Capital Asset Pricing Model

Basics

The spreadsheet must be completed with at least 4 Comparable Acquisitions with Apple

Fill out the “DCF”, “NWC”, “WACC”, “A1” and “A2”

You need change the years in the template to recent years. The historical period should be 2017, 2018, 2019, then 2020.

THEN provide a written analysis as to the statistics.

Capital Asset Pricing Model

Steps and how to calculate the statistics(FORMULAS)

Analysis Steps

Determine the company’s key performance drivers

Project cash flow – 5 years

Calculate the WACC

Determine terminal value

Calculate PV and Determine valuation

Capital Asset Pricing Model

Determine Key Performance Drivers

Know your industry

Know the company

Drivers

a) Sales growth

1) New products

2) Opening of stores

3) New markets

4) Market trends

5) Government influences

6) M&A

Capital Asset Pricing Model

b) Expense growth

1) Sales growth

2) M&A

3) Start-up costs

c) Cap Expenditures

d) Working capital requirements

Want to make sure that year 5 of the projections is at a normal rate representative of the company’s normalized operations.

Capital Asset Pricing Model

Make sure that there is a logic to the projection

a) Higher sales mean greater expenses, higher cap exp. And higher working capital

Operating expenses are usually based on historical operating margins.

S,G &A is usually based on historical % of sales

Expense margins are usually held constant unless there is something specific going on with the company

Comparable Acquisitions

Capital Asset Pricing Model

EBIT

Less: Taxes at the Marginal Rate

Equal EBIAT

What we are trying to avoid is earnings that are benefitting from extraordinary low rates for that year. Want projections to be built based on taxes that are at a normalized rate.

Capital Asset Pricing Model

What is the marginal tax rate or the normalized rate? – Look at the historical tax rate

EBIAT

Plus: Depreciation and amortization

Less: Capex

Less: (Increase or decrease in net working capital)

Depreciation is usually estimated going forward as the existing level of depreciation plus a % of CAPEX or of sales.

Amortization usually lumped in with depreciation or estimated as a % of sales

Capital expenditures are shown on the cash flow statement

a) Usually, use the historical number and the historical growth rate

b) May be adjusted if there are anticipated changes in the company’s strategy, etc.

c) You usually revert back to the historical rates

Capital Asset Pricing Model

Networking capital

Current assets (accounts receivable, inventory, prepaid expenses and other)

Less

Current liabilities (accounts payable, accrued liabilities and other)

The growing company usually has working capital requirements – Sales growth causes an increase in inventory and accounts receivable

Can estimate net working capital as a whole but if possible the components of current assets and current liabilities are estimated and then put together

DSO (Days sales outstanding) = A/R / Sales x 365

Inventory Turns = COGS / Average Inventory

Capital Asset Pricing Model

Prepaid and other current assets projected as a % of sales

DPO = Average A/P / COGS x 365

Other current liabilities and accrued liabilities projected as a % of sales

Weighted Average Cost of Capital

Rd x (1- t) x (total debt / total capitalization)

Re x (total equity / total capitalization)

The cost of debt is equal to the weighted average cost of each outstanding debt issuance. Where there are bond issues it the current yield to maturity of the bonds.

t is the current tax rate

Capital Asset Pricing Model

Cost of Equity

Capital Asset Pricing Model

Rf + Beta x (market risk premium) = Cost of Equity

Market risk premium = 7.1%

Beta found on financial web sites. It is dependent on the capital structure of the company.

Rf is the yield to maturity of the 10 year US Treasury

Capital Asset Pricing Model

We need to look at the debt to total capital of comparable companies. If it is similar then you can use the beta for the company. If it is not then you need to go through the calculation of the average unlevered beta.

Capital Asset Pricing Model

Sensitivity Analysis

Usually derived based on the comparable company approach. Most often EBITDA x (EBITDA multiple)

Determine the Value

Calculate the PV of each projected cash flow

Remember to add terminal value to the last period. The terminal multiple is multiplied times the last 12 months’ results.

Add the PVs to get the value

Divide by the fully diluted number of shares to get the value per share

Comparable Acquisitions

Capital Asset Pricing Model

Usually, you create a chart of values with a number of different terminal values and WACCs

Then you need to pick the value that makes the most sense.

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