Finances: Company Valuation

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To evaluate financial investments, it’s necessary to understand how the company’s Cash Flow Cycle, CFC works or will work in the marketplace. This requires an understanding of how the company:

1. … raise capital from the market?
2. … reinvest it, and in what?
3. … renerate capital from operating activities?
4. … reinvest the income it receives?
5. … repay the borrowed capital, and to whom?

To make investments externally attractive, any participant will first need to understand points 1 and 5 - how much capital the company receives and how much it gives away.

Secondly, it is necessary to understand the Time Value of Money, TVM - if a market participant invests in a company, what are the time indicators of Cash Flows, CF, as well as the riskiness of the investment.

A company’s current value can be assessed in several ways. One such method is by calculating expected future profits. This method uses Cash Flows, CF expected in future periods to calculate the Current Value, CV. Roughly speaking, if the expected return is 10% per period and $1000 is available, then the expected capital for the next period can be easily calculated: $1000 + (100% + 10%) = $1100. You can conduce the reversed calculations (to calculate Present Value, PV) up to initial period (i.e. backwards to the nowadays):

$${''Present\; Value,\; PV''}_1=\frac{''FV''}{{''(1\; +\; I/Y)''}^{''N''}}=\frac{\mathrm{\$1100}}{{''(100\%\; +\; 10\%)''}^{''1''}}=\mathrm{\$1000}$$

or calculation using a calculator: PV = $1100 / (100% + 10%) ^ 1 = $1000

A similar calculation can be performed for a larger number of periods:

$${''Present\; Value,\; PV''}_2=\frac{\mathrm{\$1210}}{{''(100\%\; +\; 10\%)''}^{''2''}}=\mathrm{\$1000}$$

or calculation using a calculator: PV = $1210 / (100% + 10%) ^ 2 = $1000

So, the formula for calculation PV:

$${''Present\; Value,\; PV''}_N=''\sum ''\frac{{''FV''}_N}{{''(1\; +\; I/Y)''}^{''N''}}$$

This process is called dicounting, and the value it calculates is called Dicounted Cash Flow, DCF. The calculation is done in the opposite direction to the standard perception of time flow—from right to left. The process, according to the standard perception, compounding, calculates Cash Flow, CF.

Example
Let’s assume that there is a certain company whose investment attractiveness needs to be assessed. The company has the following financial metrics for the previous period:

Metric	Value
Net sales, $	1000
Profit margin, %	20
Tax rate, %	15
Discount rate, WACC, %	5
Long-term growth, %	1

Using the available metrics, we can calculate:

EBIT = Net sales * Profit margin = $1000 * 20% = $200
NOPLAT = EBIT * Tax rate = $200 * 15% = $30

which allows us to calculate Enterprise Value, EV - reflects how the company will be able to manage its assets and what the operating prospects are in the near future:

EV = NOPLAT * (100% + Long-term growth) = $30 * (100% + 1%) = $30.3

Let’s also assume the company has $400 in borrowed capital and 1,500 shares issued for a total of $3250. In this case, the market value of one share can be calculated:

Stock price = $3250 / 1500 = $2.166

Evaluation sequence

First, it is necessary to evaluate DCF and FCF - Financial Analysis and Financial Planning. Next, it is necessary to estimate the Cost of Capital, CC and compare it with cash flows. This will allow us to evaluate the company’s future by determining its Continuing Value, CV. Assessing the sensitivity to inaccuracies in calculations and assumptions is an important tool for calibrating assumptions about the company’s financial position - Sensitivity Analysis. And finally, after this, the current Enterprise Value, EV can be calculated.