Firm valuation the practical case of traphaco joint stock company

FPT UNIVERSITY
Bachelor of Business Administration Thesis

Firm valuation: The Practical case of
Traphaco Joint stock company
SUPERVISOR: Lê Mạnh Đức

GROUP MEMBERS:
Nguyễn Thanh An

SB02062

Lê Văn Thi

SB02523

Đỗ Văn Đạt

SB02039

Nguyễn Tuấn Hưng

SB02002

Nguyễn Hữu Nguyệt Vy

HS130278

Hoa Lac, May 2020

Table of Contents
Table of Contents .............................................................................................................. 1
LIST OF ABBREVIATION .............................................................................................. 4
LIST OF TABLES ............................................................................................................ 6
LIST OF FIGURES ........................................................................................................... 8
1.

Chapter 1: Introduction............................................................................................... 9
1.1.

2.

Background ......................................................................................................... 9

1.1.1.

Topic background ........................................................................................ 9

1.1.2.

Company background ................................................................................ 10

1.2.

Research objective ............................................................................................ 11

1.3.

Research question.............................................................................................. 11

1.4.

Research Scope ................................................................................................. 11

1.5.

Overview methodology and data ....................................................................... 11

1.6.

Thesis structure ................................................................................................. 12

1.7.

Conclusion ........................................................................................................ 12

Chapter 2: Literature review ..................................................................................... 13
2.1.

Firm valuation ................................................................................................... 13

2.1.1.

Definition ................................................................................................... 13

2.1.2.

Reason and Purpose of firm valuation ........................................................ 13

2.2.

Valuation Approaches ....................................................................................... 14

2.2.1.

Asset Approach .......................................................................................... 14

2.2.2.

Market approach ........................................................................................ 15

2.2.3.

Income approach ........................................................................................ 15

2.3.

The Discounted Cash Flow model ..................................................................... 16

2.3.1.

Concept ...................................................................................................... 16

2.3.2.

Reason for choosing the DCF model .......................................................... 17

2.3.3.

Simple: Book value .................................................................................... 17

2.3.4.

Differences in book value and market value ............................................... 18

2.3.5.

Discounted Cash Flow method ................................................................... 18

2.3.6.

Advantages and Disadvantages .................................................................. 22

2.4.

Free Cash Flow to Firm ..................................................................................... 23

2.4.1.

Definition ................................................................................................... 23
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2.4.2.

Meaning of FCFF ....................................................................................... 23

2.4.3.

Calculation of FCFF ................................................................................... 24

2.4.4.

Some notes for Firm Valuation after calculating the FCFF ......................... 26

2.5.

2.5.1.

Definition ................................................................................................... 26

2.5.2.

Popular Multiples used in Relative Valuation ............................................. 27

2.5.3.

Relative Valuation Method ......................................................................... 28

2.5.4.

Advantages and Disadvantages .................................................................. 29

2.6.
3.

Conclusion ........................................................................................................ 29

Chapter 3: Methodology ........................................................................................... 30
3.1.

Introduction....................................................................................................... 30

3.2.

Methodology ..................................................................................................... 30

3.2.1.

Research Philosophy .................................................................................. 30

3.2.2.

Research Approach .................................................................................... 30

3.2.3.

Research Method........................................................................................ 31

3.3.

Data Collection Method .................................................................................... 31

3.3.1.

Sampling .................................................................................................... 32

3.3.2.

Primary Data .............................................................................................. 32

3.3.3.

Secondary Data .......................................................................................... 32

3.4.

4.

Relative Valuation ............................................................................................. 26

Data Analysis Method ....................................................................................... 33

3.4.1.

Qualitative Analysis ................................................................................... 33

3.4.2.

Quantitative Analysis ................................................................................. 34

3.5.

Research Limitation .......................................................................................... 34

3.6.

Ethics Consideration ......................................................................................... 34

3.7.

Conclusion ........................................................................................................ 35

Chapter 4: Findings and Analysis ............................................................................. 36
4.1.

Industry Analysis .............................................................................................. 36

4.1.1.

The overall pharmaceutical industry in the World....................................... 36

4.1.2.

The overall pharmaceutical industry in Vietnam ......................................... 36

4.1.3.

Five Forces analysis of the industry ............................................................ 39

4.2.

Company Analysis ............................................................................................ 44

4.2.1.

Traphaco’s Qualitative Analysis ................................................................. 44

4.2.2.

Financial Statement Analysis ..................................................................... 48

4.3.

Firm Valuation .................................................................................................. 63

4.3.1.

Weighted Average Cost of Capital ............................................................. 63
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5.

6.

4.3.2.

