DCF valuation begins with forecasting of financial statements, this process is also known as financial modelling. Financial modelling requires assumptions of key performance drivers of the company. In the case Britannia industries we have used the following assumptions:
The first line of income statement is the revenue line. Revenues are product of units sold times price per unit (realization). Since there are three product lines, biscuits, bread and rusk and cakes, we need to monitor the units sold for all three products and their relevant prices. The rate of change for the revenue (sales growth) is also calculated and will be used as a proxy of the evaluation of sales in forecast period.
Next we calculate major raw material and other expenses and forecast their trend using the assumption of price growth of raw material in future and other operating cost related items.
Below is the projected income statement of Britannia industries. Earnings before Interest Tax Depreciation and Amortization (EBITDA) is used to indicate the ability of a company to service its debt and allows us to analyse the performance of its operations while eliminating all non-operating and non-recurring items such as depreciation, interest, taxes or any one time charge.
The EBITDA margin is helpful when analysing the growth of a company year over year because it reflects whether this growth is profitable and to what extent. Depreciation is recorded and the profit before tax is calculated after subtracting depreciation and interest expenses respectively from EBITDA.
Having finished with income statement, we need to work on the projection of the balance sheet. Sales normally influence the current asset and current liability account balances. As sales increase or decrease, the company will generally need to carry more or less inventory and will have a higher or lower account receivable balance respectively.
Debtors days, creditor days, inventory days are used in the process of forecast which gives us the sense of working capital requirement.
Assets are broken down into non- current assets and current assets. Non-current assets are divided into net fixed assets that is: – fixed assets purchase price (gross fixed assets) + subsequent additions to existing assets – accumulated depreciation. And other non-current assets include intangible assets and investment in subsidiaries.
As depreciation expense has already been forecasted till year 2021, accumulated depreciation for year 2018 = accumulated depreciation 2017 + depreciation 2018 = Rs. 6528mn+ Rs. 1243mn = Rs. 7770mn. In the same way others are also calculated. The accumulated depreciation is a credit account and is always subtracted from gross fixed assets in order to give net fixed assets.
Next to forecast account receivable we have forecasted sales for the year 2018 to 2021 and taken the assumptions of debtor days.
Account receivable 2018 = sales of 2018 * debtor days 2018/365 = Rs 98,515mn * 5/365 = Rs 1,347mn. And in the same way rest of the year’s calculation is done.
In similar ways inventories and payables are calculated by multiplying cost of goods sold for the respective year and assumed days inventory and payable divided by 365 days to get inventory and payable value for the years.
Modelling of cash flow statement is done using 2 consecutive year balance sheet and the current income statement. After the additions and subtraction in the statement the net cash balance is added back to the balance sheet for the next year. The forecasted working capital and capex is used in projecting cash flow for future period and help us derive discounted cash flow valuation.
To apply DCF, we need at least 5 years of data in projection. However we have 4 years, we use a quick and dirty approach to forecast for the fifth year 2022.
We can forecast EBIT, depreciation and working capital figures as a percentage of sales. We can keep capital expenditure constant as that of year 2021 and so is the tax rate for the year.
The sales figure for 2022E is estimated using linear regression methodology in excel.
The weighted average cost of capital is calculated by taking weight of debt proportion multiplied by cost of debt and weight of equity portion multiplied by cost of equity.
Cost of Equity = Risk Free Rate + Beta x (Expected Market Return – Risk Free Rate)
We have calculated beta by running slope function in excel with historical return data of Britannia industries and market index nifty which come to value of 0.70. Risk free is taken as long term bond rate of 6.4% and expected return on market as 15.6% which is the long term historical average of Nifty index. Cost of debt is taken at 11%.
Terminal value is arrived by taking steady growth rate of 8%.
The fair value of Britannia industries calculated according to DCF valuation comes to Rs. 4,811.