FINA Quiz #1: Valuation

Investment in Working Capital

-Balance Sheet (one moment in time/ value of asset or liability right now) -Investment means change in working capital

Investment in Fixed Assets

-Balance sheet -Property, Plant, Equipment (fixed assets) -CAPEX: Capital Expenditures

Value of the Firm is the

Enterprise Value

Current Event #2: VIX (Volatility Index)

-a derivative security (this means its value is based on some other asset or indicator) that measures the "fear" of investors -VIX is the ticker symbol and the popular name for the Chicago Board Options Exchange's CBOE Volatility Index, a popular measure of the stock market's expectation of volatility based on S&P 500 index options -calculated and disseminated on a real0time basis by the CBOE, and is often referred to as the fear index or fear gauge -traces its origin to the financial economics research of Menachem Brenner and Dan Galai -the VIX index formulation provides a measure of market volatility on which expectations of further stock market volatility in the near future might be based -the current VIX index value quotes the expected annualized change in the S&P 500 index over the following 30 days, as computed from options-based theory and current options-market data -sometimes criticized as a prediction of future volatility -the VIX is quoted in percentage points and represents the expected range of movement in the S&P 500 index over the next month, at a 68% confidence level -High VIX readings mean investors see significant risk that the market will move sharply, whether upward or downward -the higher VIX readings occur when investors anticipate that huge moves in either direction are likely

What does FCF < 0 mean? (FCF less than 0/ negative FCF)

1) To maintain the business, you must RAISE MORE capital 2) A FCF < 0 can happen, especially for a growing business -> we still expect to see growth in EBIT ~A FCF < ) for a mature company can raise issues

Current Event #1: Dow Jones Industrial Average

Article: -the Dow Jones Industrial Average (DJIA), Dow Jones, or simply the Dow, is a stock market index that measures the stock performance of 30 large companies listed on stock exchanges in the U.S. -although it is one of the most commonly followed equity indices, many consider the Dow to be an inadequate representation of the overall U.S. stock market compared to total market indices such as the Wilshire 5000 or Russell 3000 because it only includes 30 large cap companies, is not weighted by market capitalization, and does not use a weighted arithmetic mean -the value of the index is the sum of the price of one share of stock for each component company divided by a factor which changes whenever one of the component stocks has a stock split or stock dividend, so as to generate a consistent value for the index -the second-oldest U.S. market index -the index's performance continues to be influenced by not only corporate and economic reports, but also by domestic and foreign political events such as war and terrorism, as well as by natural disasters that could potentially lead to economic harm -first published in the mid-1880s -critics argue that the DJIA is an inaccurate representation of overall market performance compared to more comprehensive indexes -criticized for being a price-weighted index, which gives higher-priced stocks more influence over the average than their lower-priced counterparts, but takes no account of the relative industry size or market capitalization of the components Email: -over the last 3 weeks, the Dow average has lost substantial value due to a few factors that relate to our class: 1) Investors see substantial risk in the economy due to the unknown reach of COVID-19 2) Future Cash Flows for firms are now expected to be much lower in the short run -In our valuation models for this week, this translates to a lower present value or enterprise value of the firm -The Dow Jones is calculated using the value of ONE share of its 30 composite firms, so firms with more expensive shares carry more weight in the Dow Index. -A 1% gain in an expensive share company would have a much greater impact on the Index than a 1% gain in a smaller priced share -For me, I pay more attention to the value of the S&P 500 Index as it is a broader measure of the market's condition

Value of Any Asset

PV of Cash Flows it Pays the Investors

Value of Firm is equal to

PV of all FCFs

Pros and Cons of Multiples

Pros: -Dynamic -Market driven -Widely used Cons: -Ignores time value of money -Assumes that multiples hold OVER TIME

Pros and Cons of Free Cash Flow (Discounted Cash Flow) Model

Pros: -Uses financials -Uses cost of capital -Uses time value Cons: -Hard to forecast financials -Long term forecast