Firm Valuation: Method 1 .......................................................................... 68

4.3.3.

Method 2: Pro Forma ................................................................................. 76

4.3.4.

Relative Valuation...................................................................................... 89

Chapter 5: Conclusion and Recommendation ........................................................... 91
5.1.

Introduction....................................................................................................... 91

5.2.

Summary of findings and analysis ..................................................................... 91

5.3.

Recommendation .............................................................................................. 92

5.4.

Research limitation............................................................................................ 93

References................................................................................................................ 94

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LIST OF ABBREVIATION
USD

United States dollar

DBD

Binh Dinh Pharmaceutical and Medical Equipment JSC

BV

Book value

CAPEX

Capital Expenditure

CCC

Cash conversion cycle

COGS

Cost of good sold

DPO

Days payable outstanding

DSI

Days sales in inventory

DSO

Days sales outstanding

DHG

DHG Pharmaceutical Joint Stock Company

DCF

Discounted cash flow

DMC

Domesco Medical Import-Export Joint Stock Corporation

EPS

Earning per share

EBIT

Earnings Before Interest and Taxes

ERP

Enterprise Resource Planning

EV

Enterprise value

ETC

Ethical drugs

EVFTA

European-Vietnam Free Trade Agreement

FPT

FPT Corporation

FCF

Free cash flow

FCFF

Free cash flow to the firm

GLP

Good Laboratory Practice

GMP

Good Manufacturing Practice

GPP

Good Pharmacy Practices

GSP

Good Storage Practices

GDP

Gross domestic product

MWG

Mobile World Investment Corporation

OPC

OPC Pharmaceutical Joint Stock Company

OTC

Over the counter

PS

Price/Sales ratio

PB

Price to book ratio
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PE

Price to earnings ratio

PP&E

Property, Plant, and Equipment

PME

Pymepharco Joint Stock Company

ROE

Return on equity

ROS

Return on sale

SARS-CoV2

Severe acute respiratory syndrome coronavirus 2

TRA

Traphaco Joint Stock Company

US

United States

VND

Vietnam dong

WACC

Weighted Average Cost of Capital

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LIST OF TABLES
Table 4-1: Pharmaceutical Industry's five-force analysis .................................................. 44
Table 4-2: Traphaco's SWOT Analysis ............................................................................ 47
Table 4-3: Current Assets' Structure ................................................................................ 48
Table 4-4: Cash and Cash Equivalents of Pharmaceutical Companies .............................. 50
Table 4-5: Long-term assets structure .............................................................................. 50
Table 4-6: Liabilities Structure ........................................................................................ 51
Table 4-7: Traphaco's Capital Structure ........................................................................... 52
Table 4-8: Traphaco's Liquidity Ratios ............................................................................ 56
Table 4-9: Inventory Turnover and DSI ........................................................................... 57
Table 4-10: Account Receivable Turnover and DSO ....................................................... 57
Table 4-11: Account Payable Turnover and DPO ............................................................ 58
Table 4-12: Cash Conversion Cycle................................................................................. 58
Table 4-13: Fixed assets Turnover ................................................................................... 59
Table 4-14: Gross profit margin of some pharmaceutical companies ............................... 60
Table 4-15: Net profit margin of some pharmaceutical companies ................................... 60
Table 4-16: Z-Score Model Result ................................................................................... 62
Table 4-17:TRA’s EBIT from 2015 to 2019 .................................................................... 68
Table 4-18: TRA’s adjusted EBIT from 2015 to 2019 ..................................................... 69
Table 4-19: TRA’s ROC from 2015 to 2019 .................................................................... 69

Table 4-20: TRA’s CAPEX from 2015 to 2019 ............................................................... 70
Table 4-21: TRA’s depreciation from 2015 to 2019 ......................................................... 70
Table 4-22: TRA’s net working capital from 2015 to 2019 .............................................. 71
Table 4-23: TRA’s reinvestment amount from 2015 to 2019 ........................................... 71
Table 4-24: TRA’s reinvestment rate from 2015 to 2019 ................................................. 71
Table 4-25: Forecast DCF for 2020 ................................................................................. 72
Table 4-26: Expected adjusted EBIT, FCFF, and DCF of TRA from 2021 to 2023 .......... 73
Table 4-27: Expected adjusted EBIT, FCFF, and DCF of TRA from 2024 to 2025 .......... 74
Table 4-28: Expected growth rate, reinvestment rate and FCFF of TRA in the stable period
........................................................................................................................................ 74
Table 4-29: Calculating Firm's Value (million VND) and Price per share (VND) ............ 75
Table 4-30: Sensitivity Analysis follows the change of EBIT growth rate ........................ 76
Table 4-31: Rewritten Income Statement (million VND) ................................................. 79
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Table 4-32: Historical Sales growth ................................................................................. 80
Table 4-33: Sales growth projection ................................................................................ 81
Table 4-34: Historical operating costs/sales and projection .............................................. 81
Table 4-35: Historical working capital/sales and projection ............................................. 82
Table 4-36: Historical net assets/sales and projection....................................................... 82
Table 4-37: Historical depreciation and projection ........................................................... 83
Table 4-38: Historical tax rate and projection .................................................................. 83
Table 4-39: Dividend per share projection ....................................................................... 84
Table 4-40: Historical Cash/Current Assets and projection .............................................. 84
Table 4-41: Forecasted Income Statement in Pro Forma Model ....................................... 85
Table 4-42: Forecasted Balance Sheet in Pro Forma Model ............................................. 86
Table 4-43: Pro Forma Valuation .................................................................................... 88

