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Normalization Adjustments

This document discusses normalization adjustments that are made when calculating a firm's terminal value in a discounted cash flow valuation. It explains that in the terminal year, cash flows are normalized by growing metrics like EBIT, depreciation, and net working capital by the assumed constant growth rate going into perpetuity. It also provides an example calculation of firm value that applies these normalization adjustments to arrive at the projected free cash flows and terminal value.

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Abraham Chin
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92 views1 page

Normalization Adjustments

This document discusses normalization adjustments that are made when calculating a firm's terminal value in a discounted cash flow valuation. It explains that in the terminal year, cash flows are normalized by growing metrics like EBIT, depreciation, and net working capital by the assumed constant growth rate going into perpetuity. It also provides an example calculation of firm value that applies these normalization adjustments to arrive at the projected free cash flows and terminal value.

Uploaded by

Abraham Chin
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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Normalization Adjustments (Normalizing Terminal Cash Flows)

FCF of the Firm


Terminal Year Terminal Year +1
EBIT (1-T) EBIT (1-T) x (1+ constant growth rate)
Dep and Amort Dep and Amort x (1 + constant growth rate)
(Cap Expend) EBITDA
(Increase in NWC) (Cap Expend) EQUATE to Dep and Amort at TY+1
FCF of the Firm (NWC BALANCE at TY x constant growth rate)
FCF of the Firm at TY +1
basis for terminal value calcualtion

How to arrive at NWC End Balance at TY


NWC Balance
divided by EBITDA (in non cosntant growth phase)
then x EBITDA at TY

Sample Case: Calculate Firm Value

Year 2020 2021 2022


EBIT 20,000,000.00 30,000,000.00 45,000,000.00
Tax rate 30% 30% 30%
Depreciation (deducted to get EBIT) 5,000,000.00 8,000,000.00 9,000,000.00
Capital Expenditure 3,000,000.00 1,000,000.00 4,000,000.00

Increase in Inventory and Receivables 6,000,000.00 3,000,000.00 4,000,000.00


Increase in Payables 2,000,000.00 1,000,000.00 1,000,000.00
Increase in NWC 4,000,000.00 2,000,000.00 3,000,000.00

At December 31 2019 Non-Cash NWC 5,000,000.00


Expected growth of CFF constantly 3%
WACC 12%

CHIN ABRAHAM D
2020 2021 2022 2022 x ( 1+ 3%)
EBIT (1-T) 14,000,000.00 21,000,000.00 31,500,000.00 32,445,000.00 EBIT
Dep 5,000,000.00 8,000,000.00 9,000,000.00 9,270,000.00 Depreciation
Cap Exp - 3,000,000.00 - 1,000,000.00 - 4,000,000.00 41,715,000.00 EBITDA
NWC - 4,000,000.00 - 2,000,000.00 - 3,000,000.00 - 9,270,000.00 Cap Exp (same as Dep)
FCF 12,000,000.00 26,000,000.00 33,500,000.00 - 420,000.00 NWC x (1+3%)
PV Favtor 0.89 0.80 0.71 32,025,000.00 FCF at Ty+1 (Normalized)
10,714,285.71 20,727,040.82 23,844,638.30 9% WACC - Growth
Sum of PV 55,285,964.83 355,833,333.33 Terminal Value +1
1.40 (1+WACC^3)
Non-Cash NWC 2019 5,000,000.00 253,275,138.18 PV of terminal value +1
2020 4,000,000.00 55,285,964.83 Sum of PV
2021 2,000,000.00 308,561,103.01 Firm value
2022 3,000,000.00
NWC Balance Terminal Year 14,000,000.00

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