Foreword xiii
Preface xvii
Acknowledgments xxiii
Abbreviations xxv
Part I Discounted Cash Flow (DCF) Models 1
Jan Viebig and Thorsten Poddig
1 Introduction 3
2 The Fundamental Value of Stocks and Bonds 5
3 Discounted Cash Flow Models: The Main Input Factors 11
3.1 Analytical balance sheets and free cash flow discount models 11
3.2 The dividend discount model 14
3.3 The free cash flow to the firm (FCFF) model 21
3.3.1 Stirling Homex: why cash is king! 21
3.3.2 FCFF during the competitive advantage period 27
3.3.3 Weighted average cost of capital (WACC) 35
3.3.4 Terminal value calculation 45
References 49
Part II Monte Carlo Free Cash Flow to the Firm (MC-FCFF) Models (Deutsche Bank/DWS) 53
Jan Viebig and Thorsten Poddig
4 Introduction 55
5 Standard FCFF Model 57
5.1 Net revenues 59
5.2 Cost structure and operating income 63
5.3 Reconciling operating income to FCFF 66
5.4 The financial value driver approach 71
5.5 Fundamental enterprise value and market value 76
5.6 Baidu's share price performance 2005-2007 79
6 Monte Carlo FCFF Models 85
6.1 Monte Carlo simulation: the idea 85
6.2 Monte Carlo simulation with @Risk 88
6.2.1 Monte Carlo simulation with one stochastic variable 88
6.2.2 Monte Carlo simulation with several stochastic variables 98
6.3 Disclaimer 103
References 105
Part III Beyond Earnings: A User's Guide to Excess Return Models and the HOLT CFROI® Framework 107
Tom Larsen and David Holland
7 Introduction 109
8 From Accounting to Economics - Part I 113
9 From Economics to Valuation - Part I 115
10 Where Does Accounting Go Wrong? 117
11 From Accounting to Economics: CFROI 119
11.1 The basics 119
11.1.1 Return on net assets (RONA) or return on invested capital (ROIC) 120
11.1.2 Return on gross investment (ROGI) 121
11.1.3 Cash flow return on investment (CFROI) 121
11.2 CFROI adjustments using Vodafone's March 2005 annual report 123
11.2.1 Gross investment 123
11.2.2 Non-depreciating assets 131
11.2.3 Project life 135
11.2.4 Gross cash flow 137
11.3 CFROI calculation for Vodafone 140
11.4 A comment on goodwill 141
12 From Accounting to Economics: Economic Profit 145
12.1 The basics 145
12.2 Caveats 147
12.3 EP adjustments using Vodafone March 2005 annual report 148
12.3.1 Balance Sheet 148
12.3.2 Net operating profit after tax (NOPAT) 153
12.3.3 Economic profit 153
12.3.4 EP or CFROI? 154
13 From Economics to Valuation - Part II 157
13.1 General rules 157
13.2 Market value added 157
13.3 CFROI 157
13.4 A word on debt 158
13.5 Valuation 159
13.5.1 CFROI valuation: general framework 159
13.5.2 Understanding project returns 159
13.5.3 The residual period 161
13.5.4 CFROI residual period approach 164
13.5.5 Economic profit valuation: general framework 165
13.6 Valuation of Vodafone 167
13.7 EP or CFROI? 171
13.8 A final word 173
Appendix 1: Vodafone Financial Statements and Relevant Notes for CFROI Calculation 175
Appendix 2: Additional Notes from Vodafone Annual Report for EP Calculation 185
References 191
Part IV Morgan Stanley ModelWare's Approach to Intrinsic Value: Focusing on Risk-Reward Trade-offs 193
Trevor S. Harris, Juliet Estridge and Doron Nissim
14 Introduction 195
15 Linking Fundamental Analysis to the Inputs of the Valuation Model 199
16 Our Valuation Framework 203
17 Linking Business Activity to Intrinsic Value: The ModelWare Profitability Tree 211
18 ModelWare's Intrinsic Value Approach 219
19 Treatment of Key Inputs 231
20 The Cost of Capital 233
20.1 Risk-free rate 233
20.2 Equity risk premium 234
20.3 Beta-estimation 234
21 Summary and Conclusions 237
Appendix 239
References 251
Part V UBS VCAM and EGQ Regression-based Valuation 253
David Bianco
22 Introducing "EGQ" - Where Intrinsic Methods and Empirical Techniques Meet 255
23 A Quick Guide to DCF and Economic Profit Analysis 257
23.1 Powerful analytical frameworks, but not a complete solution 257
23.2 Dynamics of economic profit analysis 257
23.3 "Unadulterated EVA" 258
23.4 Value dynamic 1: ROIC 258
23.5 Value dynamic 2: invested capital 259
23.6 Value dynamic 3: WACC 260
23.7 Value dynamic 4: the value creation horizon 261