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LIST OF FIGURES
Figure 4-1: Current Assets Growth Chart......................................................................... 49
Figure 4-2: Long-term Assets Growth Chart .................................................................... 51
Figure 4-3: Liabilities Growth Chart ................................................................................ 52
Figure 4-4: Equity Growth Chart ..................................................................................... 53
Figure 4-5: Sales Growth Chart ....................................................................................... 54
Figure 4-6: Cash Flow Chart ........................................................................................... 55
Figure 4-7: DuPont Analysis ........................................................................................... 61

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1. Chapter 1: Introduction
1.1. Background
1.1.1. Topic background
The valuation of the company is essential in the current market economy. This price, if it
was analyzed and evaluated details and accurately, reflects the financial health of the
company. This helps not only internal managers to control the current situation of their
company, but also lenders and investors to consider loans and investments in that
company. Besides, in merger and acquisition or bankruptcy cases, firm valuation plays an
irreplaceable role in identifying a reasonable price for those cases. Furthermore, with the
development of stock markets all around the world, firm valuation helps personal investors
make the right decision of their investment. Last but not least, from analysis to estimate
firm valuation, economists could have an overall judgment about the current situation of
market and economy.
In the world, pricing needs are seen as the norm of a market economy. Those needs allow
economists to see the real situation of the company, and take place in different company
models. In Vietnam, enterprise valuation is mainly valuing equitized companies and SOEs.

In production and business activities, firms must always focus on increasing their value
because this will create favorable conditions for them to increase profit scale, improve
reputation, and competitive advantages in the market.
However, the valuation of the business is challenging and complicated for many different
reasons, especially in an emerging market like Vietnam. Firstly, the term of firm valuation
is still new, so there is no agreement on the concept and valuation method for enterprises.
Different methods of valuation, or even the same method with different perspectives, will
bring different results. Therefore, there is no model for a perfectly accurate valuing model.
Besides, the lack of historical information about the financial position of the business is
also a concern for valuation. Vietnam has many new-formed enterprises, and many stateowned enterprises are in the stage of restructuring to equitize. As a result, there are many
inaccuracies about the economic indicators needs for declaration.
The market has always grown and attracted both domestic and foreign investors. With the
development of living standards and its necessity, pharmaceutical turns out to be a
potential industry for investors due to rapid growth recently. The worldwide
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pharmaceutical market is worth up to 1.2 trillion dollars and forecasts a 3-6% annual
growth by the IQIVIA Research Institute (The Global Use of Medicine in 2019 and
Outlook to 2023, 2019). In Vietnam, demands for medical products are growing fast due to
people’s high-awareness and increasing income. According to BMI Research, in 2018, the
market size of Vietnam's pharmaceutical industry reached $5.9 billion, increased 11.5%
over the previous year (Forum, 2018). Also, Vietnam ranked second in Southeast Asia and
among the group with the highest pharmaceutical industry growth. Therefore, investing in
a pharmaceutical enterprise can be considered as a beneficial investment for investors at
the moment.

1.1.2. Company background
Traphaco Pharmaceutical Joint Stock Company (stock code: TRA) was established on
November 28, 1972. This company specializes in trading, researching, and developing

pharmaceutical products, chemicals, functional food, cosmetic products, and other medical
equipment and supplies. At the moment, their products are distributed in both OTC, ETC1
channels nationwide. They are also planning to export their products in the near future.
Headquarter: No. 75 Yen Ninh Street, Ba Dinh District, Hanoi.
Chairman of the Board, General Director: Vu Thi Thuan.
Charter capital: 414,536,730,000 VND (TRA: CTCP Traphaco - TRAPHACO |
VietstockFinance, 2020).
Email:
Website:
In the pharmaceutical industry, Traphaco is one of the largest companies with a vision to
become a strong economic group in the field of health care and protection in 2020 and
carry out a sustainable development plan. Traphaco’s missions include devoting to society
products and services of the age and traditional values to improve the quality of life,
satisfying customer needs, creating meaningful jobs and promotion opportunities for
employees, and commits to bringing added value to investors. With that vision and
mission, Traphaco has created great trust from customers and investors. Therefore, during

