.4%, respectively, as assumed at the beginning.
To eliminate the identified distortions, it is necessary step by step to carry out a similar calculation of the cost of the company's invested and equity capital, at each step using the proportions of equity and interest-bearing borrowed capital obtained in the previous iteration. A similar calculation is presented in Table 4. The table shows that the result of the calculation, which is the cost of equity, is gradually approaching a certain value, which lies in the range between 3,475 thousand rubles. (step 7) and 3,333 thousand rubles. (step 8).
Table 4. Step-by-step calculation of the cost of invested capital and equity of the company
| step number | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 |
| Cost of invested capital (r IC), % | 15,3% | 18,0% | 16,2% | 17,4% | 16,6% | 17,1% | 16,8% | 17,0% |
| Interest-bearing borrowed capital (E), thousand rubles | 5 000 | 5 000 | 5 000 | 5 000 | 5 000 | 5 000 | 5 000 | 5 000 |
| Equity capital (D), thousand rubles | 2 000 | 4 709 | 2 692 | 3 929 | 3 065 | 3 621 | 3 264 | 3 475 |
| 1 000 | 1 000 | 1 000 | 1 000 | 1 000 | 1 000 | 1 000 | 1 000 | |
| Capitalization rate (r IC -g), % | 10,3% | 13,0% | 11,2% | 12,4% | 11,6% | 12,1% | 11,8% | 12,0% |
| 9 709 | 7 692 | 8 929 | 8 065 | 8 621 | 8 264 | 8 475 | 8 333 | |
| 4 709 | 2 692 | 3 929 | 3 065 | 3 621 | 3 264 | 3 475 | 3 333 |
After more iterations, you can get a more accurate value of the cost of equity of the company. However, in the case of the capitalization method, such a calculation can be made using a single formula, which has the following form:
, (3)
where
E V
- total cost of own capital;
NCF IC
- net cash flow on invested capital of the 1st forecast year;
D
rE
- discount rate for equity;
rD
- interest rate on credits and loans;
T
- income tax rate;
g
- long-term growth rate of cash flow.
The total cost of the company's equity, determined on the basis of this formula, is 3,400 thousand rubles. The cost of invested capital is 8,400 thousand rubles. The weighted average cost of invested capital, calculated based on the resulting capital structure, will be 16.9%.
This result would be obtained using a step-by-step calculation in the case of a large number of iterations in the absence of rounding.
Example 1 illustrates how the cost of equity of a company is calculated based on the cash flow capitalization method for invested capital.
However, the calculation of the value of companies using the income approach is usually carried out using the discounted cash flow method. Example 2 shows how a calculation similar to the one described in Example 1 can be made for the discounted cash flow method.
Example 2
With the same initial data on the book value of equity (E) and interest-bearing (D) capital of the company, the discount rate for equity (r E), interest rate for loans and borrowings (r D) and income tax rate (T), as in Example 1, and also in the presence of a forecast of changes in net cash flow on invested capital (NCF IC), it is possible to calculate the cost of equity of the company presented in Table 5.
The formula for calculating the cost of invested capital is as follows:
, (4)
where
NCF IC
i
- cash flow to the invested capital of the i-th interval;
NCF IC
n+1
- cash flow on invested capital in the post-forecast period;
n
- number of forecast intervals;
g
- long-term growth rate of cash flow in the post-forecast period.
Table 5. Calculation of the cost of equity by discounting cash flows on invested capital (1st iteration)
| Index | 1 year | 2 year | 3 year | Post-forecast period |
| Annual net cash flow on invested capital (NCF IC), thousand rubles | 1 000 | 1 070 | 1 100 | 1 150 |
| 5% | ||||
| 15,3% | 15,3% | 15,3% | 15,3% | |
| 10,3% | ||||
| 11 181 | ||||
| Discount period, years | 0,5 | 1,5 | 2,5 | 3 |
| discount factor | 0,93135 | 0,80786 | 0,70075 | 0,65264 |
| 931 | 864 | 771 | 7 297 | |
| Estimated cost of invested capital (IC), thousand rubles | 9 863 | |||
| Estimated cost of equity (E), thousand rubles | 4 863 |
The estimated value of the company's equity capital was RUB 4,863 thousand. Estimated value of all invested capital - 9,863 thousand rubles. Similar to the situation described in Example 1, the weights of equity (49.3%) and interest-bearing debt (50.7%) in the structure of invested capital, obtained on the basis of the estimated cost, contradict the original data (28.6% and 71.4% respectively).
The cost of capital, calculated on the basis of the obtained shares, is 18.1%. The estimated cost of the company's equity, obtained by discounting cash flows on invested capital at a discount rate of 18.1%, is 2,806 thousand rubles. (see Table 6).
