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Subtract market value of outstanding net debt and preferred capital from the present value of assets to get present value of equity. Free cash flow is after-tax operating earnings plus non-cash charges less increases in working capital less capital expenditures. (On leveraged DCF analysis, free cash flow is reduced by after-tax interest expense)

• Sensitivities on discount rates, terminal value assumptions and operating scenarios are frequently used to estimate the uncertainty in the values obtained

Advantages

• Theoretically, the most sound method of valuation
• Less influenced by temperamental market conditions or non-economic factors
• Can value components of business or synergies separately from the business

Disadvantages

• Present value obtained are sensitive to assumptions and methodology
• Terminal value represents significant portion of value, and is highly sensitive to valuation assumptions

Comments

• DCF value may be adjusted for non-operating items such as environmental liabilities and the value of salable assets, as well as seasonality of key variables
• Need realistic projected financial statements over at least one business cycle (seven to 10 years) or until cash flows are “normalized”
• Sales growth rate, margins, investment in working capital, capital expenditures, terminal value assumptions and discount rates are key to value

Leveraged buyout or recapitalization analysis

Description

• Model the Company’s financial performance under an initially highly-leveraged capital structure
• Assume transaction occurs in today’s borrowing environment and determine maximum initial debt the Company can realistically repay in a timely manner
• Several operating and business environment scenarios are used to estimate the uncertainty in the values obtained

Advantages

• Will help determine realizable financial value that any strategic bidder will have to exceed
• LBO value is realistic, in the sense that it can be achieved by a well-defined process

Disadvantages

• Stand-alone LBO may underestimate strategic sale value by ignoring synergies with acquiror
• Value obtained is sensitive to projections and aggressiveness of operating assumptions (but less so than DCF methodology)

Comments

• LBO value only meaningful for companies which could operate under high financial leverage (i...

Subtract market value of outstanding net debt and preferred capital from the present value of assets to get present value of equity. Free cash flow is after-tax operating earnings plus non-cash charges less increases in working capital less capital expenditures. (On leveraged DCF analysis, free cash flow is reduced by after-tax interest expense)

• Sensitivities on discount rates, terminal value assumptions and operating scenarios are frequently used to estimate the uncertainty in the values obtained

Advantages

• Theoretically, the most sound method of valuation
• Less influenced by temperamental market conditions or non-economic factors
• Can value components of business or synergies separately from the business

Disadvantages

• Present value obtained are sensitive to assumptions and methodology
• Terminal value represents significant portion of value, and is highly sensitive to valuation assumptions

Comments

• DCF value may be adjusted for non-operating items such as environmental liabilities and the value of salable assets, as well as seasonality of key variables
• Need realistic projected financial statements over at least one business cycle (seven to 10 years) or until cash flows are “normalized”
• Sales growth rate, margins, investment in working capital, capital expenditures, terminal value assumptions and discount rates are key to value

Leveraged buyout or recapitalization analysis

Description

• Model the Company’s financial performance under an initially highly-leveraged capital structure
• Assume transaction occurs in today’s borrowing environment and determine maximum initial debt the Company can realistically repay in a timely manner
• Several operating and business environment scenarios are used to estimate the uncertainty in the values obtained

Advantages

• Will help determine realizable financial value that any strategic bidder will have to exceed
• LBO value is realistic, in the sense that it can be achieved by a well-defined process

Disadvantages

• Stand-alone LBO may underestimate strategic sale value by ignoring synergies with acquiror
• Value obtained is sensitive to projections and aggressiveness of operating assumptions (but less so than DCF methodology)

Comments

• LBO value only meaningful for companies which could operate under high financial leverage (i...

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