1

OTC and ETC are abbriviations for over the counter and ethical drugs, respectively

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48 years of establishment and development, Traphaco has achieved many exemplary
achievements.
Up to now, in the system of Traphaco, there are 28 branches in provinces and cities across
the country, a distribution company, four subsidiaries and more than 27.000 customers
nationwide.

1.2. Research objective
The main objective of this thesis is to identify an appropriate price for Traphaco based on
knowledge at university. The application of valuation models such as discounted cash flow
(DCF) model and relative valuation multiples to this thesis will help to evaluate fairly
accurately the value of Traphaco. After this, recommendations for Traphaco managers and
investors will be made.

1.3. Research question
This research must answer the following questions comprehensively to complete those
objectives above:
Question 1:What is the best method to evaluate Traphaco?
Question 2: What are the recommendations for managers, company planners, and investors
to improve the company's negative situation and thereby, help investors more secure in the
future?

1.4. Research Scope
This thesis examines Traphaco's financial valuation based on consolidated financial
statements and annual reports from 2014 to 2019.

1.5. Overview methodology and data
The research methods of this thesis include both qualitative and quantitative analysis,
which are the two optimal analytical ones used for researching. In particular, the
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qualitative analysis aims to collect information, the objective situation of the domestic and
foreign economies. From that, a general trend to forecast the development of the company
will be provided. On the other side, the quantitative analysis considers accurate and precise
figures from the company's financial statements as a guide to calculating the related
financial indicators. Thereby, economists could have the most accurate assessment of the

financial situation of the company. In terms of data, this thesis collects data from
secondary sources.

1.6. Thesis structure
This thesis is divided into five main chapters, as follows:
Chapter 1: Introduction: Brief presentation of the topic overview, Traphaco company,
making assumptions, and presenting the basic structure of the thesis.
Chapter 2: Literature review: Presentation of theories and methods for Traphaco
valuation.
Chapter 3: Methodology: Discussion of the methods of analysis and data collection used
in this thesis.
Chapter 4: Analysis and Findings: Declaration of industry analysis, company analysis,
and construction of Traphaco valuation work.
Chapter 5: Conclusion: Briefly summary of all the above chapters, giving
recommendations to Traphaco and investors.

1.7. Conclusion
In a word, chapter 1 gives readers an overview of the topic this group is working on, helps
readers take the first look at Traphaco, and gradually familiarizes themselves with the
methods used in the article. This project introduces the knowledge learned about valuing a
company, and thereby evaluating the performance, measuring the value of any business.

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2. Chapter 2: Literature review
2.1. Firm valuation
2.1.1. Definition
A firm’s value (FV) is the market value of the company’s productive or operational assets
that reflects the value of a business. According to Investment Valuation (2012) of

Damodaran, valuation is the analytical process of determining the current worth of an asset
or a company when investigators decide and estimate the future value to discover out how
much it worth.
Similar to an asset, a firm’s value can be estimated based on either market value or book
value. However, generally, this term refers to the market value of a company. When we
conduct to estimate a company’s valuation, industry analysis, corporate research, valuation
methodology, collection and analysis of market value are first and foremost components to
find the intrinsic value of the common stock (Damodaran, 2012). On the other side, to
identify whether the company is undervalued or overvalued according to market mood,
price multiples such as P/E, P/B, P/S are recommended to use.
To conclude, valuation is the process of determining the fair market value of assets at a
given time to serve a specific purpose, consider all market economic factors and those
assets’ characteristics.

2.1.2. Reason and Purpose of firm valuation
Valuations increasingly play an essential role in today's market economy because it
provides an overview of a firm’s value. Currently, company valuation is often used by
businesses and investors because it can serve a variety of purposes. The valuation will
provide sufficient information that affects the company's operations activities, helping
identify the fair price for the business, especially when having merger and acquisition or
bankruptcy event. Valuation also establishes a basis for exchanging this property with
other assets, related to the interests of shareholders. Additionally, valuation plays a vital
role in the investment and development of businesses. It is an essential basis for companies
to attract capital from financial investors as well as support credit for businesses. Banks
and lenders will assess the potential of firms from valuation, thereby making investment
decisions for the company.
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2.2. Valuation Approaches

Research and selection of the "Valuation Approach" is an indispensable step in the
valuation process of a company on the market. There are three approaches to determine
business value: the market approach, the cost approach, and the income approach.

