VALUE BASED INDICATORS:

-> DEF: indicators that look to the future and try to predict the result of the company.

• Equity = Value of the company. But it looks to the past (Is the result of the past actions).

-> Today is a FINANCIAL Prospective;

Cash Generation Cycle:

-> Consider the most relevant Cash Flows (not exhaustive):

ENTERPRISE: subject of the discussion;

SHAREHOLDERS: are the one that give the Equity to the enterprise.

• Pratically is once every 5-10 years.

DEBTHOLDERS: is the other entity that land money, as debt, to enterprise.

CAPEX (t):

• Company is collecting money in order to make investments;
• Every year we have to pay for assets we invested;

CASH FLOW FROM OPERATIONS (t):

⚠️C.F.from Operations is DIFFERENT thanC.F. from oprating activities:

• C.F. from O. consider only operating activities (the one that create EBIT);
• C.F. from O.A. consider:
  • Financial Activities;
  • Fiscal Activities;
  • Operating Activities (consider revenues from production, R&D and MRK).

CASH VIEW: movement of the cash;

REVENUES VIEW: they are in base to the margin principle.

CORPORATE-FINANCE PERSPECTIVE:

-> OBJ Corporate Strategy: sustain the growth over time and competition against competitors at minimum cost possible.

ASSETs-SIDE:

EQUITY-SIDE:

👁️: how company use money; 👤: middle-line manager; 🎯: get the most from assets. -> Capability of assets to generate value; -> Want to calculate WACC: Needed to compute residual income (most important indicator); To maximise the ROI; -> TAXES: the middle-line manager know that have to pay taxes but don’t know the interest they have to pay; -> ENTERPRISE–VALUE: is the element with higher value for the Asset-Side. Consider all the cash flows.

👁️: cash inflows/ outflows; 👤: shareholders; 🎯: expect dividends. -> Must consider banks from this view; -> C-Level has this view. -> EQUITY-VALUE:  is the element with higher value for the Equity-Side; In a perfect market, SH buy shares at the Equity-Value;

Enterprise Value (Assets-Side):

-> The Assets-Side is focused on business:

-> We start from EBIT (t) because when forecasting the future:

1. We translate straetgy and CA in expected revenues vs operating costs;
2. We adjust them in expected cash inflows vs cash outflows.

❓Why start form the EBIT?

-> It allows to understand how the strategy is going. We want to judge the strategy. EBIT is the first real result in which we see the effect of the strategy thanks the Competitive Advantage.

-> HP: we are able to predict EBIT of the next year.

-> OBJ: from EBI -> EBITDA

1.EBIT:

-> Understimate cash generation because it considers D&A among operating costs even if they do not generate cash outlows.

• In this view, we must adjust EBIT (t) readding D&A (t).
• Depreciation: not connected to cash flows;

-> ACCRUAL POV: we see increasing assets and depreciation of it every year (when buy a new asset);

-> CASH POV: only see the installment.

📌 For small companies in Italy we don’t have to do cash low statement =>  We use EBITDA.

2.ADJUST REVENUES:

-> Customers can pay later => Revenues needs adjustments:

• Remove the receivables that will be pay next year;
• Consider the receivables of the previous year.

📌RECEIVABLES: crediti

-> To adjust them we have to think about receivables => I have to eliminate the portion of revenues that will not be paied by the customers.

-> Only 9 months will be paied

-> We ave to consider:

• That only the first 9 months will be paied,the other we well be paied next year. => Consider that as RECEIVABLES.
• CURRENT ACTIVITIES:
  • They will become cash next year;
  • They include receivables of the year before: they will be translate in cash this year.

3.ADJUST THE COSTS:

-> EBIT consider COGS (Cost of Good Sold) because are the cost for goods sold.

-> For matching principle we have to consider only the part of products that company solds => We detract inventories.

-> Only cost that are connected to the revenues must be consider => COGS consider even the material/products that company has in inventories (but the company has to pay for them).

📌If we create some products and stock it =>

• Income Statement: cost of production = 0
• But thare are some negative cash flows (to pay the Material Raw)

4.PAYABLES:

-> We have the possibility to not pay all the cost => Difference between cost and all outflows =>

• PAYABLES(t): costs that we are allow to pay later, we don’t consider this (costs that due in the next twelve months).
• PAYABLES (t-1): we have to pay for the cost of the last year.

-> Payables mean increase of cash flows.

