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hi welcome

back I hope you have thought about the

valuation methods

we’ll just walked through them and then we'll do a mega example

and I think this is important so that you have this with you

because you're going to use this repeatedly

okay so the method we are talking about is

enterprise value right turns out it's the most complicated

so what does it do it assumes you know

EBIT 1 minus TC

repeat again plus depreciation minus change in working capital

minus cap ex this is the nice thing I like about videos is that

I can repeat myself and you can always go fast forward but I want to be sure

you're getting the gist of it

and then what does it do imagine

that everything is a perpetuity it just discounts by WACC

if it's not a perpetuity just to the PV

formula and NPV formula whatever

and you’ll just have multiple cash flows that's all that we're missing here

okay now the question is what do we have from our comparable we have Ra

and in a second I’ll start using numbers

we have Ra how do you go from Ra

to WACC in an ideal world without taxes or tax benefits to interest on debt

the two are the same but now one is greater

and which one is it Ra because WACC is the subsidized

cost of capital okay so let's get started

what is WACC WACC is Re

E over D plus E

plus Rd

leave the gap there D

over D plus E fair enough but the gap

there is 1 minus TC why

because your return on debt is subsidized okay

we are going to need to make some assumptions so the first assumption is

we know what this is this has been determined

already because WACC requires you to know this ratio

but for whom we are outside the comparable

we are now figuring out our WACC and one way to think about it is

the Ra of the comparable is relevant to you

but because of financial policy that Ra is not equal to WACC

and therefore your WACC depends on your financial policy

so you have to figure out what your debt to equity ratio is

but remember in here you will

typically know your Rd you’ll know your TC

and you ‘ll know your debt to equity ratio right if you know debt to equity ratio

you also know your

equity to debt ratio the only thing that you don't know

is your return on equity your return on equity

and the return on equity on a comparable in the same business

will not be the same pause reason

financial policy because of taxes financial policy matters it matters also

because of bankruptcy and so on but we're keeping that a

little bit at bay right now okay so your Re

is the main thing to figure out how do you figure it out remember

our first approach was and you're going to get a

little tired of this first approach was Rd

is the discount rate for the tax shield

you have to make that same two approaches again

so in approach one Re was Ra

plus D 1 minus TC

over E Ra

minus Rd and I'll ask you to do beta equation as well

what would it look like the beta question would look very similar

and it would look something like this: beta E

would be beta A not something like this it would look like this

sorry D you know I’m a bozo

I guess you know that by now so there’s no point

in saying it repeatedly

so beta asset minus beta debt so do you see the reflection

of this what is the question that matches the two

CAPM so always remember in finance there’s some

fundamentals once you know them you're in business but I've gotta repeat them

right what is this risk called this part its called financial risk

what is this risk called business risk this is the return for business risk

this is the return for financial risk to whom

the shareholders okay so we got that in place but the question is what

data will you have

if you have beta data you go to the beta equation

if you have return data you use the return equation so

again another principle always you the information you have

to figure it out so once you know Ra where will you plug it in

you’ll plug it in right here once you know this number

call it X just plug it right

here so this is approach number one assuming what

that Rd

is the discount rate for the tax shield

okay let’s just take a couple of minutes to do method number two

and then we will move to an example okay

so let's start with approach two

to do WACC right

again we need what I'm writing this very quickly again

just for the sake of it plus

Rd 1 minus TC

D over D plus E this equation never changes

it’s the components that are in there that change right so we know this

I’ve assumed we have figured out our debt policy we therefore know

the data on these pieces the tougher part is

Re again what do you know from your comparable

Ra but to figure out your Re you have to figure out what is the tax shield’s

discount rate approach a says

Ra is the discount rate of the tax shield what will Ra be

I mean Re be under those circumstances remember you’re trying to figure it out

very similar to the first one but with a minor twist

that there's no 1 minus TC

fair enough what will

the beta equation be and I'm going to go to a little bit fast because I think

you're getting the drift I'm sure and look I can write very fast too

so okay by the way as I've said many times

I’ll say it in shorts if I make a mistake fix it

because you know the logic of it hopefully I’m making mistakes that

are small and not huge mindboggling mistakes

okay so these are the two equations one you figure it out and call it

X again you just go plug it in so we have done WACC

be now know WACC we can do enterprise value

remember method one enterprise value

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very quickly the beauty about APV is

you don't need to calculate a WACC and it's cleaner

of course it depends it requires different kinds of information

so EBIT 1 minus TC

divided by Ra but you know Ra is going to be greater than WACC

so you know the answer here will be lower than that answer so what are you missing

the one thing you have to remember APV is clean but it

assumes that you don't have the tax shield so what you gotta do is

add back TS and TS can be now thought of again

as the value being determined on what its discount rate is

so you could have Rd as its discount rate

or Ra as its discount rate okay

what is the cash flow from TS

very quickly you know this it is D

Rd TC

right this many times

is also called I not many times always called I

so interest times tax shield okay and then you discount it so there are

APV has two possibilities you have to make a call whether to use Ra or Rd

method three I call it equity valuation

what do you do there very straightforward

you take EBIT right

but now you subtract interest before you pay

taxes and you now need

Re and then to that you add

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the level of debt which you already know now

do we know Re if we have done

WACC we know Re so for example right here

approach two Re is given to you so if you've done WACC you already know

Re if you haven't done WACC how many Ra’s can you get

two one based on Ra being the discount rate for the tax shield shown in

this equation and the other equation is Rd being the tax shield

and there you multiply D by 1 minus TC so

all three methods are ready to go I want you to please think about this for a

couple of minutes

when we come back we will spend a lot of time

sorting through an equation focus there will be on what

not the cash flows they’ll be given to you the focus there will be

on valuation and the focus on

how to get your discount rates using comparable information

but apply it to two different sorry three different methods of valuation

trick in order to get your Ra

you have two choices for the tax shield

okay so let’s take a break come back

and keep going with a great example