23.8 Combining all four value dynamics: EGQ 261
23.8.1 EGQ vs. PVGO 261
23.8.2 The search for the ultimate valuation methodology 262
24 Regression-based Valuation 263
25 UBS Economic Growth Quotient 265
25.1 The EGQ calculation 265
25.2 EGQ special attributes 265
25.2.1 A complete metric 265
25.2.2 Not influenced by the current capital base 265
25.2.3 Limited sensitivity to the assumed cost of capital 266
25.2.4 Comparable across companies of different size 266
25.2.5 Explains observed multiples on flows like earnings or cash flow 267
26 UBS EGQ Regression Valuation 269
26.1 Intrinsic meets relative valuation 269
26.2 EGQ regressions: relative valuation theater 270
26.3 EGQ regressions: a layered alpha framework 271
26.4 Y-intercept indicates cost of capital 271
26.5 Slope vs. Y-intercept indicates style 271
26.6 Emergent valuation 272
26.7 Why regress EGQ vs. EV/NOPAT? 272
26.8 Think opposite when under the X-axis 273
27 Understanding Regressions 275
27.1 Key takeaways 275
27.2 The line - what is the relationship? 276
27.2.1 Slope (beta) 276
27.2.2 y-intercept (alpha) 277
27.3 The explanatory power or strength of the relationship 277
27.3.1 Correlation coefficient (R) 277
27.3.2 Coefficient of determination (R-squared) 277
27.4 Reliability or confidence in the quantified relationship 278
27.4.1 Standard error (of beta) 278
27.4.2 t-Statistic 278
27.5 Regression outliers 278
27.5.1 Influence outliers 278
27.5.2 Leverage outliers 278
27.6 Beware of outliers in EGQ regressions 279
28 Appendix Discussions 281
28.1 EGQ's muted sensitivity to assumed WACC 281
28.2 EV/IC vs. ROIC/WACC regressions 282
28.3 PE vs. EPS growth regressions or PEG ratios 284
28.4 Return metrics: ROIC vs. CFROI 285
28.5 Accrual vs. cash flow return measures 286
28.6 ROIC vs. CFROI 286
28.7 Adjusting invested capital important, but not for EGQ 288
References 291
Part VI Leverage Buyout (LBO) Models 293
Jan Viebig, Daniel Stillit and Thorsten Poddig
29 Introduction 295
30 Leveraged Buyouts 297
31 IRRs and the Structure of LBO Models 301
32 Assumptions of LBO Models 307
33 Example: Continental AG 317
33.1 Background 317
33.2 LBO modeling approach - appropriate level of detail 318
33.3 Key LBO parameters 318
33.4 Step-by-step walk through the model 320
34 A Word of Caution 329
References 333
Part VII Valuation 101: Approaches and Alternatives 335
Aswath Damodaran
35 Introduction 337
36 Overview of Valuation 339
37 Discounted Cash Flow Valuation 341
37.1 Essence of discounted cashflow valuation 341
37.2 Discount rate adjustment models 341
37.2.1 Equity DCF models 343
37.2.2 Firm DCF models 344
37.3 Certainty equivalent models 345
37.4 Excess return models 346
37.5 Adjusted present value models 346
37.6 Value enhancement in the DCF world 347
37.6.1 Determinants of value 347
37.6.2 Ways of increasing value 349
38 Liquidation and Accounting Valuation 355
38.1 Book value-based valuation 355
38.1.1 Book value 356
38.1.2 Book value plus earnings 356
38.1.3 Fair value accounting 357
38.2 Liquidation valuation 358
38.3 Value enhancement in the accounting world 358
39 Relative Valuation 361
39.1 Steps in relative valuation 361
39.2 Basis for approach 361
39.3 Standardized values and multiples 362
39.4 Determinants of multiples 363
39.5 Comparable firms 365
39.6 Controlling for differences across firms 365
39.7 Value enhancement in the relative valuation world 366
40 Real Option Valuation 369
40.1 Basis for approach 369
40.2 The essence of real options 370
40.3 Examples of real options 371
40.4 Value enhancement in the real options world 372
41 Closing Thoughts on Value Enhancement 375
References 377
Part VIII Final Thoughts on Valuation 379
Armin Varmaz, Thorsten Poddig and Jan Viebig
42 Introduction 381
43 Valuation in Theory: The Valuation of a Single Asset 383
43.1 Certain cash flows 383
43.2 Uncertain cash flows 384
43.3 Risk premia 386
43.4 Certainty equivalents and utility-based valuation 388
43.5 Risk neutral probabilities 391
44 Outlook: The Multi-asset Valuation and Allocation Case 395
45 Summary 399
References 401
Index 403