-> Net Operating Working Capital:

5.TAXES:

-> Taxes are computed directly on EBIT because Shareholders and Debtholders are assumed as a single entity and thus  financial costs are assumed as an “internal flow” that does not act as a tax shield

-> HP: tax rate is the same => Sum of all flows is null => Considering SH and banks as unique subject => Financial flows are null (they are in the same group)

-> Cost of debt banks are like dividend and are calculated in a different way.

• Are not the one that we find in the income statement and cash flow statement. Are taxes calculated on the EBIT. The taxes in the income statment and cash flow statement are calculated in a different way because is no real that banks and SH are the same entitiy.
• We are calculating the taxes on EBIT because we don’t consider financial flows between enterpriese and banks.

Cash Flow statement > TAXES: taxes that company payed; (anticipaiton next year + compensation previous year).

• Cash logic: Income Statement > TAXES: taxes that company will pay. (matching principle)
• Accrual logic: company pay a portion of taxes. The next year The previous year the company payied a portion of the taxes, because the next year the company will know the perfect numebr of the taxes (it comes in december). The breal number will be known in may => The company anticipate something and there will be compensations (debt taxes or …. Taxes)

-> Financial statements are approved only in may => In cash flow statmentes don’t know taxes untill may.

NOPAT: Net Operating Profit After Taxes

-> CHAR:

• Responsability of middle-line manager;
• Key performance indicator for BU (many case);
• Reduce it by reducing avertage taxes or relocating activities in different BU around the world;

6.CAPEX:

-> CAPital EXpenditures = Installments = Portion of assets that will be payied that year.

-> HP: Disposal (t) = 0 (Is not consider that company sell assets, but could happen).

• In EBIT calculation Disposal > 0 because I’m collecting money.

-> In case of disposal assets, we consider:

Net CAPEX = CAPEX (t) – Disposals (t)

-> To obtain…

 

FCFF, Free Cash Flow to Firm:

FCFF(t) = Free Cash Flow to Firm = EBIT(t) + D&A (t) – ΔNOWC(t-t-1) – TAXES (t) – CAPEX (t)

-> DEF: cash that is available for the company, the middle-line manager:

• Include capital expenditures (net of taxes and capex).
• Cash flow available for the company, not for the SH (we still need to pay banks).

-> Part of this money will be used to pay banks, shareholders and part to reinvest.

-> Which one:

• We want FCFF (t) > 0, but one year isn’t enought;

• Cumulative FCFF(t):

-> The value of money change over time because there is risk!

=> We need to discount CF in order to make them omogeneus:

-> WACC because consider both shareholders (Ke) and the banks (Kd) (the money that middle-line manager invest are coming from both banks or shareholders) to translate discontinities.

-> It’s equal to the Enterprise Value!

-> ✔PROS:

• Based on cash;
• It looks till infinite.

📌Why no over 10 years, don’t know:

• Desease;
• Evolution of market;
• Evolution of person.

❓How manage the overtime?

-> We define a period: Capital T: maximum period in the future in which we are able to produce an Analytical Forecas (: a period in the future in which we can predict the future.) (3-5 years for start up, 5-10 years for mature company)

TV, TERMINAL VALUE: is the enterprise value that company can ganerate after the Capital T.

• D: value that company generate after Capital T, measured in capital T, for this t-T.
• Are authorized to sum cash flow that are in the same year. Because the value decrease (for inflation and risk) every year in the future.
• Must be discounted (because is calculated in T).

Enterprise Value:

-> CHAR:

• Focus inside the company;
• To 🔺 EV => 🔺 FCFF and 🔻 WACC;
• We need to consider also market capitalization to have a perspective of the market.

-> ASSUMPTION:

1. TV = 0 -> Not really sense to be prudent, but the best guess is the real one. (make sense only if T is long enough)

E.g. Amazon was intresting because of its Terminal Value.

-> Remember to discount WACC, is the result of mathematical series that is not 1+WACC).

-> After the condition af a yearly growth (g = yearly growth rate)

-> This method is called “Analitical approach to the calculation of Enterprise value“.

• Analitical Approach: we are assuming that we are able to calculate the FCFF.

-> Means that we are inside the company, we know the strategy of the company.

-> Relative evalueation

Equity Value (Equity Side):

-> Lets see the Equity Value side.

ENTERPRISE VALUE: is the ability of the company to generate cash for the operating activities (same idea of BCG matrix).

