dcf evaluation

8/6/2019 DCF Evaluation

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DCF Evaluation

In discounted cash flow (DCF) valuation, the value of an asset is the present value of expected future cash flows on the asset, discounted back at the rate that reflects theriskiness of these cash flows.There are 3 important variables that are required to value an asset

y Discount ratey E xpected Cash Flowy Timing of Cash Flow

WA CC

Cost of EquityBeta Estimation

ITC has four major businesses and the beta was calculated by taking the industry betas foreach of the different business. The following steps have been taken for Beta estimation.i. Cigarette Business

In the cigarette business ITC is the largest player in this sector and no other industry can becompared to ITC. Hence for the estimation of Beta we have taken the Beta E quity of ITC itself.

The D/ E ratio of ITC has been taken and unlevered to calculate the Beta Asset. The Beta Asset was calculated to be .74 approximately.The formula used for Beta Asset calculation is given below: asset = equity /{1+D/E(1-T c)}

ii. Personal HealthcareIn the personal healthcare business, we have compared ITC with E mami, Marico and GodrejConsumers. The Beta equities have been unlevered taking the D/ E ratios of respectivecompanies. The average Beta asset has been calculated by taking the weighted average of the

WACC

Return onE quity

Betaequity

Risk Premium

Cost of Debt

=r d*(1-t c)


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individual Beta assets. The weights have been calculated by taking the sales ratios of thecompanies. The average Beta asset is .313

iii. Paper In the paper business, JK Paper, Ballarpur, West Coast Paper and Sirpur Paper have been used.The method used is similar to the one described in the Personal Healthcare business. The Beta

asset so calculated is equal to .508iv. L ifestyle Retail

In the Lifestyle business, Pantaloon, Shoppers Stop and Provogue have been used ascomparables. The Beta equities have been unlevered and beta asset is calculated. The weightedaverage beta asset is .811.

Once the Beta assets have been calculated for each of the businesses, they are re-levered tocalculate the Beta equity. The weighted average of individual beta assets is calculated. Theweights are the individual revenues of each of the sectors of ITC. The weighted average

asset =.62The Debt- E quity ratio of ITC is 0.01. We have used the market values of equity to calculatethe debt equity ratio. The beta equity is calculated in the following way

equity = asset *{1+D/E(1-T c)}equity =.63

R isk Free R ate

The risk free rate is taken as the India s 10 year Government Bond yield. The 10-year bondhas been selected as it is the most liquid bond in India and has averaged 7.91% in the past.We have taken the current yield as the risk free rate. Thus R f = 8.4%

R isk Premium

In order to calculate the Risk premium first we have calculated the market return. Theweekly data of BS E sensex has been taken to calculate the weekly returns of sensex for thepast 10 years. The data has been taken from 1 st January 2001 till the current date. We havecalculated the geometric mean returns for the past 10 years. The standard deviation of theweekly returns has been annualized to calculate R m. The value of R m = 25.09%Thus market risk premium is: R m - R f = 25.09 - 8.4 = 16.69%Therefore Cost of E quity: R e = R f + equity *(R m - R f ) .R e = 18.92%

Cost of DebtThe cost of debt has been calculated by taking the interest expense of the current year(2011) and dividing it by the average debt of the past two years. The cost of debt before taxis calculated as R d= 10.62%. The after tax cost of debt is:Kd = Rd*(1- T c) = 7.05%

Debt-Equity W eightsThe debt has been calculated by taking the total debt on the balance sheet as in 2011. Theequity has been calculated by multiplying the total number of outstanding shares by theaverage price of the share in the current year.


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Thus D/V = 0.01 and E /V = 0.99

WA CCThe WACC has been calculated using the following formulae:WACC = Kd*D/V + R e*E /V

ThusWACC

= 18.91%

Expected Cash Flow

Growth R ateThere are 3 ways of estimating this

Company s past historical growth ratesAnalyst s estimatesProduct of reinvestment rate and return

We have estimated the growth rate using historical growth rates. One disadvantage of thismethod is that past growth rates cant estimate the future growth of the company .

Here the assumption of 20% maximum growth rate is assumed because the FMCG industryis becoming more competitive and with talks of FDI in organized retail this industry maybecome more competitive.

