Discounted Cash Flow analysis is an equity valuation technique which is an equity valuation technique that is being utilized by prospective investors both individual and institutional. The DCF model helps to gauge the potential value of a stock by estimating an intrinsic value of the stock which is based on the future cash flows of the company. The model discounts the expected cash flows of the company by an appropriate discount rate which is generally the weighted average cost of capital of the company to arrive at the fair value of the stock. The purpose of the project is to perform a Discounted Cash Flow analysis of Walt Disney, an American multinational entertainment industry using the financial data of the company for the years 2017 to 2019. The intrinsic value of the stock was determined using the DCF technique for the year 2019. For the purpose of discounting the Free Cash Flows of the firm, the Weighted Average Cost of Capital (WACC) was calculated using firm specific and market specific data. The assumptions involved in each of the calculations is explained in detail in the report. The Comparable Company Analysis is another equity valuation method which is employed in calculating the intrinsic value of a stock using multiple valuation multiples like EV/EBITDA and Price to earnings ratio. The report explains the methods and steps that goes into calculation of the intrinsic value of the stock of Walt Disney.
The Cash Flow Discounted The equity valuation technique is a way of evaluating assets that is used to evaluate different organisations or projects. The model analyses the company’s or project’s expected future cash flows and uses a discount rate that reflects the needed return on capital from stakeholders to evaluate the firm’s worth. This approach is used by decision makers such as individual and institutional investors, governments, regulatory bodies, research firms, and others to evaluate the investment possibilities of a stock or asset. If the total value of the discounted cash flows for each year exceeds the sum invested, the investment is deemed profitable. The formula for discounted cash flow approach is shared below:
The cash flow of a single year is indicated by CF in the above equation, whereas the cash flows of subsequent years are indicated by CF1 and CF2. The discount rate, denoted by r, is utilised as a proxy for the required return in the equation above.
There are multiple benefits associated with the discounted cash flow analysis which are discussed in detail below:
The following section analyses and discusses the assumptions which were made to arrive at an intrinsic value of the stock of Walt Disney:
Free Cash Flow for the Firm (FCFF) – Free Cash Flow for the firm refers to the cash flow available to the company after it has accounted and adjusted for the external and internal liabilities of a firm. The company utilizes this free cash flow to meet the expenses of dividend and interests which are to be paid to the capital providers of the company. To calculated the free cash flow for the firm the following formula was used:
Ebit(1-t)+ depreciation-capital expenditure- changes in net working capital
The formula adjusts the Earnings before interest and tax of the company for the year 2019 with the depreciation expense, capital expenditure and the change in net working capital to arrive at the Free cash flow of the company. The following table represents the FCFF of Walt Disney for the years 2017 to 2019:
|
Year |
2019 |
2018 |
2017 |
|
FCFF |
8941.2 |
11051 |
8483 |
The company’s financial statements provided the figures for depreciation expenditure, EBIT, and tax expense. The cash flow from investment activities was calculated using the company’s capital expenditures from the cash flow statement. The company’s cash flow statement was also used to gather information on changes in working capital.
Growth rate – The growth rate of the company was calculated using a combination of two growth estimation models; PRAT model and the growth in EPS for the years 2017 to 2019. The PRAT model uses inputs like profit margin of the company, retention rate of the company for the same year, asset turnover ratio and the financial leverage of the company. The growth rate suggested by the PRAT model was equal to 16.67 percent. The Compounded Annual Growth Rate (CAGR) of EPS of the company for the years 2017 to 2019 was the second growth method which was employed for the purpose of valuation and the rate suggested by it was around 8.03 percent. The PRAT model’s growth rate was seen to be a little high, thus it was given 40% weights in the growth rate computation. The company’s interim growth rate was 11.48 percent, and the growth rate was decreased in the transition period by employing interpolation techniques, eventually attaining a terminal growth rate of 2%, which is comparable to the US GDP growth rate. The following table represents the growth rate of the company:
|
Interim Growth Stage |
Transition Stage |
Terminal Growth |
||||
|
Growth (g) |
2019 |
2020 |
2021 |
2022 |
2023 |
2023 onwards |
|
12.13% |
12.13% |
12.13% |
7.07% |
4.53% |
2.00% |
Terminal Value – The terminal value reflects the company’s cash flow that occurs after the valuation period has ended. It is an important aspect of the company’s values since it includes the company’s long-term growth possibilities. The terminal value takes up the major portion and is given a major weight in calculation of the intrinsic value of the firm. The terminal value in this case was calculated using the Gordon growth model which divides the ultimate cash flow with the rate that is arrived at by deducting the required rate of return with the growth rate of the firm. The terminal value in this case was calculated as $111,809 and represents the value of the firm 2023 onwards.