2.2.1. Asset Approach
The asset approach is based on determining the net assets of the company. Net assets value
is determined by total assets minus total liabilities. The basic formula of the asset approach
(Julie Young, 2019) is as follows:
Company value = Assets – Liabilities
2.2.1.1 Net Asset Method
The net asset method is a business valuation method that adjusted the expressed
estimations of an organization's advantages and liabilities to mirror their assessed current
reasonable market esteems better. The adjustment of the balance sheet is made when the
market value of assets and present debt value had been determined. And then, the equity
value of the company is determined based on the difference between the market value of
the assets and the current debt value.

2.2.1.2 Liquidation value method
The liquidation value method relies on the balance sheet, particularly the difference in the
proceeds from the sale of assets and the liquidation costs determined through the
evaluation of values from the appraisers.
Determination of liquidation value through stages: Property sales calendar, calculate the
market value of assets, calculate liquidation costs, calculate corporate debt, operating profit
during the liquidation period, and estimate the price of assets until the date of valuation.

2.2.1.3 Advantages and Disadvantages
The advantages of the cost approach are easy to evaluate a primary business and operate
when the asset value is determined on the market. Moreover, they work well for companies
that own reasonable balance sheets.
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However, there are some drawbacks to using the cost approach. For diversified
corporations, it is difficult to determine the value of assets because market value is
different from book value. Furthermore, this approach does not occupy intangible assets
and inflation issues of the valued enterprises in the host countries.

2.2.2. Market approach
The market approach, as known as relative valuation, is also an efficient approach when
estimating a firm’s value. This approach appraises present the value of the business based
on comparison with other “relative” companies, which might be ones in the same industry,
have the same capital structure. This method uses some price multiples such as EV to
EBITDA, price to earnings ratio, price to book value, and price to sales ratio to evaluate a
firm (Tim Smith, 2019).
The relative Valuation method is considered as an essential part of firm valuation so that it
will be explicitly presented later in this thesis.

2.2.3. Income approach
Income method is a popular method, which is widely applied by appraisers and experts
because of its pragmatic (Marshall Hargrave, 2019). This approach discounts the expected
future economic benefits, usually of cash flow and present value. Basically, this approach
is based on the potential of future economic development, not the current book value of the
company, so it is suitable for stable businesses. The results of this approach allow the
company to identify the fundamental issues that hinder its development and thereby offer
the best solution. There are two methods when using the income approach, which are
capitalization cash flow method and the discounted cash flow method.

2.2.3.1 Capitalization Cash Flow method
The capitalization cash flow method is a more straightforward and generally utilized
technique. This method determines the company's value by calculating the net present

value (NPV) of the expected future cash flow. The net current value is determined by
taking future earnings to divide the discount at the capitalization rate. This method is

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applicable in case the enterprise operates continuously and continues to develop in the
future.
This method has the advantage of simple, easy to use, based on a financial basis to
calculate, so the accuracy is almost absolute. However, this method has many
disadvantages. The determination of the correct capitalization rate is complicated because
it depends on the business and production industries that each business is operating. At the
same time, assuming that enterprises have permanent, stable income is challenging to
realize in the context of intense competition in the current market.

2.2.3.2 Discounted Cash Flow
Discounted cash flows (DCF) is the valuation methods used to estimate the value of an
investment based on its future cash flow (Jame Chen and Julius Mansa, 2020). This is the
most common method today and also the technique applied in the valuation of Traphaco
Company.
There are two main models in the discounted cash flow method: Free cash flow to the firm
(FCFF), Free cash flow to equity (FCFE).
Because of its popularity and complex, the Discounted Cash Flow Method will be
discussed in the following sections.

2.3. The Discounted Cash Flow model
2.3.1. Concept
The methods of estimate the price of a firm based on Discounted Cash Flows built on the
value that the enterprise's price depends on the expected income that it can create in the
future as risks of that anticipated income.