E xpected CashFlow

growth rate

Competitiveadvantage

period

stablegrowth rate

terminalvalue

stablegrowth rate

2011 2010 2009 2008 2007 2006 2005 2004 2003Growth rates in sales 0.16 0.16 0.13 0.16 0.22 0.29 0.18 0.10 0.19

Average growth rate intop line 17.66%Assumption: The growth rate increases till 20% as it is seen that the growth in top line is graduallyincreasing.Growth rate by 2020 20%

1.25% Steps in which the growth rate steadily increases to 20%


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Competitive A dvantage Period

We assumed that Competitive advantage period as 10 years; the reason for taking 10 yearsis because of the fact that FDI s in Organized Retail may become fully operational by that

time.Stable Growth R ate

The stable growth rate is assumed to be 10 %. This figure is bit over estimated value andthis 10% is chosen because of the increasing purchasing power of Consumers and theirincreased demand for Products.

Forecasting of Cash Flows

Operating Margin

2011 2010 2009 2008 2007 20

Operating Margin 0.37 0.36 0.34 0.35 0.35 0.Avg op Margin 0.38

The average operating margin for the past 10 years is 38% and we assumed that the sameop margin would be maintained in the coming yeas as well.

Depreciation

2011 2010 2009 2008 2007 20Depreciation as % of sales 0.03 0.03 0.04 0.03 0.03 0.Average 0.036

Here the depreciation is taken as % of sales for the past 10 years and average Depr as % of sales is calculated which will be maintained by company going forward

Capex and W C

2011 2010 2009 2008 2007 2006 2005 2004 2003Capex as % of sales 0.04 0.08 0.10 0.14 0.07 0.07 0.10 0.08 0.11WC as % of sales 0.10 0.04 0.22 0.19 0.23 0.20 0.11 0.00 0.14Capex/depr 1.43 2.24 2.98 4.28 2.37 2.00 2.45 1.96 2.50Average Capex

as % of sales

0.09

Avg WC as %of Sales

0.14

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020202

1


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Revenue 22273.66 26257.14

31011.75 36697.51

43509.81

51687.68

61524.07

73378.72

87694.31

105016.63

126019.

96

E BIT 8378.38 9876.80

11665.27 13804.01

16366.50

19442.66

23142.68

27601.88

32986.79 39502.69

47403.2

3Depreciatio

n 811.17 956.24

1129.4

0 1336.46 1584.56

1882.3

8 2240.61 2672.33 3193.68 3824.53

458

9.44

Capex 1962.87 2313.912732.9

1 3233.97 3834.314554.9

8 5421.81 6466.51 7728.07 9254.60

11105.5

2

WC 3157.04 3721.654395.5

6 5201.46 6167.027326.1

4 8720.3410400.6

012429.6

8 14884.92

17861.9

0Change inWC 2479.31 564.61 673.91 805.89 965.57

1159.12 1394.20 1680.26 2029.07 2455.24

2976.98

OperatingCFs 4747.38 7954.51

9387.84 11100.61

13151.18

15610.94

18567.27

22127.45

26423.33 31617.38

37910.1

7

Hypothetica

l Taxes 2820.16 3324.53

3926.5

3 4646.43 5508.96

6544.4

0 7789.83 9290.79

11103.3

5 13296.61

15955.9

3

FCFF 1927.21 4629.98

5461.31 6454.18 7642.22

9066.54

10777.45

12836.65

15319.98 18320.78

21954.2

4

Terminalvalue

270736.

14PVfact or 1.00 0.84 0.71 0.59 0.50 0.42 0.35 0.30 0.25 0.21 0.18PVOf CF's 1927.21 3893.36

3861.78 3837.75 3821.20

3812.12 3810.54 3816.52 3830.18 3851.68

51743.9

3

Firmvalue 88206.27Net debt -2302.30E quityValue 90508.57 CroresOutstandingShares 768.07 Crores Current Share PricePr iceta rget 117.84

198.65

Sensitivity A nalysis


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From the sensitivity analysis, the target price is approximately equal to current share pricefor WACC of 13 % and Growth rate of 6%.Since the analysis done is with respect to the Closing of March 31 st 2011, The share price at that point of time is around 207 which is in Sync with target price of 207.8542 for WACC of 14% and growth rate of 8%.

dcf evaluation

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