Discount rate – The discount rate should appropriately represent the potential cost of investing in similar businesses’ projects for the investor. The WACC for the company represents the amount of return required by the equity shareholders and the debt holders of the company. There are two aspects of the WACC; the cost of equity and the cost of debt both of which are calculated using the financial data of the company.
Cost of equity – The cost of equity was calculated using the CAPM model of cost of equity estimation which have three components; the risk-free rate, market risk premium and the beta of the stock. The yield on 10-year treasury bonds issued by the US government was taken as the proxy for the risk-free rate. The 10-year average return on the S&P 500 index was taken as the proxy for market risk premium and the beta of the stock was taken from third party financial websites. Putting the inputs in the formula for CAPM, we got a cost of equity of around 16.89 percent.
Cost of debt – The cost of debt was estimated using the company’s interest costs for 2019 and the total debt for the same year. The company’s debt cost of debt was evaluated at 2.25 percent before taxes. The company’s tax rate was derived by dividing the company’s tax cost by the company’s earnings before tax for the year 2019. The cost of debt after taxes was determined to be 1.63 percent.
The book value of the company’s debt and the market value of the company’s equity for the same year were used to determine the weights of equity and debt. After accounting for all of the above factors, the WACC was calculated to be 14.59 percent.
The following table represents the discounted cash flows of the company for the period starting from 2020:
|
2020 |
2021 |
2022 |
2023 |
2024 |
Terminal Value |
|
|
DCF |
9967.82 |
11112.31 |
12388.21 |
13223.30 |
13801.22 |
14077.24 |
|
PV |
8698.65 |
8462.69 |
8233.12 |
7669.16 |
6985.18 |
111809.84 |
The intrinsic value per share of the was determined to be $91.15 based on the total number of shares outstanding, which was equal to 1666 million. The stock is now overpriced in comparison to its observed market value in 2019, and it should be sold.
Comparable company analysis is an equity valuation technique which takes into account the financial performance of comparable companies using multiples like EV/EBITDA and P/E ratios of the companies. If all other factors remain constant, firms with similar attributes should trade at similar multiples. It is quite simple to carry out, and data is readily available. If the marketplace is successfully pricing other firms’ securities, this procedure should produce an appropriate value range, but some other valuing methods, such as DCF, are based on a wide variety of assumptions. This factor adds to the broad adoption of this assessment method. Market analysts, investment bankers, sell-side academic researchers, and investment firms all hire them.
To conduct the analysis the first step was to choose appropriate comparable companies. The comparable companies chosen for the purpose of relative valuations are discussed below:
Netflix – Netflix provides consumers with a highly handy service that allows them to access a large variety of movies and TV episodes ‘anytime, anywhere.’ Customers can quickly explore Netflix’s collection and get a lot of content for their money. Netflix also provides a variety of high-quality and engaging original material to its subscribers. Just like Walt Disney, Netflix also operates in the media and entertainment industry and operates in multiple countries. The company is a large cap company with a positive financial performance which justifies the choice of the company as a comparable firm.
Comcast – Comcast is another American Multinational company operating in the telecommunications and the multimedia industry just like the company we are trying to value. Comcast is the biggest cable tv business in the United States, as well as the second biggest Internet company and the 4th biggest phone service company. The company, which is known for providing high-quality and dependable service, is occasionally subjected to unplanned service outages. The company’s financials match the financials of Walt Disney and also operates in different parts of the world.
Viacom – The company is also a multinational conglomerate company which has operations all around the world and operates in the media and communications industry. The company develops and buys content for television, the Internet, mobile devices, computer games, and other household gadgets. Viacom also produces, funds, and distribute films to theatres, Cds, broadcast, digital services, and other systems throughout the world. The nature of the business and the similarity in the financial performance of the company with the Walt Disney is the major reason behind selecting the company as a comparable firm.
For the purpose of estimating a valuation range of the stock price of Walt Disney, the multiples of EV/EBITDA and P/E ratio was used.
