Valuing a Company with Cash
Basic Proposition: Cash is different from other assets, insofar as
 its value is known with certainty
 it has no risk associated with it
The easiest way to value cash (and marketable securities) is to separate them from other assets, and value them separately.
Steps involved:
Step 1: Estimate the cash flows for the firm, as if it had no cash, i.e., take out any interest or other income that accrued from cash from the reported income. Thus, if the firm is being valued,
Adjusted EBIT = EBIT  Pretax Interest Income on Cash and Marketable Securities
If equity is being valued,
Net Income = Net Income  Interest Income (1  tax rate)
Step 2: Estimate the discount rate for the firm, as if it had no cash. Since cash has no risk, this will mean that the risk parameteris for the firm have to be reestimated. Since the reported beta for the firm reflects the cash holdings that the firm had during the regression period, the beta has to be adjusted by doing the following:
Step 2a: Estimate the cash balance as a percentage of firm value during the period of the regression.
Step 2b: Estimate the unlevered beta for the firm, using the average debt/equity ratio during the period of the regression.
Step 2c: Note that this unlevered beta was a weighted average of the beta of cash (zero) and the beta of all other assets.
Unlevered Beta = Beta of all other Assets (1  Cash Balance as % of Firm Value) + 0 (Cash Balance as % of Firm Value)
Step 2d: Solve for the beta of all other assets
Unlevered Beta without cash = Unlevered Beta/ (1  Cash Balance as % of Firm Value)
Step 2e: Calculate the new beta for the firm, using the firmís current debt/equity ratio
New Beta for Stock = Unlevered Beta without Cash (1 + (1 tax rate) (Current Debt/Equity Ratio))
Step 2f: Calculate the new cost of capital for the firm, using this new beta for cost of equity
Step 3: Value the assets of the firm using the cash flows adjusted (in step 1) and the reestimated discount rates (in step 2)
Step 4: Add the current cash balance
Value of the Firm = Value of the Assets from step 3 + Current Cash Balance
Step 5: Subtract out the total debt outstanding to get value of equity
Value of Equity = Value of Firm  Value of Debt
Alternatively, the firm value can be compared to the sum of the values of equity and debt.
The Standard Practice (and what could be wrong with it)
The standard practice on Wall Street in valuations is to do a status quo valuation of the firm (using reported net income and cost of capital) and compare it to the sum of value of equity and net debt, which is the difference between debt and cash.
Status Quo Valuation of Firm Compared to Value of Equity + Value of Debt  Cash Balance
In other words, they do the same thing that we do, except that
they do not adjust the income and cost of capital for the existence
of cash. This could result in the double counting of cash, since
the interest income from cash is counted in the status quo valuation
and cash is counted again as an asset.
An Example: Valuing Chrysler in March 1996
Step 1: Estimate the operating earnings without the interest income from cash



EBIT = 


Less Interest Income from Cash = 


EBIT without interest income = 



EBIT (1t) = 


Step 2: Estimate the discount rate, without the cash effects
2a: Estimate the cash balance as a percent of firm value for period of the regression







Cash 






MV of Equity 






Debt 






Firm Value 






Cash as % of Value 






2b: Estimate the unlevered beta for Chrysler, using the average debt equity ratio during the period of the regression







MV of Equity 






Debt 






Debt/Equity Ratio 






Unlevered Beta for Chrysler = Beta for the Stock / ( 1 + (1 tax rate) (Debt/Equity))
= 1.20 / (1 + 0.64 * 1.87) = 0.55
2c & d: Estimate the unlevered beta without cash
Beta of other assets (1  Cash/Firm Value) + 0 (Cash/Firm Value) = Unlevered Beta for the Firm
Beta of other assets (1  0.1906) + 0 (0.1906) = 0.55
Unlevered Beta of other assets = 0.55/0.8094 = 0.68
2e: Estimate the new levered beta
Levered Beta without Cash = 0.68 ( 1 + (1  tax rate) ( Current Debt Equity Ratio)
= 0.68 ( 1 + 0.64 (0.68)) = 0.98
2f: Estimate the cost of capital
Cost of Equity = 6.5% + 0.98 (5.5%) = 11.87% Current Proportion of Equity = 20854/(20854+14193) = 59.50%
Cost of Debt = 7.5% (based upon bond rating) Current Proportion of Debt = 14193/(20854+14193) = 40.50%
Cost of Capital = 11.87% (0.595) + 7.5% (10.36) (0.405) = 9.00%
Step 3: Value Chryslerís noncash assets.
Model Used: Stable Growth FCFF Model
Reasons: Firm is in stable growth; Cyclical Firm in a Mature Industry
Estimated Free Cash Flow to Firm Next Year
EBIT (1t) =  $ 2,449  
 (Net Capital Expenditure) =  $ 1,000  
 Change in Working Capital =  $ 195  
Free Cashflow to  Firm  $ 1,254 
Value of Chryslerís noncash assets = Expected Free Cash Flow to Firm Next Year / (WACC  Stable Growth Rate)
= $ 1,254 / (.09  .05) = $ 31,344 million
Step 4: Value all of Chryslerís assets by adding back the cash
Value of noncash assets = $ 31,344 million
+ Cash & Marketable Securities = $ 8,125 million
Value of Chrysler = $ 39,469 million
Step 5: Subtract out the value of the outstanding debt, and estimate the value of equity.
Value of Chrysler = $ 39,469 million
 Value of Debt = $ 14,193 million
 Value of Preferred Stock = $ 683 million
Value of Equity = $ 24, 413 million
/ Number of Shares = 382.56 million
Value per Share = $ 63.82