Current Event #4: Zoom's Stock Response

Shares of Zoom Video Communications Inc. fell 8% on Monday, adding to their sharp declines in the past few days, as the video conferencing app battles privacy concerns and increased competition from deep-pocketed rivals -the stock had surged to a record high in March as demand for the app skyrocketed with millions of people around the world using it for everything from school lessons to business meetings amid lockdowns imposed to slow the spread of the coronavirus but multiple reports last week that questioned the company's data privacy practices have spooked investors, erasing nearly a third of the company's market value from its record high -the stock was down 7.9% at $118.05 on Monday and was the worst performer on the Nasdaq -"While implied new customer growth may seem undemanding compared to recently disclosed 20x participant growth, we expect much of the recent surge will prove ephemeral, and/or comes from free users or education, which are very difficult to monetize -some school districts in the US, as well as Elon Musk's rocket company, have started to ban the app for online learning from home and business use because of growing security concerns

Accounting Income Versus Cash Flow

Three Basic Differences Between Accounting Income and Cash Flow: 1) Accounting recognizes revenues and expenses as they occur. Finance focuses on when the cash is received. 2) Finance considers side effects which is the impact of project on the rest of the firm. (Ex: Disney releases new movie -> positive impact on sales/ Apple releases a new phone -> negative impact on other phone sales) 3) Finance focuses (considers) opportunity cost

Cash Flow Estimation

We can use cash flow estimation to evaluate new projects for the firm and also value the firm as a whole -to estimate the value of a firm, we need the firm's Free Cash Flow (FCF)

Multiple

comes from the value of the company compared to some financial metric on its income statement or balance sheet -once we have the multiple, we can use it to find the value of our target firm

The forecasting stage consists of

constant growth in FCFs

Current Event #3: COVID's Far Reaching Impact

economic disruption impacts areas of the supply chain Despite strong demand for basic foods like dairy products amid the coronavirus pandemic, the milk supply chain has seen a host of disruptions that are preventing dairy farmers from getting their products to market -mass closures of restaurants and schools have forced a sudden shift from those wholesale food-service markets to retail grocery stores, creating logistical and packaging nightmares for plants processing milk, butter and cheese -the dumping of mil comes even as consumer demand for dairy has soared due to the inability to get the dairy to market -finding enough truck drivers is part of the challenge -suppliers struggle to make the shift from wholesale packaging for restaurants to preparing retail products for stores -processors can't take cheese back and resell it - or even donate it - because they can't ensure it has been safely handled -most can't pivot to retail because they don't have customer-facing packaging or relationships with stores for shelf space -in rural communities, smaller food retailers such as bakeries are starting to stock products that have been running short in the grocery stores

When finding Net Working Capital, EXCLUDE _________________ and ___________________ from current liabilities

notes payable (investor money) and dividends

The planning stage consists of

predictable FCFs

Gross Plant, Property, and Equipment (Gross PPE)

represents the actual spending on new assets

Earnings Before Interest and Taxes (EBIT)

represents the firm's cash income prior to any investor payments

Net Working Capital

represents the use of current assets and current liabilities for a firm -we want to measure the investment in working capital which is the net change for the year -this is then the cash invested in current assets or liabilities that supports the operations of the firm -we exclude any investor supplied capital or assets -we remove notes payable from our current liability total as it is investor supplied capital

Free Cash Flow (FCF)

the cash flow available for distribution to all investors after the company has made all the investments in fixed assets, new products, and working capital necessary to sustain ongoing operations -what money does the firm make before they pay any of their investors? -project future firm financials -represents the cash created before any investor distributions are made -signal the health and long-run potential for the firm

Planning Stage

the time frame in the immediate future for a firm where free cash flows can be reasonably estimated

Free Cash Flow Model (Discounted Cash Flow Model)

use time value of money principles to value a firm -we look at the cash flow created by the firm for all investors, not just common shareholders

Multiple Approach

where we find the implied value of a firm by using a comparable firm -another approach to valuing firms -a way of comparing yourself against something else -ex: If I was valuing Pepsi, I might look at Coke as a proxy for its value