Free Cash Flow in a DCF – Quick Reference
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Enforcement and Cash Flow Management to Delay Goodwill
Enforcement and Cash Flow Management to Delay Goodwill Impairments under IFRS Andrei Filip, ESSEC Business School [email protected] Gerald J. Lobo, University of Houston – Bauer College of Business [email protected] Luc Paugam,1 HEC Paris [email protected] Acknowledgements We gratefully acknowledge the helpful comments of Anastasios Elemes, Martin Glaum, Humayun Kabir (discussant), Alexander Müller, Katherine Schipper and of workshop participants at the following workshops: Concordia University, Bocconi University, WHU University, 2016 EUFIN conference (Fribourg, Switzerland), 2017 EAA meeting (Valencia, Spain), and International Accounting Section 2017 Midyear AAA meeting (Tampa, Florida). A previous version of the manuscript was circulated under the title “The Effect of Audit Quality and Enforcement of Accounting Standards on Goodwill Impairment Avoidance”. 1 Corresponding author 0 Enforcement and Cash Flow Management to Delay Goodwill Impairments under IFRS Abstract: Under IFRS, managers can use two approaches to increase the estimated recoverable value of a cash generating unit (CGU) to which goodwill has been allocated in order to justify not recognizing impairment: (1) make overly optimistic valuation assumptions (e.g., about discount rate, revenue growth, terminal growth rate), and (2) increase future cash flow estimates by increasing current cash flows. Because enforcement constrains the use of optimistic valuation assumptions we propose that the strength of enforcement influences the relative use of these two choices. Using an international sample of listed firms that report under IFRS, we document that the use of cash flow increasing management for firms that delay goodwill impairment is more positively associated with enforcement relative to a control sample that recognizes impairments. We also find that as enforcement increases, firms that delay goodwill impairment shorten the cash conversion cycle in the current year by delaying cash payments to suppliers, and that these transactions reverse in the next year. -
Fundamental Analysis and Discounted Free Cash Flow Valuation of Stocks at Macedonian Stock Exchange
Ivanovska, Nadica, Zoran Ivanovski, and Zoran Narasanov. 2014. Fundamental Analysis and Discounted Free Cash Flow Valuation of Stocks at Macedonian Stock Exchange. UTMS Journal of Economics 5 (1): 11–24. Preliminary communication (accepted February 24, 2014) FUNDAMENTAL ANALYSIS AND DISCOUNTED FREE CASH FLOW VALUATION OF STOCKS AT MACEDONIAN STOCK EXCHANGE Nadica Ivanovska1 Zoran Ivanovski Zoran Narasanov Abstract: We examine the valuation performance of Discounted Free Cash Flow Model (DFCF) at the Macedonian Stock Exchange (MSE) in order to determine if this model offer significant level of accuracy and relevancy for stock values determination. We find that stock values calculated with DCF model are very close to average market prices which suggests that market prices oscillate near their fundamental values. We can conclude that DFCF models are useful tools for the companies’ enterprise values calculation on long term. The analysis of our results derived from stock valuation with DFCF model as well as comparison with average market stock prices suggest that discounted cash flow model is relatively reliable valuation tool that have to be used for stocks analyses at MSE. Keywords: valuation, securities, free cash flow, equity, stock-exchange. Jel Classification: G1,G12 INTRODUCTION Valuation of an asset can be determined on three ways. First, as the intrinsic value of the asset, based on its capacity to generate cash flows in the future. Second, as a relative value, by examining how the market is pricing similar or comparable assets. Finally, we can value assets with cash flows that are contingent on the occurrence of a specific event as options (Damodaran 2006). -
Over-Investment of Free Cash Flow
Rev Acc Stud (2006) 11:159–189 DOI 10.1007/s11142-006-9012-1 Over-investment of free cash flow Scott Richardson Published online: 23 June 2006 Ó Springer Science+Business Media, LLC 2006 Abstract This paper examines the extent of firm level over-investment of free cash flow. Using an accounting-based framework to measure over- investment and free cash flow, I find evidence that, consistent with agency cost explanations, over-investment is concentrated in firms with the highest levels of free cash flow. Further tests examine whether firms’ governance structures are associated with over-investment of free cash flow. The evidence suggests that certain governance structures, such as the presence of activist shareholders, appear to mitigate over-investment. Keywords Free cash flow Æ Over-investment Æ Agency costs JEL Classification G3 Æ M4 This paper examines firm investing decisions in the presence of free cash flow. In theory, firm level investment should not be related to internally generated cash flows (Modigliani & Miller, 1958). However, prior research has docu- mented a positive relation between investment expenditure and cash flow (e.g., Hubbard, 1998). There are two interpretations for this positive relation. First, the positive relation is a manifestation of an agency problem, where managers in firms with free cash flow engage in wasteful expenditure (e.g., Jensen 1986; Stulz 1990). When managers’ objectives differ from those of shareholders, the presence of internally generated cash flow in excess of that required to maintain existing assets in place and finance new positive NPV projects creates the potential for those funds to be squandered. -