Table 6. Calculation of the cost of equity by discounting cash flows on invested capital (2nd iteration)
| Index | 1 year | 2 year | 3 year | Post-forecast period |
| Annual net cash flow on invested capital (NCF IC), thousand rubles | 1 000 | 1 070 | 1 100 | 1 150 |
| Long-term growth rate of cash flow in the post-forecast period (g), % | 5% | |||
| Discount rate (cost of capital) (r IC), % | 18,1% | 18,1% | 18,1% | 18,1% |
| Capitalization rate in the post-money period, % | 13,1% | |||
| Residual value in the post-forecast period, thousand rubles | 8 775 | |||
| Discount period, years | 0,5 | 1,5 | 2,5 | 3 |
| discount factor | 0,92016 | 0,77910 | 0,65966 | 0,60700 |
| Discounted cash flow, thousand rubles | 920 | 834 | 726 | 5 326 |
| Estimated cost of invested capital (IC), thousand rubles | 7 806 | |||
| Estimated cost of equity (E), thousand rubles | 2 806 |
Based on the results of Table 6, using the weighted average cost of capital formula, the discount rate is 16.3%.
It is obvious that the cost of equity of the company lies in the range of the results of the first and second iterations and can be determined by stepwise calculation. The result of such a calculation (20 consecutive iterations) for this example is the cost of equity, approximately equal to 3,500 thousand rubles. The cost of capital in this case is 17.0%.
However, unlike the capitalization method, it is impossible to correctly calculate the cost of a company's equity by discounting cash flows on invested capital based on a single universal formula. This is primarily due to the fact that, depending on the situation, the appraiser may encounter different lengths of the forecast period, as well as different lengths of one forecast interval within the forecast period.
In the situation described in Example 2, to reduce the number of iterations and simplify calculations, you can use an approximate formula for calculating the cost of capital of a company.
The company's cost of capital (discount rate) is determined by the weighted average cost of capital formula (1). Given that
where
E
- equity;
D
- Interest-bearing borrowed capital;
IC
- invested capital,
formula (1) can be represented in the following form:
(6)
A step-by-step calculation of the cost of equity based on the use of the shares of equity and interest-bearing borrowed capital in the invested capital of the company, obtained in the previous iteration for substitution into formulas (1), (6) and determining the capital costs of the next iteration, is expressed by the formula:
, (7)
r n +1
- capital costs (discount rate) n + 1 -th iteration;
IC(
rn)
- estimated cost of invested capital after the n-th iteration.
When using the cash flow capitalization method for invested capital, the dependence of the cost of invested capital on the discount rate (IC(r n)) is expressed by formula (2).
Substituting the cost of invested capital from formula (2) into formula (7), we can obtain the dependence of capital costs of the n + 1st iteration on the costs of capital n iterations:
The recursive relation r n +1 and r n obtained in formula (8) is linear and has the form:
r n+1 = b - ar n, where (9)
a and b are constant values.
In the general case, when using the method of discounting cash flows on invested capital, the dependence of the cost of invested capital on the discount rate (IC(r n)) is expressed by formula (4).
It is obvious that the capitalization method is a special case or approximation of the cash flow discounting method, subject to a constant growth in cash flows in the forecast period. It can be assumed that in the case of the discounting method, the recursive dependence of r n +1 on r n will also be close to a linear function and can be expressed by formula (9).
In order to verify the above assumption, it is necessary to analyze the results of calculations from Example 2. Figure 1 shows the graphical dependence of r n +1 on r n for 20 iterations, as well as the trend line formula and the value of the R 2 indicator for the analyzed dependence.
Figure 1. Dependence of r n +1 on r n
As can be seen from the figure, the linear function quite accurately (R 2 -> 1) characterizes the change in capital costs in Example 2(*).
The verification carried out is not a mathematical proof. However, the results of the audit allow us to use the stated assumption for valuation of companies.
Thus, assuming that the dependence of r n +1 on r n is expressed by formula (9), and knowing the coordinates of two points (r1; r2) (r2; r3), we can calculate the coefficients a and b by solving the system of equations:
r 2 \u003d b - ar 1; r 3 \u003d b - ar 2 . (10)
The solution of the system of equations (10) is the recurrent dependence of r n +1 on r n:
. (11)
A multi-step process for determining equity based on the discounted cash flow on invested capital method results in a result where the discount rate of the next iteration is approximately equal to the discount rate of the previous iteration. Assuming that r n +1 = r n = r, you can get an approximate formula for calculating the cost of capital of the company for two points (r1; r2), (r2; r3), presented below.
, (12)
where
r
- the total cost of the company's invested capital;
r1
- cost of invested capital before the 1st iteration;
r2
- cost of invested capital after the 1st iteration;
r3
- cost of invested capital after the 2nd iteration.
In the case of Example 2, r 1 =15.3%, r 2 =18.1%, r 3 =16.3%. As a result of using formula (12), the cost of capital of the company (r) is approximately 17.0%. The calculation of the cost of equity at a discount rate of 17.0% gives a result approximately equal to 3,500 thousand rubles. (see Table 7). Substituting this value into the capital cost formula (1) to verify the calculations gives a result of approximately 17.0%.