According to these methods, the value of the enterprise will be estimated by discounting
the expected cash flow of business with an appropriate discount rate. It includes the risk
factor of this cash flow. Generally, the DCF model is derived from the current process of
the expected cash flow as follows:

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DCF is the present value of all future cash flows at the discount rate
CF is the cash flow or future payment
r is the discount rate or the interest rate in which the business would be charged to
obtain capital.
2.3.2. Reason for choosing the DCF model
Currently, corporate valuation is a factor that has complicated views, diverse approaches,
and cause controversy. Different business valuation methods will have different results
based on different assumptions. First of all, the focus of research has changed from stock
valuation to corporate valuation, that expression is the increasing use of valuation models
in the purchase process, consolidation, and restructuring of enterprises. Besides, more and
more new businesses are being established, requiring researchers to pay more attention to
estimation measures. As a result, the characteristics of emerging markets and growing
businesses require researchers to reconsider their reliance on the figures in the financial
statements which they have used for the valuation process.
Additionally, the importance of an enterprise strategy to its value is increasing.
Understanding why a business earns superior income in the top position and why these
high incomes can be achieved in a competitive landscape is a prerequisite for a proper
appraisal process.
The above research of Aswath Damodaran is a good suggestion for efforts to find solutions
to improve existing practices when applying the DCF model in Vietnam because most of
the small and medium enterprises in our country also have the same characteristics as what
Damodaran mentioned. Hence that all why we decide on choosing the DCF model.

2.3.3. Simple: Book value
Book value is understood as the value of an enterprise recorded in "books" or financial
statements. In this case, the book value is calculated based on balance sheet accounting,
and it differs from the total assets and total liabilities.
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2.3.4. Differences in book value and market value
Simple book value means a firm's interest in its accounts, also called accounting value,
which is the value once the auditors of a company have accounted for the assets and
liabilities. Whether or not the carrying number is regarded as an accurate measure of the
firm's worth is calculated by investors in the stock market-who buy and sell stocks. The
reality of the financial markets, we can find that the book value and the market value of
variables in different periods. The difference between market value and book value
depends on a variety of factors such as the company's business line, the asset and liability
situation, and that company's unique characteristics. There are three cases following the
fundamental relationship between book value and market value.
•

Case 1: Book value is higher than the market value

The financial market values the company for less than its stated value or net value.
Usually, it is because the market has lost confidence in the company's ability to generate
future profits and cash flow. Investors often prefer to search for value companies like this
and hope that the market's assessment of the company is wrong. In short, the market is
giving investors an excellent opportunity to buy a business with lower prices to its real
value.
•

Case 2: The market value is higher than the book value

The company's market value at a higher level depending on the manufacturing capacity to
benefit from the company's assets. Nearly all the regularly profited businesses would have
a more significant market value than the book value.
•

Case 3: The Book value equals the market value

In this case, the investor sees no valid reason to believe the company is worth or is less
than what the balance sheet records.

2.3.5. Discounted Cash Flow method
As mentioned above, the Discounted Cash Flow Method is considered as the most used
method when evaluating a firm. As the name of this method, a firm’s valuation will be
measured by estimating the Cash Flow and an appropriate rate to discount. Enterprise
Value is defined as the value of operating assets, which directly produce the company’s
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revenue (Benninga, 2014). Therefore, when using the DCF methods, investors and analysts
will estimate the Free Cash Flow created by those operating assets only. Also, the
appropriate discount rate here would be the Weighted Average Cost of Capital (WACC
hereafter) of the company so that the present value of those cash flows will be calculated.
Therefore, the Enterprise Value of the company will be identified according to this formula
as follow
∞

𝐸𝑉 = ∑
𝑡=1

𝐹𝐶𝐹𝑡
(1 + 𝑊𝐴𝐶𝐶)𝑡

Where
EV is the Enterprise Value, as known as the value of operating assets.
FCFt is the Free Cash Flow to the firm at time t
WACC is the Weighted Average Cost of Capital of the company

2.3.5.1 Weighted Average Cost of Capital
Weighted Average Cost of Capital (WACC) is a crucial part when estimating a firm’s
valuation. WACC is defined as the cost of capital of the company in which every category
of the firm’s capital is proportionately weighted. Therefore, all sources of capital, such as
debt, common stocks, preferred stocks, bonds, will be included when calculating WACC.
In the DCF Model, the WACC is considered as the discount rate to estimate the present
value of FCF from the operating activities. The formula of WACC is
𝑊𝐴𝐶𝐶 =

𝐸
𝐷
∗ 𝑅𝐸 +
∗ 𝑅𝐷 ∗ (1 − 𝑇𝑐 )
𝐷+𝐸
𝐷+𝐸

Where
E is the value of the Equity of the firm
D is the amount of Debt of the firm
Re is the cost of equity of the firm
Rd is the cost of debt of the firm

