NPV, DCF valuation

  1. what is the difference between NPV and DCF valuation?

From my deduction

in NPV you use DCF to discount all the future cash flow and subtract the initial investment

IN DCF valuation, you also use DCF to discount all future cash flow and end up with a thing call enterprise value

so does it mean that NPV = enterprise value - initial investment?

and then enterprice value = equity + debt - cash

so finally is it NPV = equity + debt - cash - initial investment?

  1. how should i interpret enterprise value?

if enterprise value = 160, equity = 100, debt = 80, cash =20

then 160 = 100 + 80 -20

if this company want to be sold at 120, is it worth to buy it??

  1. BTW, a side question, when you calculate the dividend payout ratio, that is dividend per share/ earning per share, should i use basic or dilute EPS?

The only difference is that NPV subtracts the initial cost, whereas DCF does not.

If by DCF you mean discounting FCFF, then you should end up with the value of the firm, not enterprise value. Or are you discounting something other than FCFF?

Enterprise value is the (net) value you should pay for a company, recognizing that when you purchase the company you will get the company’s cash, which effectively reduces the purchase price.

Yes: you would be willing to pay 180 (and receive the cash of 20 for a net price of 160); getting it at 120 is quite a bargain.

Basic EPS.

Fully diluted EPS is only a theoretical construct (if options had been exercised, if bonds had been converted, etc.); basic EPS is real, based on shares really outstanding.

Really thank you for your detail explanation

“If by DCF you mean discounting FCFF, then you should end up with the value of the firm, not enterprise value. Or are you discounting something other than FCFF?”

Yes, i mean discounting FCFF when DCF, but do you mean firm value not equal to enterprise value???

I have read some material by some investment bank about valuation and DCF, and they say that firm value = enterprise value and everytime they finish a DCF they end up with enterprise value, they would then further subtract the total debt to get the equity value and divide by number of share to get Implied Price per Share

so that is my understanding about valuation, can you explain a bit more about the difference between the firm value and enterprise value?

The value of the firm includes the value of the cash it owns; enterprise value deducts the value of the cash (because if you buy the firm you get the cash).

An analogy would be buying a wallet for $50: the value of the wallet (and its contents) is $50, but the enterprise value of the wallet is only $40 because the wallet contains a $10 bill.

I got into a big argument with a professor in college about buying a wallet.

He had a question on an exam asking what the minimum price we’d be willing to pay for an asset. Without thinking, I put $0 and moved onto the next question. He marked my answer wrong.

When I argued my answer to him, he asked me what the minimum amount I’d be willing to pay for his wallet was, and I said $0. He didn’t like that answer, so he told me that he had a 20 in the wallet - what’s the minimum I’d be willing to pay now? I again said $0.

He told me that the minimum that I’m willing to pay is $20, since there’s $20 in the wallet. I said that if I paid $0, then I’d get $20 plus a wallet for free. So, I’m sticking to my original answer.

I think he didn’t understand the difference between minimum and maximum. Anyway… I didn’t convince him to change my grade.

How funny!

I got into an argument with a professor in university about the reason that Leibniz is well-known.

It was a class in Logic (in the Philosophy department). The question was to name a couple of philosophers who contributed to the development of Logic, and to describe for what they were best known. I listed Leibniz, and said that he was best known for inventing calculus. (This wasn’t his best-known contribution to the development of Logic, but the professor didn’t ask for his best-known contribution to the development of Logic; if he had, that’s what I would have written.) The professor marked it wrong. I argued that if he went into the quad (the center of the university campus) and grabbed ten people at random, if they’d ever even heard of Leibniz, it would have been from their calculus class. He still marked it wrong.

A few years later he was convicted of murdering the ex-husband of one of his female students. Poetic justice?

Hi S2000magician,

I hope you are well - I just wanted to know if you have received my email. There is no rush to respond but i just want to make sure I have the correct email address.

Thanks again.

I did. I’ve been swamped these last few days, and have an interview with a patent examiner later this morning (on a patent application we’ve submitted for some investment portfolio analysis software we’ve developed). Once that’s behind me I’ll be respondign to a number of e-mails, yours included. Sorry for the delay.

Well that was unexpected. Well done.

one more question,

so in the case of acquisition, is that I should compare the acquisition price to enterprise value??

if the acquisition price is lower than enterprise value, then it is good deal?

if enterprise value = 160, equity = 100, debt = 80, cash =20, then any acquisition price lower than 160 is good?

does it make a difference if if enterprise value = 160, equity = 0, debt = 160, cash =0 ??

To make it simple: you’re buying assets. It doesn’t matter whether the assets are cash, accounts receivable, inventory, PP&E, whatever.

If the price is lower than the value of the assets, it’s a good deal.

Any acquisition price below 180 is good; above 180 is bad (relatively speaking)

Yes; here, any acquisition price below 160 is good; above 160 is bad (relatively speaking). You (probably) wouldn’t want to pay 180 here (unless the intangible value – brand name, skill of employees, whatever – justifies the extra 20).

It looks like to me that when you are talking about enterprise value, you are almost just talking about a book value here. When you put it in terms of equity, debt, and cash, I’m not sure how you are relating that to an NPV calculation. It looks more like a balance sheet. If you are purchasing a company for its book value(which based on info provided, it looks like you are), then you may be getting a good deal depending on future cash flows. As long as it is a viable and good business, to buy a business at book value can sometimes be a steal because the NPV of future cash flows proves to more valuable than the book value.

To your question, does NPV = equity + debt - cash…short answer is NO…and I’ve already alluded to why that is in the first paragraph. An NPV calculation equals the discounted future cash flows…nothing more, and nothing less. It doesn’t equate to some balance sheet calculation which it sounds like you are trying to do. If your NPV calculation is positive, then that means that your internal rate of return (annualized rate of return) will potentially be greater than the discount rate chosen to do the NPV calculations. By using the NPV result to compare one investment to another investment and using the same discount rate, it allows you to determine which investment will potentially provide a greater rate of return(without doing an internal rate of return calculation which can be more difficult without an NPV IRR calculator.

Also, when you are doing your determining your future cash flows, do not forget to include the value of a potential sale of the asset or business. Many times when people do these types of analysis, they can forget to factor in the sale of the business at the end into their NPV calculation. It would be more conservative to exclude this, but its still a final cash flow that should be considered. If one is going to consider the initial cash flow of purchasing the asset, then it would make sense that they consider the final cash flow of selling the asset.

It gets made fun of but Wikipedia has a good article on NPV, as well as enterprise value that you should check out. Good luck in what sounds like a potentially profitable business endeavor.

Classic example of a teacher/professor wanting you to answer the question they meant to ask, not the question they actually asked. Always drove me crazy. You are right about what Leibnitz is known for. And then other times, if you answer the question you think they meant to ask, but they actually meant to ask the question they asked, they’d mark you wrong for that too. I’m sorry Mr./Ms. teacher/profession, but I can’t always discern your intent, even when I know the answer to both the question you asked and the question you may have meant to ask.