Table 7. Calculation of the cost of equity by discounting cash flows on invested capital
| Index | 1 year | 2 year | 3 year | Post-forecast period |
| Annual net cash flow on invested capital (NCF IC), thousand rubles | 1 000 | 1 070 | 1 100 | 1 150 |
| Long-term growth rate of cash flow in the post-forecast period (g), % | 5% | |||
| Discount rate (cost of capital) (r IC), % | 17,0% | 17,0% | 17,0% | 17,0% |
| Capitalization rate in the post-money period, % | 12,0% | |||
| Residual value in the post-forecast period, thousand rubles | 9 583 | |||
| Discount period, years | 0,5 | 1,5 | 2,5 | 3 |
| discount factor | 0,92450 | 0,79016 | 0,67535 | 0,62436 |
| Discounted cash flow, thousand rubles | 924 | 845 | 743 | 5 983 |
| Estimated cost of invested capital (IC), thousand rubles | 8 496 | |||
| Estimated cost of equity (E), thousand rubles | 3 496 |
Thus, after 2 iterations and using the formula for approximate calculation of capital costs (12), it is possible to obtain the final capital cost rate for the company being valued, on the basis of which the cost of equity is determined by discounting cash flows on invested capital.
It should be noted that an analysis similar to the one described above can be carried out with respect to the share of equity in the invested capital of the company (w 1) used in exchange for capital expenditures. The recurrent dependence of w n +1 (share of equity in invested capital after the n+1st iteration) on w n (share of equity in invested capital after the nth iteration) is also close to a linear function.
When using an approximate capital cost formula, it must be taken into account that the accuracy of the calculations is influenced by the initial information and the rounding used in the calculations. The greater the difference between the discount rate for equity and the rate for loans and borrowings, the greater the fluctuations in net cash flows for invested capital in the forecast and post-forecast periods, the greater the calculation error.
Literature
- Frank C. Evans, David M. Bishop, "Valuation of companies in mergers and acquisitions: Creating value in private companies" / Per. from English. - M.: Alpina Publisher, 2004.
- , Business Valuation. - M: "Finance and statistics", 2004.
(*) A similar analysis was carried out for other companies. At the same time, the initial data differed in discount rates for equity, rates on loans and borrowings, cash flow growth rates in the forecast and post-forecast periods, the ratio book values own and interest-bearing borrowed capital. For all cases, the linear function corresponded quite accurately to the dependence of r n +1 on r n .
FCFE is the amount of money left over from profits after taxes, debt payments, and expenses to maintain and develop a company's operations. The calculation of free cash flow to equity FCFE starts with the company's net income (Net Income), the value is taken from the income statement.
To it is added depreciation, depletion and amortization (Depreciation, depletion and amortization) from the income statement or from the cash flow statement, since in fact this expense exists only on paper, and in reality no money is paid.
Further, capital expenditures are subtracted - these are the costs of servicing current activities, upgrading and purchasing equipment, building new facilities, and so on. CAPEX is taken from the investment activity report.
Something the company invests in short-term assets - for this, the change in the amount of working capital (Net working capital) is calculated. If working capital increases, cash flow decreases. Working capital is defined as the difference between current (current) assets and short-term (current) liabilities. In this case, it is necessary to use non-monetary working capital, that is, to adjust the amount of current assets by the amount of cash and cash equivalents.
For a more conservative estimate, non-cash working capital is calculated as (Inventory + Accounts Receivable - Accounts Payable last year) - (Inventory + Accounts Receivable - Accounts Payable of the previous year), figures are taken from the balance sheet.
In addition to paying off old debts, the company attracts new ones, which also affects the amount of cash flow, so it is necessary to calculate the difference between payments on old debts and receipt of new loans (net borrowings), the figures are taken from the financial performance report.
General formula calculation of free cash flow to equity has the form:
FCFE = Net Income + Depreciation - Capital Costs +/- Change in Working Capital - Loan Repayments + New Borrowings
However, depreciation is not the only "paper" expense that reduces profits, there may be others. Therefore, you can use another formula using cash flow from operations, which already includes net profit, adjustment for non-cash transactions (including depreciation), and changes in working capital.
FCFE = Net cash flow from operating activities - Capital expenditures - Repayment of loans + Obtaining new loans
13. Classification of cash flows in accordance with IFRS-7 and RAS No. 23.
The cash flow statement should contain information about the cash flows for reporting period broken down into flows from operating, investing or financing activities.
An entity presents cash flows from operating, investing or financing activities in the form that best suits the nature of its business. Classification by type of activity provides information that allows users to evaluate the impact of this activity on financial position enterprise and the amount of its cash and cash equivalents. This information can also be used to assess the relationship between these activities.
The same transaction may include cash flows classified differently. For example, when the cash payment on a loan includes both interest and principal, the interest portion may be classified as an operating activity and the principal portion may be classified as a financing activity.
Operating activities
The amount of cash flows from operating activities is key indicator the extent to which an entity's operations generate sufficient cash to repay loans, maintain the entity's operating capacity, pay dividends, and make new investments without recourse to external sources financing. Information about specific components of cash flows from operating activities for previous periods when combined with other information, it is useful in predicting future cash flows from operating activities.
Cash flows from operating activities are predominantly related to the main income-generating activities of the entity. Thus, they are generally the result of transactions and other events included in the determination of profit or loss. Examples of cash flows from operating activities are.