Tc is the current corporate tax rate that the firm pays
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As seen from the formula above, to calculate the WACC of a firm, investors and analysts
must calculate the cost of debt, cost of equity, and weigh their proportion carefully.
The cost of debt is calculated based on the amount of debt and the interest of those debts.
The source of debts here could be financial debts in the short and long term, issued bonds,
and others. The interest rate is identified based on the borrowing contract and coupon rate
on the bond. Generally, the cost of debt is the quotient of interest expense and the average
amount of debt. Also, debts could create a tax shield for the company, so the tax rate
should be calculated for the WACC.
On the other side, the cost of equity is estimated based on the required rate return of
investors on the equity of the company. Typically, the cost of equity is calculated based on
the Capital Asset Pricing Model, which estimates the correlation of that company’s stock
price and an index on the stock market. There are two standard methods to calculate the
cost of capital, which are direct and indirect ones. The direct method to identify 𝑅𝐸 is
based on figures of the market that the company is operating. This method is often used for
a mature market such as the United States or Europe. For emerging markets like Vietnam
or Southeast Asia where the stock market is not entirely efficient, investors, especially
foreign ones, prefer to use the indirect market, which transforms the US or European
figures to apply for Vietnamese companies and consider some risk.
The details of estimate those figures will be presented in the latter part of this thesis.

2.3.5.2 Free Cash Flow
Free Cash Flow (FCF hereafter) is a vital part of estimating a company’s value. Cash Flow
is the inflows and outflows of the cash for the firm’s business. Those might be operating
activities, investing activities, or financial activities. However, because the DCF Model
tends to estimate the valuation of operating assets, the word “free” means that they care
about only operating activities. The investing and financial ones are “free” in the

calculation of this model. The value of other types of assets will be added back after the
calculation of the operating assets.
There are several ways to calculate the Free Cash Flow of the operating activities, but the
most popular one is to start from the EBIT (Earnings Before Interest and Taxes). The
specific calculation steps will be as followed
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Free Cash Flow Based on the EBIT (earnings before interest and taxes)
EBIT
= + Depreciation and other non-cash expense
= - Increase in Operating Current Assets

The sum -ΔCA + ΔCL is the change in

= + Increase in Operating Current Liabilities

the firm's net working capital ΔNWC

= - Increase in Fixed Assets at cost (CAPEX)
(Source: Benninga, S., 2014. Financial Modeling. 4th ed. p.62.)
In reality, when using the Free Cash Flow Model, investors and analysts might consider
some types of FCF. To whom might concern how much cash the firm receives to generate
for both owners and creditors, Free Cash Flow to the Firm (FCFF hereafter) will be
considered. The appropriate discount rate for this approach is the weighted average cost of
capital (as known as the WACC). On the other hand, many investors might pay attention to
the cash generates for investors only, after subtracting all debts. In this case, Free Cash
Flow to the Equity (FCFE hereafter) would be preferred, and the appropriate discount rate
here is the cost of capital only.
Additionally, to estimate the FCF of a firm for the following years, investors and analysts

tend to calculate the growth rate of that FCF. This growth rate based on the reinvestment
rate of that firm and the return on the capital ratio. Another way to estimate the Future Free
Cash Flow is to give some assumptions related to the financial figures of the company.
From those, a new financial statement will be created, and the free cash flow will be
calculated directly. This method is called the pro forma model. For more details, readers
could take a look at Financial Modeling by Simon Benninga, the first part: Corporate
Finance and Valuation.
However, on identifying the present value of those future free cash flows, there is a
problem that people cannot approximate those figures every year forever. Therefore, the
solution is that the company will be assumed to grow stably forever with a fixed growth
rate g. The value of a company with a stable growth rate in the future is called Terminal
Value.

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2.3.5.3 Terminal Value
As mentioned above, the Terminal Value is the value of a company that has a fixed growth
rate permanently.
𝑇𝑒𝑟𝑚𝑖𝑛𝑎𝑙 𝑉𝑎𝑙𝑢𝑒 =

𝐹𝐶𝐹𝑡 ∗ (1 + 𝑔)
𝑊𝐴𝐶𝐶 − 𝑔

In which
FCFt is the free cash flow of the firm at the beginning of the stable growth stage
g is the steady growth rate of the company
WACC is the weighted cost of capital of the firm.
Practically, analysts often assume that the FCF will develop at a specific rate in a period.
After that, the firm will grow stably at a long-term growth rate. Therefore, the Valuation of

the Firm Formula can be rewritten as followed:
𝐹𝑖𝑟𝑚 𝑣𝑎𝑙𝑢𝑒 =

𝐹𝐶𝐹0 × (1 + 𝑔1 ) 𝐹𝐶𝐹1 × (1 + 𝑔2 )
𝐹𝐶𝐹𝑛−1 × (1 + 𝑔𝑛 )
+
+⋯+
2
(1 + 𝑊𝐴𝐶𝐶 )𝑛
(1 + 𝑊𝐴𝐶𝐶)
(1 + 𝑊𝐴𝐶𝐶)

