Assignment 3 – valuation using the perpetual growth method, value multipliers and cap rates

Part 1. Calculating capitalization rates

In this part, you calculate capitalization rates (“cap” rates) and value multipliers used to calculate horizon value, or to estimate current value of a company.

Select a non-financial company for which financial information is available for at least the three most recent years. Obtain financial statements the three most recent years. Use the company’s financial statements, together with other information described, to calculate the values indicated in questions 1-4.

Growing perpetuity based valuation multiplier and cap rate

1a. Estimate a growth rate for the company. Use average growth in any appropriate variable, such as sales (or total revenue), net income, operating income, dividends, etc.  Specify how you determine the growth rate.

1. Estimate the required return for the company using the capital asset pricing model if beta is available for the company (assume the risk free rate is 1.75% and the expected market return, 12.25%). If beta is not available, use the company’s average annual stock return for the last three years as the required return.
2. Use the answers to parts a and b to calculate the company’s cash flow multiplier based on the growing perpetuity valuation method
3. Convert the value in 1c to a cap rate.

Valuation multipliers and cap rates based on an operating variable

2a. Select an operating variable for the company (total sales, EBIT, operating cash flow, net income, etc.) from which to calculate a value multiplier

1. Calculate the value multiplier using the company’s current market capitalization and the most recent year’s value for that operating variable. [E.g., if you select net income as the operating variable, calculate the price to net income ratio, PE ratio. Be sure that the units for the company’s market capitalization and the selected operating variable are the same. If the income statement entries are in thousands, the market cap must also be in thousands.)
2. Convert the value in b to a cap rate.

Valuation multipliers and cap rates based on value of an asset

3a. Select an appropriate non-operating, financial variable (total assets, total stockholders equity, net fixed assets, etc.) for the company from which to calculate a value multiplier.

1. Calculate the value multiplier using the company’s current market capitalization and the most recent year’s value for that non-operating variable. [E.g., if you select total assets as the non-operating, financial variable, calculate the price to total asset ratio. (Be sure that the units for the company’s market capitalization and the non-operating variable are the same. If the balance sheet entries are in thousands, the market cap must also be in thousands.)
2. Convert the value in b to a “cap rate”.

Valuation multipliers and cap rates based on a non-financial asset

4a. Find the number of employees for the company for the most recent fiscal year.

1. Calculate the value multiplier using the company’s current market capitalization and the number of employees in part a. (Be sure that the units for the company’s market capitalization and the number of employees are the same. If the market capitalization is in millions, the number of employees must also be in millions.)
2. Convert the value in b to a capitalization rate.

Part 2. Using industry multipliers or cap rates to estimate the market value of a privately held company.

In this part, you use value multipliers and/or cap rates to estimate the current market value of a privately held company (the current value is the horizon value as of time 0).

Data for the private company is attached below.

5a. Use the multiplier from question 1 as a proxy for the industry multiplier to estimate the market value of the private company.

1. Use the cap rate from question 2 as a proxy for the industry cap rate to estimate the market value of the private company.
2. Use the multiplier or cap rate from question 3 as a proxy for the industry multiplier or cap rate to estimate the market value of the private company.
3. Use the multiplier or cap rate from question 4 as a proxy for the industry multiplier or cap rate to estimate the market value of the private company.
4. Briefly discuss the differences in values obtained in question 5 using the different methods, and based on the characteristics of the company you selected for part 1, indicate which value(s) are likely to be most accurate for a private company in the same industry.

Part 3. Horizon value

7. For one of the multipliers or cap rates from questions 1-4, explain how that multiplier or cap rate can be used to estimate the value of the private company as of 5 years from now.

 

Income Statement (thousands)
Total Revenue	3290
Cost of Revenue	2144
Gross Profit	1146
Operating Expenses
Research Development	220
Selling General and Administrative	538
Non Recurring	11
Other	69
Total Operating Expenses	838
Operating Income or Loss	308
Income from Continuing Operations
Total Other Income/Expenses Net	23
Earnings Before Interest and Taxes	285
Interest Expense	26
Income Before Tax	259
Income Tax Expense	104
Net Income	155

 

Balance Sheet (thousands)
Cash And Cash Equivalents	168
Net Receivables	252
Inventory	207
Other Current Assets	12
Total Current Assets	639
Property Plant and Equipment	1266
Goodwill	321
Intangible Assets	162
Other Assets	130
Total Assets	2518
Accounts Payable	176
Short/Current Long Term Debt	118
Other Current Liabilities	205
Total Current Liabilities	499
Long Term Debt	518
Other Liabilities	26
Deferred Long Term Liability Charges	26
Total Liabilities	1069
Common Stock	838
Retained Earnings	654
Other Stockholder Equity	-43
Total Stockholder Equity	1449
Number of employees	18

 

Statement of cash flows (thousands)
Net Income	155
Operating Activities
Depreciation	87
Adjustments To Net Income	51
Changes In Accounts Receivables	12
Changes In Liabilities	-11
Changes In Inventories	4
Changes In Other Operating Activities	-8
Total Cash Flow From Operating Activities	290
Investing Activities
Capital Expenditures	-22
Investments	12
Other Cash flows from Investing Activities	-76
Total Cash Flows From Investing Activities	-86
Financing Activities
Dividends Paid	-128
Sale Purchase of Stock	-100
Net Borrowings	0
Other Cash Flows from Financing Activities	0
Total Cash Flows From Financing Activities	-228
Effect Of Exchange Rate Changes	-12
Change In Cash and Cash Equivalents	-36