# valuation in emerging markets

was just wondering how the rest of you are approaching this section. There is a lot to remember and some of the calculations are really tedious. Any ideas on what is important in the section? and/ or how to tackle a vignette on it? mike

didn’t remember it being THAT big… know how to restate for inflation, calcuate components of CAPM, ex-rate differences with EM and developing - how to adjust. am i missing something?

my approach is to pray the thing doesnt come up, possibly my weakest area.

just remember that for FcINv, taxes and NWinv you adjust it by inflation

smileygladhands Wrote: ------------------------------------------------------- > my approach is to pray the thing doesnt come up, > possibly my weakest area. I just realized that I forgot the material of this chapter so I went back and read the summary in Schweser and looked at the EoC questions there. Here’s the one thing that I think you should know if you don’t want to study this thing thoroughly: To value an emerging company, you have to adjust for inflation when calculating FCFF. The FCFF formula is the same old FCFF = NOPAT + Dep - FCinv - NWCinv The sole trick here is to remember is whether each element of this formula should be calculated based on Nominal or Real basis. NOPAT: Nominal Dep: Real FCinv: Real NWCinv: Nominal The goal is to setup all these components of FCFF based on Real or Nominal and then discount by the corresponding discount rate: Real CF -> Real discount rate Nominal CF -> Nominal Discount Rate This simple thing might get you 2-3 questions maybe if we get a vignette on this, IMO (typical disclaimer)

Can somebody briefly explain these nominal-real things with a numerical example? Thanks in advance.

Schweser dissects it for you. Pointless to try and recreate it. Give it a shot. Book 3 page 118.

Wavington Enterprises is headquartered in an emerging market nation that is expected to have 27% inflation over the next year. Charleston Johnson expects the local government to be successful in bringing inflation under control, and anticipates that it will fall to 20% in the second year and 10% in the third year, where he expects inflation to stabilize. Johnson predicts that by year 3, Wavington will have nominal free cash flow of \$187 million growing at 4% annually in real terms. In view of his optimistic outlook, he is considering an investment in Wavington, and has calculated the real WACC for Wavington at 8%. The nominal continuing value of Wavington in year 3 is closest to: A) \$4,675. B) \$4,862. C) \$4,250. Your answer: A was incorrect. The correct answer was B) \$4,862. The nominal growth rate for Wavington in the steady state is (1.10 × 1.04) – 1 = 14.4%. The nominal WACC in the steady state is (1.10 × 1.08) – 1 = 18.8%. The nominal continuing value for Wavington in year 3 is: nominal continuing value = FCF3 × (1 + nominal growth rate) / (nominal WACC – nominal growth rate) nominal continuing value = 187 × (1.144) / (0.188 – 0.144) nominal continuing value = 213.9 / (0.044) = 4,862 translation: brutal stuff

Wavington Enterprises is headquartered in an emerging market nation that is expected to have 27% inflation over the next year. Charleston Johnson expects the local government to be successful in bringing inflation under control, and anticipates that it will fall to 20% in the second year and 10% in the third year, where he expects inflation to stabilize. Johnson is considering an investment in Wavington, and has calculated the real weighted average cost of capital (WACC) for Wavington at 8%. Johnson states: Statement 1: The nominal WACC for Wavington next year is 35%. Statement 2: The firm value will be approximately the same using either the real or nominal approach to valuation. With respect to these statements: A) both are incorrect. B) only one is correct. C) both are correct. Your answer: A was incorrect. The correct answer was B) only one is correct. The nominal WACC for Wavington next year is (1.27 × 1.08) – 1 = 37.2%, not 35%. Johnson is incorrect regarding Statement 1. He is correct regarding Statement 2 that the nominal and real valuation approaches will produce approximately the same result.