+

𝐹𝐶𝐹𝑛 × (1 + 𝑔)
(𝑊𝐴𝐶𝐶 − 𝑔)(1 + 𝑊𝐴𝐶𝐶)𝑛

In this formula
g1, g2,…, gn are specific growth rate from year 1 to year n
g is the long-term stable growth rate
FCF1, FCF2,…, FCFn are Free Cash Flow to the firm from year 1 to year n
WACC is the weighted cost of capital of the firm
2.3.6. Advantages and Disadvantages2
As a matter of fact, the DCF Model is used widely because it has some advantages as
follows. This model could estimate the intrinsic value of the corporation and needs to be
done extremely carefully with appropriate assumptions. As a result, the DCF Model would
give information about the middle and long-term investment opportunities for investors.
2

Source: Stephen, E., n.d. Discounted Cash Flow Business Valuation: Advantages And Pitfalls. [online]

Firmex Resources.

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Besides, the investment plans of the firm would be judged carefully before choosing. Also,
in practical M&A cases, the DCF Model turns out to be one of the most suitable methods
to evaluate the price of those cases. Lastly, the DCF Model could give the board of
directors an overview of the firm’s current business activities so that they can make the
right decision for the following period.
In contrast, the DCF Model also has some disadvantages that need to be considered
carefully. As mentioned above, because this method requires many assumptions about the
company’s performance, different opinions would lead to different estimations. Therefore,
the risk of error in the DCF Model is pretty high. With the same methods, there might not
be the same results. Additionally, the DCF Model focuses on the intrinsic value of the
company, so it does not look at the relative valuation of competitors. That is why in this
thesis, both DCF Model and the Relative Valuation will be estimated carefully.

2.4. Free Cash Flow to Firm
2.4.1. Definition
Free cash flow to the firm is a cash flow generated from operating activities of investors,
including creditors and owners, after subtracting any outlays of depreciation expenses,
taxes. It is an excellent driver to compare and analyze a firm’s financial health. In this
method, the discounted rate will be the WACC of the company because it relates to the
cash flow that belongs to both owners and lenders.
∞

𝐸𝑉 = ∑
𝑡=1

𝐹𝐶𝐹𝐹𝑡
(1 + 𝑊𝐴𝐶𝐶)𝑡

2.4.2. Meaning of FCFF
Based on free cash flow to the firm, the firm value of both creditors and owners is
identified by discounted cash flow. Therefore, if there is a need to calculate the value of the
owner, debt will be subtracted. In this model, as the cash flow is to the owners and
creditors, the appropriate discount rate here should be the WACC.
The determination of FCFF is also used to adjust the financial policies of the firm. For
example, if FCFF < 0, the operating cash flow generated is not sufficient to finance the
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need for new investments in fixed assets, and the net working capital is increased. At the
time, this deficit will need to be funded by raising new capital or readjust the capital
investment policy of the firm to reduce the investment demand. In contrast, if FCFF > 0,
the cash flow generated satisfies the investment demand but is still redundant, so the firm
will adjust the dividend policy towards increasing.

2.4.3. Calculation of FCFF
There are three approaches to calculate the FCFF, which is from the Cash Flow Statement,
the Earning before Interest and Taxes (EBIT), and the Net Income. In this thesis, the first
two approaches will be presented in detail as follows.
2.4.3.1 Cash Flow Statement Approach
As mentioned above, the Enterprise Value estimates the cash flow from operating activities
that could be created in the future. As a result, when calculating the free cash flow based
on the Consolidated Cash Flow Statement, cash related to operating activities should be
paid attention to.
Generally, a Cash Flow Statement has three main parts, which are Cash Flow of Operating
Activities, Investing Activities, and Financing Activities, respectively. First of all,

Operating Cash Flow must remain the same because they are directly related to operating
activities. Secondly, Investment Activities should be considered carefully. In this part, only
investment in operating assets that directly create revenue for the firm will be calculated in
FCFF. These investments are often long-term tangible assets. Therefore, CAPEX, as
known as Capital Expenditure, will be considered as a cash outflow in FCFF, which
presents for the cash the firm uses to buy Property, Plant, and Equipment (PP&E
hereafter). The last part of Cash Flow Statement, Financial Activities, will be completely
ignored in this calculation. However, interest gained from financing activities such as
lending is believed a cash inflow for operating activities; therefore, this interest amount
after subtracting taxes will be added in FCFF.
To sum up, the FCFF Calculation following Consolidated Cash Flow Statement Approach
is presented as follows
FCFF = Operating Cash Flow + Interest Income * (1 – Tax rate) – CAPEX
Which is CAPEX = PP&E (current) – PP&E (last period) + Depreciation
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