Question

I have to find the value of Urban Outfitters using the Discounted cash flow model (DCF) as well as the Residual operating income model (ROPI). How would I go about solving for this information?

Answer 1

DCF used to assess the value of the company. In this, we expect all future company free cash flows of a period of 5=10 years and the terminal value are discounted to the present value.Total of these amounts is then used to determine the enterprise value of the company, From such value Debt value will be removed to get the value for the company.

Steps in doing DCF:

1. Establishing the figures (Free Cash flows) for a defined period of time along with terminal year where we sell all the which we hold, Free cash flows are prepared using revenue statement (profit after tax) added back with Non-cash Expenditure.

2. Discounting the Free cash Flows @ required rate of return.The required rate of return is what the expected from such investment considering the risk.

3.Value of company = Aggregate of All Cashflows - Value of Debt.

4. Share value = Value of company/Shares outstanding.

A Project may be viable to a company if it produced positive cashflows but not to the shareholder. Residual method something different from operating Income. Operating is what we arrive from our books. Residual method is the cash that we have generated from multiple sources in the company after meeting all the corresponding costs, Taxes, Capital Expenditure and Cost of financing the project including equity.

In simple Free cash flows for the Year after meeting Capital Expenditure - Return to shareholders on Capital employed = Residual Income.

residual Income has more importance on Dividend Decisions. If the return from a project is more than what shareholders expect then no dividend will be paid, Amount will be invested in such project otherwise declare dividend so that shareholder can earn more than what project gives.

Steps in doing Residual Income Approach:

1. Value of the company = Book value of Assets (Today)+Residual Incomes discounted at Cost of equity.

2. If you can observe it is similar to the DCF model but here we calculate residual Income for a defined period and discounted Cost of Equity.

2. Share value = (Value of the company-Debt value)/Shares outstanding.