EV/EBITDA – Earnings before interest, taxes, depreciation, and amortisation are referred to as EBITDA and it offers a clear picture of the organization’s financial health. In EV/EBITDA, the impact of equities, preferred shares, bonds, and debentures is taken into account. The total of stock, preferred shares, bonds, and debentures is referred to as enterprise value (EV).
P/E ratio – The price to earnings ratio compares the value of a firm’s shares to the level of earnings generated by the company. When a business’s P/E ratio is high, it is viewed as a red signal by many investors since it suggests that the company is not earning enough to warrant its high valuation. On the other side, it might also signal the stock’s demand in terms of future possibilities.
To assess the intrinsic value of the company, the forward P/E ratio of all the companies was collected for the year 2021 to get the average forward P/E multiple. The average PE multiple was around 16.97 which was multiplied by the forward Earning Per Share of the company for the year 2021. The resulting intrinsic value per share of the company was equal to $103.11.
Similarly, the EV/EBIDTA multiple for the year 2021 was estimated using the consensus forecast of analysts and the average multiple was around 11.63. The forward enterprise value of the company was equal to $225,326 million which was converted into enterprise value per share equal to $135.25. The EV/EBITDA multiple was multiplied with the EV per share and the resulting intrinsic value was around $135.25.
All of the approaches were based on publicly accessible financial facts and estimations and were effective in calculating the stock’s intrinsic value. To determine the stock’s ultimate value, each technique was given identical weights, with each method receiving 33.33 percent of the total weights in the final value computations. The stock’s ultimate value was $109.84, which was close to the stock’s market price of $118 per share on November 9th of this year. Since, the intrinsic value of the stock is less than the observed market value, it is recommended to sell the stock.
Conclusion
The goal of this research is to do a Discounted Cash Flow study of Walt Disney, an American multinational entertainment firm, utilising financial data from 2017 to 2019. The DCF approach was used to calculate the stock’s intrinsic value for the year 2019. The Weighted Average Cost of Capital (WACC) was derived utilising company and market specific data in order to discount the business’s Free Cash Flows. In the report, the assumptions used in each calculation are stated in depth. The intrinsic value of the stock as suggested by the method of discounted cash flow after taking into consideration all the assumptions regarding growth rate and discount rate, was equal to $93.02. This intrinsic value was less than the market price observed of the stock on 9th of November 2019 hence it can be recommended based on the method that the stock must be sold. Another equity valuation approach is Comparable Company Analysis, which uses several valuation multiples such as EV/EBITDA and Price to Earnings Ratio to calculate the intrinsic value of a stock. The paper discusses the methodology and processes used to calculate the intrinsic value of Walt Disney’s shares. Netflix Inc, Viacom Inc, and Comcast Inc, all of which operate in the same industry as Walt Disney and have comparable financial performance, were picked for the comparable business valuation technique. The EV/EBITDA multiple and P/E multiple revealed that the intrinsic value was $103 and $135, respectively. According to the three methodologies that were given equal weights, the stock’s ultimate intrinsic value was $110, which was less than the market price of $118.
References
Carmichael, D.G., 2016. A cash flow view of real options. The Engineering Economist, 61(4), pp.265-288.
Dewi, I.A.M.C., Sari, M.M.R., Budiasih, I.G.A.N. and Suprasto, H.B., 2019. Free cash flow effect towards firm value. International research journal of management, IT and social sciences, 6(3), pp.108-116.
Espinoza, D., Morris, J., Baroud, H., Bisogno, M., Cifuentes, A., Gentzoglanis, A., Luccioni, L., Rojo, J. and Vahedifard, F., 2020. The role of traditional discounted cash flows in the tragedy of the horizon: Another inconvenient truth. Mitigation and Adaptation Strategies for Global Change, 25(4), pp.643-660.
Fernandez, P., 2019. Three residual income valuation methods and discounted cash flow valuation.
Keck, T., Levengood, E. and Longfield, A.L., 1998. Using discounted cash flow analysis in an international setting: a survey of issues in modeling the cost of capital. Journal of Applied Corporate Finance, 11(3), pp.82-99.
Mårtensson, D. and Oljemark, S., 2016. Evaluating comparable company valuation-how to derive at the right multiple.
Smith, L.D., 2002. Discounted cash flow analysis methodology and discount rates.
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