Unit 8

• Valuation is the process of estimating values for ventures
• Required cash is cash tied up in the normal course of business, while surplus cash is what remains after required cash, operating expenses, and reinvestments
• The process for developing projected financial statements used in a valuation involves the discounted cash flow (DCF) valuation technique
• Valuation is inherently about the future
• Discounted cash flow (DCF) valuation technique involves estimating future cash flows, discounting them for risk and delay, summing up all discounted cash flows to obtain the venture's present value
• Evaluators commonly partition the future into an explicit forecast period (2-10 years) and a terminal value
• Terminal value is calculated using a constant discount rate and growth rate
• Venture investor discount rate is crucial in determining the venture's present value
• Surplus cash is "cash flow available to equity" and can be paid out to shareholders as a dividend
• Equity valuation involves the pseudo-dividend approach, where pseudo dividends are calculated by ensuring required investments in working capital do not include surplus cash
• Pseudo dividends are discounted to get a value for the venture's equity ownership
• Developing the projected financial statements for a DCF valuation involves using the percent-of-sales method
• Balance sheets with surplus cash "plug" are used in the valuation process
• Statements of cash flows with retained surplus cash are essential for equity valuation
• Modified income statement with maximum dividend payments is part of the valuation process
• Modified balance sheet with maximum dividend payments is crucial for equity valuation
• Surplus cash is part of current assets, and it is important to exclude surplus cash in working capital calculations
• Net Present Value is the present value of a set of future flows plus the current undiscounted flow
• DCF valuation technique

  1. Estimate future cash flows;

  2. Discount future cash flows for risk and delay.

  3. Sum up all discounted cash flows to obtain...

  4. ... the venture’s present value.ue
• Capitalization rate

  Spread between the discount rate and the growth rate of cash flow in terminal value period.
• Required cash

  Cash tied up in the normal course of business.
• Surplus cash

  Cash remaining after required cash, all operating expenses, and reinvestment are made.

  • Is “cash flow available to equity”, i.e. can be paid out to shareholders as a dividend.
• Pseudo dividend approach

  Whenever some of the cash is not needed to carry out the business plan, that excess portion of total cash is treated as paid out as pseudo dividend.

  1. Projected PDC out five years assuming that a “surplus cash” account “plugs” the balance sheet (catching all remaining cash).

  2. Calculate pseudo dividends by making sure that required investments in working capital do not include surplus cash.

  3. Discount the resulting pseudo dividends to get a value for the venture’s equity ownership.