Accounting Adjustments on the Discounted Free Cash Flow Valuation Model for Appraising Smes in Greece
Chinese Business Review, Oct. 2016, Vol. 15, No. 10, 498-506 doi: 10.17265/1537-1506/2016.10.006 D DAVID PUBLISHING Accounting Adjustments on the Discounted Free Cash Flow Valuation Model for Appraising SMEs in Greece Athanasios D. Karampouzis, Dimitrios Ginoglou University of Macedonia, Thessaloniki, Greece The present paper examines accounting issues that come up when evaluating a private firm under the Greek accounting standards. More specifically, we try to provide an accounting framework for appraisers who, when they try to retrieve intrinsic values of SMEs, make use of the Free Cash Flows to the Firm (FCFF) model. We focus on adjusting the firms’ statements’ items in order to produce a nominator that is consistent with the FCFF theory, taking in response—among others—the Greek tax legislation and the Greek General Chart of Accounts. Finally, we produce a rather normative formula, which can be positively used upon this very model (FCFF valuation) in order to assess the value of a private firm in Greece. The formula is explained thoroughly enough via a practical example of a real Greek private firm. Keywords: firm valuation, private firm, FCFF, taxation Introduction Valuation of a firm via discounted free cash flows to the firm is a common way to evaluate a non-public enterprise, because of the flexibility that offers. Free cash flows to the firm are cash flows available to the potential investor (especially in cases of mergers, acquisitions, audit etc.) after deduction—from net income—of investments in fix and working capital, after addition of net non-cash charges and after-tax interest charges. -
The Intrinsic Value of an Enterprise Determined by Means of the FCFE Tool
sustainability Article The Intrinsic Value of an Enterprise Determined by Means of the FCFE Tool Veronika Jezkova, Zuzana Rowland, Veronika Machova * and Jan Hejda Institute of Technology and Business, School of Expertness and Valuation, Okruzni 517/10, 37001 Ceske Budejovice, Czech Republic; [email protected] (V.J.); [email protected] (Z.R.); [email protected] (J.H.) * Correspondence: [email protected]; Tel.: +778-714-680 Received: 14 September 2020; Accepted: 21 October 2020; Published: 26 October 2020 Abstract: This paper deals with the determination of the intrinsic value of the company Seznam.cz, a.s. using discounted cash flow. Specifically, it is concerned with determining the value of the business from the perspective of the company’s shareholders. The Free Cash Flow to Equity (FCFE) method is chosen for analysis and determination of the value. According to this method, the specific FCFE values are discovered. However, the enterprise value must also be analyzed on the basis of other key indicators, such as financial leverage, the Capital Asset Pricing Model (CAPM) method, or the net present and future value of the FCFE. This is especially important so that the results can be put into mutual relations and a sufficient representative value of the FCFE results can be achieved. Input values stem from the company’s annual reports. From the results of the mentioned methods and indicators, it was found that the value of the FCFE is quite high, which means that the capital used is used appropriately. Based on the result of the continuing value of the FCFE, it can be said that the company’s intrinsic value is at a very good level. -
Uva-F-1274 Methods of Valuation for Mergers And
Graduate School of Business Administration UVA-F-1274 University of Virginia METHODS OF VALUATION FOR MERGERS AND ACQUISITIONS This note addresses the methods used to value companies in a merger and acquisitions (M&A) setting. It provides a detailed description of the discounted cash flow (DCF) approach and reviews other methods of valuation, such as book value, liquidation value, replacement cost, market value, trading multiples of peer firms, and comparable transaction multiples. Discounted Cash Flow Method Overview The discounted cash flow approach in an M&A setting attempts to determine the value of the company (or ‘enterprise’) by computing the present value of cash flows over the life of the company.1 Since a corporation is assumed to have infinite life, the analysis is broken into two parts: a forecast period and a terminal value. In the forecast period, explicit forecasts of free cash flow must be developed that incorporate the economic benefits and costs of the transaction. Ideally, the forecast period should equate with the interval in which the firm enjoys a competitive advantage (i.e., the circumstances where expected returns exceed required returns.) For most circumstances a forecast period of five or ten years is used. The value of the company derived from free cash flows arising after the forecast period is captured by a terminal value. Terminal value is estimated in the last year of the forecast period and capitalizes the present value of all future cash flows beyond the forecast period. The terminal region cash flows are projected under a steady state assumption that the firm enjoys no opportunities for abnormal growth or that expected returns equal required returns in this interval. -