i also remember a schweser vignette on this in the sample exams we had to compute NOPLAT for two years (in this example EBITDA - dep - taxes) They provide the real, and we have to go from real to nominal for example real EBITDA is 27 (with a 2% growth rate, 15% inflation) so real EBITDA in year 2 = 27.54 then we go from real to nominal = 27.54 x 1.15 = 31.67 then we have to do that for depreciation, too, and then compute NOPLAT sucks

CFA.Rhythm Wrote: ------------------------------------------------------- > Wavington Enterprises is headquartered in an > emerging market nation that is expected to have > 27% inflation over the next year. Charleston > Johnson expects the local government to be > successful in bringing inflation under control, > and anticipates that it will fall to 20% in the > second year and 10% in the third year, where he > expects inflation to stabilize. Johnson predicts > that by year 3, Wavington will have nominal free > cash flow of \$187 million growing at 4% annually > in real terms. In view of his optimistic outlook, > he is considering an investment in Wavington, and > has calculated the real WACC for Wavington at 8%. > The nominal continuing value of Wavington in year > 3 is closest to: > > A) \$4,675. > > B) \$4,862. > > C) \$4,250. > > > Your answer: A was incorrect. The correct answer > was B) \$4,862. > > > The nominal growth rate for Wavington in the > steady state is (1.10 × 1.04) – 1 = 14.4%. The > nominal WACC in the steady state is (1.10 × 1.08) > – 1 = 18.8%. The nominal continuing value for > Wavington in year 3 is: > > nominal continuing value = FCF3 × (1 + nominal > growth rate) / (nominal WACC – nominal growth > rate) > nominal continuing value = 187 × (1.144) / (0.188 > – 0.144) > nominal continuing value = 213.9 / (0.044) = > 4,862 > > > > translation: brutal stuff You could also calculate the REAL continuing value = (187/1.1 *1.04) / (0.08-0.04) = 4420 and then convert to nominal by multiplying by the inflation index of 1.1 = 4420*1.1 = 4862

good post, but if this is tested heavily I’m toast

CFA.Rhythm Wrote: ------------------------------------------------------- > good post, but if this is tested heavily I’m toast I am just happy I got both of your questions correct. Thanks for posting them and boosting my confidence.

Is there not a tax implication? Taxes are nominal, Capex is the plug to the B/S and then you have an Loss due to decrease in purchasing power on the I/S… Or is it OCI? :-/ Arggg

This is nasty stuff!! worst case scenario: A full vignette on this involving forecasting real and nominal FCFF for 5 years best case scenario: no show no points for guessing which one I am hoping for…

The only way to do it is to work out real capex first, as in an inflationary environment you have no idea how much needs replacing (so the question may pose a % of revenue that FC needs to be at). Convert the expenditure into nominal and plug into a nominal table, which will result in projected Fixed Capital and Depreciation that are NOT straightforward and constant percentages of revenue. Then compute taxes, etc, and either stick to nominal (with the appropriate discount rate), or go back to real, but bringing with you the converted taxes (which you need from the nominal table). Essentially, the troublemakers are Fixed Capital (because even with a fixed real relationship to revenue the depreciation and necessary capex are not simple) and taxes (because depreciation messes things up).

I wouldn’t expect this to turn up **heavily** on the exam, because it’s just a conversion of nominal to real CFs. Most analysts use Nominal Cash Flows and it’s more likely that there’ll be at most 2-3 questions.

> You could also calculate the REAL continuing value > = (187/1.1 *1.04) / (0.08-0.04) = 4420 and then > convert to nominal by multiplying by the inflation > index of 1.1 = 4420*1.1 = 4862 I’m a bit confussed by the need to do the final adjustment (although I admit it gets the correct answer). Shouldn’t the ‘REAL valuation’ equal the ‘NOMINAL valuation’? Or does ‘continuing value’ <> ‘valuation’?

mutton, real will equal nominal only if the value is today’s. As the continuing value is a future value, the real needs to be jacked up by the index.

@lmb: Thanks. I was looking at the maths and agreeing with it all, but something wasn’t clicking re the valulation bit. Cheers.