0:09

welcome back

I hope you've been following the calculations and doing them by yourself

turns out

we started out with an Ra

of 6.3 percent and we combined that

to get the return on equity of

7.82 percent does that make sense

answer is yes why because the return on equity should

always be greater than or equal to the return on assets

you know there's some things in life that work

and imagine finance gives the most of the

otherwise life’s pretty confusing 7.82 is greater than 6.3

makes sense but then you go to WACC and you expect what

that the highest will be return on equity

then will be return on assets then will be weighted average cost of capital

and then will be return on debt weighted average cost of capital we have

calculated and I'm

keeping up my beautiful handwriting

for little while we found was 5.23

percent we used the formula of

enterprise value ignoring changes below the line

and we said 250 is the EBIT before tax

after tax it’s 250 multiplied by 0.66

and now you divide by .0523

which is WACC but that’s simply using a perpetuity

question is what is the split between the two you should know

that we know that’s half equity and half

debt because the debt to equity ratio is 1

I believe this is 1.578

1.578 approximately 1.578

debt and equity and you know that makes the debt to equity ratio

1 what I’m going to do in the next few minutes

is cover the other two methods then we'll come back

and quickly go through the same process

using approach two ok so let's go to

the APV method let’s just see what the APV method does

APV method is

EBIT 1 minus TC

divided by not WACC

but Ra this number has to be lower

than the value of the total company simply because it's ignoring

the tax shield then you have to add back the tax shield remember when you're taking

2:45

approach one

what is the value of the tax shield the value of the tax shield will be

determined by your discount rate

of Rd okay so let's do it do we know EBIT

it is 250

and do we know 1 minus TC

it is .66

do we know Ra point

.063 critical thing about the Ra is the Ra of your business

and the Ra of your comparable have to be the same that is actually one way of

figuring out

whether you have a comparable or not you know so

that's why it’s extremely important

to figure out the value of your comparable

based on it being actually a pure-play okay

turns out this number will be 2.619

2.619

billion dollars okay right

so that's the part that's easy

but we know what is the total value of the firm

total value of the firm is larger

so let's do the tax shield

the tax shield will be what it will be

D times

Rd times TC which is the cash flow of

the debt here things are very simple

we can do it pretty quickly we will be discounting by

Rd later

when we get to the valuation method where Rd is not the discount rate

Ra is the discount rate things get a little bit trickier but

not too bad here what I'm going to do is take advantage of the fact

that Rd’s cash flow and the discount rate of Rd

are the same and cancel them out and we are left with D times

TC do we know D we just figured it out

it is 1.578

do we know TC yes so

you multiply that by .34

you see how easy it becomes and I've done this calculation

and the answer is .537

the two add up to

3.155

3.155

billion ok so

what I'm going to do is give you a sense of why I like this method

I think those of you who already know it you can

take a little break the size of the pie is this

this is the total value of the firm

part of the value

comes from taxes going to whom

government not comes from goes to

right but that part well that's the way it is

but the main value I really like is Vu

value of the unlevered firm

with taxes is the key part I'm interested

right and that in this case that's

APV's main approach but

it does the PV of your value and then adjust is for what

the tax shield and the tax shield to me

is not real it is man-made so I call it

and it is financial it’s based on your financial policy

so can you imagine tomorrow that

somebody will say wait a second maybe by giving a tax break

to debt we are encouraging the adoption of debt policies

aggressive debt policies maybe we shouldn’t do this

what will happen to the tax shield it will disappear but does that mean your basic

idea wasn’t valuable in real terms

answer is yes it was valuable that's why I like the splitting up

of the total value of the firm

thinking of it like that is really awesome why because you're then

thinking of value creation in a very very positive way

I think the answer to this piece was .537

billion and the answer to this

piece was .2619 billion

WACC gives you what WACC combines them

and gives you 3.155

billion I like APV because it splits it up

both WACC and APV have one thing in common which I like though that they make you focus on

the

they make you focus on the value creation process

mainly on the asset sides now let's go to the third method

which is great but it’s now based on equity valuation so let's see what it

does

equity valuation method that takes value of equity

adds value of debt

okay I’ll do the easy part do we know the value of the debt

1.578

billion so the key here is figuring out value of

equity what do we need for it let’s see

you have EBIT you know it

but now you have to subtract interest

why because equity holders don't get all of this

equity holders get only that part of EBIT

that is after the interest is paid out but the good news is interest is tax

deductible

that's good news so you do taxes after

subtracting EBIT and then

you do by

Re question do I know TC yes

do I know Re now here's where

doing a thorough analysis is always good yes

I already know it’s 7.82

percent remember we had to calculate Re to get to WACC

going from Ra right so

we know 7.8 and I think I have that number right

250 million right

so the only number left to figure out

is how much is the interest okay let's do it

this is neat

you see how cool that was so what do you do

you do Rd

times D is the interest

okay do we know Rd yes it’s

.04 or

4 percent do we know the amount of debt

yes 1.578

so let's keep working on this and make sure that I have the numbers right

so your interest will be

63.12

billion million sorry

if it was billion we are in trouble how did I get that

.04 times

1.578

billion dollar please

notice the change in thing and if you do the multiplication

that should be the answer so let’s figure out

value using equity method

we have 250 minus 63.12

63.12 remember 250 is in million

the only number here in billion is the

total value of debt or the total value of the firm just for convenience

right multiplied by 1 minus .34

divided by what

Ra which is .0782

and this number turns out to be 1.577

1.577 billion dollars

but we know how much is debt debt is 1.578

1.578 billion dollars and the total amount turns out to be

I should call this equity method not the value of

equity okay is 3.155

billion what I would like you to do is go through this whole analysis on your own

I’ve written a lot I'm writing a lot and I'm wanting to make sure

that everything you see is transparent

and the good news is you’ll use this method many times

in finance and it's good to get you know

very comfortable with numbers we're going to take a break

and I’ll see you in a little bit what do we have left to do in this section

we now will cover doing all three methods

starting off with an Ra of 6 percent

and a beta A of .8

which was approach number two which says

that when I looked at bears as a comparable I pulled up these two numbers based on

their

information but assuming the tax shield’s discount rate was Ra

see you in a minute