Reorganization Value What It Is and Isn't
VALUATION 2016 Q3 This principle is illustrated as follows from an accounting Reorganization Value: balance sheet perspective: What It Is…..and Isn’t Assets = Liabilities + Equity BORIS J. STEFFEN, CDBV Assets are comprised of operating and non-operating RSM US LLP assets, while liabilities combine operating liabilities and The importance of reorganization value is that it is perhaps long-term interest-bearing debt. Consequently, the the measure that determines whether a debtor will be able accounting balance sheet equation comingles operating to reorganize, and the value of the reorganized debtor liabilities and financing sources on the right side of the that is distributable to holders of interests and claims. balance sheet: Nevertheless, reorganization value is not specifically Assets = Operating Liabilities + Debt + Equity defined in the Code or in case law, other than by reference to the general principle that a debtor should be valued Rearranging the formula by moving operating liabilities based on the capitalization of its expected future earnings. to the left side of the equation leads to the measure of Bankruptcy courts must therefore determine the “extent invested capital. The left side calculation shows how much and method of inquiry necessary for a valuation based on capital has been deployed by the firm; the right side earning capacity….dependent on the facts of each case.”1 calculation shows how much financing has been provided Courts determine reorganization value by reference to the by creditors and investors: debtor’s enterprise value based on the fair value standard, Assets – Operating Liabilities = Debt + Equity = Invested going concern premise, and present value of expected Capital future cash flows and/or market multiples. -
Clearing up Confusion Over Calculation of Free Cash Flow
Clearing Up Confusion Over Calculation of Free Cash Flow Dr. Howard Keen, Assistant Professor of Finance, Temple University, USA ABSTRACT This paper addresses student confusion over the calculation of the key valuation measure of free cash flow. Confusion is shown to arise from the measure used to represent capital expenditures and from the treatment of depreciation expense. Even for students who have had a full complement of undergraduate finance courses, the former is clearly a point of confusion for many students and its handling has important implications for the latter. This paper illustrates the lack of clarity and consistency in standard textbook treatment of this issue, provides evidence of resulting student confusion and offers clear and easy-to-understand guidelines for students to follow to help avoid that confusion. By adhering to the guidelines presented, even beginning students should be better able to navigate through what can appear to be mystifying presentations of how to incorporate capital spending and depreciation into the computation of a firm’s free cash flow. INTRODUCTION The motivation for this paper was born out of the teaching of the Finance Capstone course to senior Finance majors at Temple University. The paper focuses on the confusing treatment of the key components of capital expenditures and depreciation within the context of deriving free cash flow (FCF). A review of representative corporate finance textbooks reveals a glaring lack of clarity and consistency in the presentation of the use of gross or net fixed assets to derive ―capital expenditures‖ and in the separate explicit inclusion of depreciation. The question of whether capital expenditures is represented by a change in gross or net fixed assets is clearly a point of confusion for many students, even those who have had the full complement of undergraduate finance courses. -
Free Cash Flow to Equity Discount Models
ch14_p351-379.qxd 12/5/11 2:14 PM Page 351 CHAPTER 14 Free Cash Flow to Equity Discount Models he dividend discount model is based on the premise that the only cash flows re- Tceived by stockholders are dividends. Even if we use the modified version of the model and treat stock buybacks as dividends, we may misvalue firms that consis- tently fail to return what they can afford to their stockholders. This chapter uses a more expansive definition of cash flows to equity as the cash flows left over after meeting all financial obligations, including debt payments, and after covering capital expenditure and working capital needs. It discusses the rea- sons for differences between dividends and free cash flows to equity, and presents the discounted free cash flow to equity model for valuation. MEASURING WHAT FIRMS CAN RETURN TO THEIR STOCKHOLDERS Given what firms are returning to their stockholders in the form of dividends or stock buybacks, how do we decide whether they are returning too much or too lit- tle? We measure how much cash is available to be paid out to stockholders after meeting reinvestment needs and compare this amount to the amount actually re- turned to stockholders. Free Cash Flows to Equity To estimate how much cash a firm can afford to return to its stockholders, we begin with the net income—the accounting measure of the stockholders’ earnings during the period—and convert it to a cash flow by subtracting out a firm’s reinvestment needs. First, any capital expenditures, defined broadly to include acquisitions, are subtracted from the net income, since they represent cash outflows. -
Real Options the Big Picture: Part II