EQUITY VALUE: is the ability of the company to generate cash for the shareholders.

-> IDEA: we found the cash generated in t available for the shareholders from FCFF.

⚠️HP: Financial Income (IS) = Financial Cost (CFS)

Net Financial Cost (or Net Interest). We use it because they are higher than Net Financial Income.

Financial cost (t)	: we use the money generated from the operating activities, the business to pay the cost of capital
+ Financial Cost (t) * t_c	-> With the diminuish of financial cost we have a reduce of the profit, the EBIT and for this, the taxes. => We have to adjust the taxes. -> TAX SHIELD: is the benefit that company have in saving for the reduction of EBIT.
+ Financial Income  (t)	-> Income from bonds or other own that company have. -> Are not usual.
Financial Income (t) * t_c	-> The Financial Income increase the EBIT and for this we have to pay taxes.

1.  FCFF (t) must be adjusted taking into account financial activities (financial costs and financial income) and the variation of taxes. We need to add back the tax shield that we didn’t consider in the FCFF.

FCFF – financial costs (t)*(1-tc) + financial income (t)*(1-tc)

• t_c = Corporate taxrate: beenfit that company has in the tax because of the reduction of the EBIT.

-> Reducing the cash they are increasing the cash came from tax shiel.

-> We obtain the financial Cost net of taxes: include the benefit from the tax action.

-> Company can have cash in from financial activities

• Sometimes they are not so relevant.

1. FCFF (t) must be adjusted taking into account the collection of new debts (t) and the repayment of current debts (t):

FCFF – financial costs (t)*(1-tc) + financial income (t)*(1-tc) + debt (t) – debt repayment (t)

❓Financial Cost where are in the CFS? -> In the Cash flow from Operating Activities (Remember the fal friend of Operating activity and Oprative activity).

1. FCFF(t) must be adjusted taking in to account the share capital (t), so the collection of Equity(t) and the payment of dividends (t):

-> If we pay dividends there are less money for the shareholder.

-> The cash account decrease if there is a buy back of the dividends.

-> Sometimes these last two are removed because is not a generation of cash.

=> The equity value is…

• We use Ke because are considering the equity side only.

-> This is also called Comprehensive calculation for the Equity Value.

• FCFF: cash generated in t available for the company;
• FCFE: cash generated in t available for the shareholders and they can use for what they think.

-> IDEA: we can pass to one to another easily.

⚠️Capital T are different for FCFF and FCFE.

-> Is the value of the company. Is the value that company has on the market (capitalization). The market capitalization and Equity Value have the same number. The equity value is the perpective of the shareholders. Is not the book value, because the book value look to the past, equity value look to the future.

❓Why the Equity Value and Market Value of company are different?

-> Equity Value requires the capability to predict the future financial value. Only the ones that are inside the company can know these things: they have data and know the strategy. In the market there is not perfect information.

❓Why we focus attention to the Enterprise Value and not in Equity Value?

-> Because we are obsessed by the middle line manager and what they should do.

• Enterprise Value:how the company is developing and is the first proxy of the value of the company itself.

-> We calculate it before M&A;

-> Is calculated through the intrinsic method is an estimation of the value of the company on the market (for not listed companies)

-> PROBLEM: we are making a lot of assumption (T, g and others);

• Equity estimate the cash generatioed through the equity.

-> Shareholders would like to understand the value of the Equity.

-> It is usually used to evaluate if it is a good moment to buy or sell the shares of the company.

=> Enterprise Value & Equity Value are used by C-level managers to take important decisions (how much company is worth, selling of ashares).

• They are moslty indicators, they aggregate data.

-> Accounting-based indicators (ROE, ROI) are used by managers.

• Are solwer;
• Need at least a quarter of year or year.

=> Value drivers are the early signals of the value of the company (fast indicators, closest to the reality) -> Operational Level.

Terminal Value:

-> First part formula: analitical period;

-> Second part formula: Terminal Value.

-> We have three approaches:

1. TV = 0 -> Discourage this choice (think about Amazon or Tesla. The balance was negative but the terminal value was very high).

=> Try to estend TV as much as you can (5-10 years).

2. FCFE (t) = FCFE(T) when t > T:

3. FCFE (t+1) = FCFE (t) * (1+g) when t > T, Optimistic approach:

-> We are assuming that the company will continue to grow, this is not true.

-> It’s not possible calculate these number for Nestlé becouse we don’t have the next Financial Report.