Real Options Finance Theory II (15.402) – Spring 2003 – Dirk Jenter The Big Picture: Part II - Valuation A. Valuation: Free Cash Flow and Risk • April 1 Lecture: Valuation of Free Cash Flows • April 3 Case: Ameritrade B. Valuation: WACC and APV • April 8 Lecture: WACC and APV 1 • April 10 Lecture: WACC and APV 2 • April 15 Case: Dixon Corporation 1 • April 17 Case: Dixon Corporation 2 • April 24 Case: Diamond Chemicals • C. Project and Company Valuation • April 29 Lecture: Real Options • May 1 Case: MW Petroleum Corporation • May 6 Lecture: Valuing a Company • May 8 Case: Cooper Industries, Inc. • May 13 Case: The Southland Corporation 2 Finance Theory II (15.402) – Spring 2003 – Dirk Jenter Real Options: Valuing Flexibility • The “Real Options Approach” assess the value of managerial flexibility in responding to new information. • Managers have many options to adapt and revise decisions in response to new and unexpected developments. • Such flexibility is clearly valuable and should be accounted for in the valuation of a project or firm. Example: • Often, managers can expand or contract production in response to changes in demand. The firm would be less valuable if they had to choose a fixed production level before knowing the level of demand. 3 Finance Theory II (15.402) – Spring 2003 – Dirk Jenter Two Steps in Real Options Analysis: Identification • Are there real options imbedded in a given project? • What type of options? • Are they important? Valuation • How do we value the (important) options? • How do we value different types of options? • Why can’t we just use NPV? 4 Finance Theory II (15.402) – Spring 2003 – Dirk Jenter Step 1: Identifying Real Options Finance Theory II (15.402) – Spring 2003 – Dirk Jenter Identifying Real Options • It is important to identify the options imbedded in a project. -
The Impact of Free Cash Flow on Market Value of Firm
Global Review of Accounting and Finance Vol. 5. No. 2. September 2014. Pp. 56 – 63 The Impact of Free Cash Flow on Market Value of Firm Abdul Nafea Al Zararee* and Abdulrahman Al-Azzawi** This paper constitutes an attempt to investigate the relationship between Free Cash Flow to Equity (FCFE) and the firm's market value of the pharmaceutical sector of Jordan by using a valuation technique, wherein the rift between theory and practice still need to be accommodated taking in consideration the relationship of FCFE, Net Income, Net Capital Expenditure, Working Capital and Debt Position. This paper uses panel data covering the period 2004-2010. The determination of a company's market value is a difficult decision, taking into account several antagonistic factors, such as risk of debt and capital expenditure, in times when the economic environment in which the company operates is unstable, therefore the choice among the ideal equation of FCF to Equity can affect the market value of the firm as much as profit rate can. The results show that the market values of a firm are assessed by the Free Cash Flow to Equity. Our result is in accordance with the hypothesis that FCF to Equity has significant positive effect on the stock market. Our findings add to the understanding of the determinants of the market value of firms. Keywords: Market Value; Free Cash Flow; Equity 1. Introduction The debate about the Free Cash Flow (FCF) relationship with the market value of a firm has been the core of the finance literature for the previous several decades. -
Corporate Restructuring
University of Pennsylvania ScholarlyCommons Finance Papers Wharton Faculty Research 7-25-2013 Corporate Restructuring B. Espen Eckbo Tuck School of Business Karin S. Thorburn Follow this and additional works at: https://repository.upenn.edu/fnce_papers Part of the Corporate Finance Commons, Finance Commons, and the Finance and Financial Management Commons Recommended Citation Eckbo, B. E., & Thorburn, K. S. (2013). Corporate Restructuring. Foundations and Trends® in Finance, 7 (3), 159-288. http://dx.doi.org/10.1561/0500000028 author Karin S. Thorburn is affiliated with the Norwegian School of Economics, Norway. She is also a visiting faculty member in the Finance Department of the Wharton School at the University of Pennsylvania. This paper is posted at ScholarlyCommons. https://repository.upenn.edu/fnce_papers/233 For more information, please contact [email protected]. Corporate Restructuring Abstract We survey the empirical literature on corporate financial restructuring, including breakup transactions (divestitures, spinoffs, equity carveouts, tracking stocks), leveraged recapitalizations, and leveraged buyouts (LBOs). For each transaction type, we survey techniques, deal financing, transaction volume, valuation effects and potential sources of restructuring gains. Many breakup transactions appear to be a response to excessive conglomeration and attempt to reverse a potentially costly diversification discount. The empirical evidence shows that the typical restructuring creates substantial value for shareholders. The value-drivers include elimination of costly cross-subsidizations characterizing internal capital markets, reduction in financing costs for subsidiaries through asset securitization and increased divisional transparency, improved (and more focused) investment programs, reduction in agency costs of free cash flow, implementation of executive compensation schemes with greater pay-performance sensitivity, and increased monitoring by lenders and LBO sponsors.