# Calculation loop (year-by-year forecasting)

Though we do not set any assumptions on how long the company we are valuating will be in existence, and, therefore, imply that its operations will continue forever, the calculation loop cannot be indefinite. Thus, merely for practicality considerations, we put some reasonable time horizon (say, 50 years) for our forecast.

The time horizon is also the number of times we go through the calculation algorithms that forecasts key financial data, with each passage through the loop corresponding to a separate year in the future.

Below is a brief description of each step of the calculation and the appropriate formulae.

1. Revenue growth rate
2. The calculation loop starts with forecasting revenue growth rate for a particular year. For the first forecasted year following the base year, it is set to be equal to its input value. For all subsequent years it is calculated using the following formula:
Revenue growth rate = Terminal revenue growth rate +(Revenue growth rate at previous year -Terminal revenue growth rate) x Revenue decline factor
REVGR = TERMREVGR + (REVGRprev - TERMREVGR) x REVDECL

3. Revenue
Revenue = Previous year revenue x (1+ Revenue growth rate)
REVENUE = REVENUEprev x (1 + REVGR)
4. Variable costs
Variable costs = Revenue x Variable cost factor+ Goodwill / Years goodwill amortizes
Note: the second addend exists only in years when Goodwill is greater than zero (i.e. when it is not fully amortized).
VARCOSTS = REVENUE x VARCOSTF + GOODWILL / GWAMORT
5. Production assets or base (average for the year)
Production assets = Revenue x Production assets to revenue
PRASSETS= REVENUE x PRASSREV
6. New CAPEX
Here we calculate the amount of capital expenditures needed to expand the production base to the level commeasurable with the current level of revenue. We assume that all new capital expenditures are made at the very beginning of the year and, therefore, the benefits of this new CAPEX also fully accrue in the current year. Definitely, this is an oversimplification, but the one that greatly reduces complexity of the model.
New CAPEX = Production assets - Previous year production assets
NEWCAPEX = PRASSETS - PRASSETSprev
7. Maintenance CAPEX
Maintenance CAPEX, as it is used here, is different from maintenance expenses. Rather, in accounting terms it could be described as the current-year depreciation expense (estimated here on the straight line basis) on the previous-year production assets. We consciously used the word ‘maintenance’ to describe these capital expenditures, as, in essence, this is the CAPEX that is needed to keep existing production assets at their current production capacity.
Maintenance CAPEX = Previous year production assets / Depreciationlife of production assets
MAINTCAPEX = PRASSETSprev / DLIFE
8. Depreciation expense of new CAPEX
As mentioned above, we assume that all new capital expenditures are made at the very beginning of the current year. Therefore, we must also account for depreciation of the new CAPEX already in the current year. Depreciation is calculated on the straight line basis.
Depreciation expense on new CAPEX = New CAPEX / Depreciation life of production assets
DEPRNEWC = NEWCAPEX / DLIFE
9. Total depreciation
Total depreciation = Depreciation expense on new CAPEX + Maintenance CAPEX + Goodwill / Years goodwill amortizes
Note: the third addend exists only in years when Goodwill is greater than zero (i.e. when it is not fully amortized).
DEPREC = DEPRNEWC + MAINTCAPEX + GOODWILL / GWAMORT
10. Fixed operating expenses
Fixed operating expenses = Previous year fixed operating expenses x (1+Inflation rate)
FIXCOSTS = FIXCOSTSprev x (1 + INFLATION)
11. EBIT(Operating Income)
EBIT = Revenue - Variable costs - Fixed operating expenses
EBIT = REVENUE - VARCOSTS - FIXCOSTS
12. EBITDA
EBITDA = EBIT + Total depreciation
EBITDA = EBIT + DEPREC
13. Interest expense (on net debt)
Interest expense = Previous year total net debt x Interest rate on debt
INTCOSTS = NETDEBTprev x INTRATE
14. Earnings before tax
Earnings before tax = EBIT - Interest expense
EBT = EBIT - INTCOSTS
15. Tax expense
Tax expense = Earnings before tax x Corporate tax rate
Note: only if Earnings before tax are positive
TAXES = EBT x TAXRATE
16. Net income
Net income = Earnings before tax - Tax expense
NETINCOME = EBT - TAXES
17. Funds from operations (FFO)
Funds from operations = Net income + Total depreciation
FFO = NETINCOME + DEPREC
18. Working capital
Working capital = Revenue x Working capital to revenue
WC = REVENUE x WCREV
19. Change in working capital
Change in working capital = Working capital  - Previous year working capital
WCCHG = NFWC - NFWCprev
20. Cash from operations (CFO)
Cash from operations = Funds from operations - Change in working capital
CFO = FFO - WCCHG
21. Free cash flow (FCF)
Free cash flow = Cash from operations - New CAPEX - Maintenance CAPEX
FCF = CFO - NEWCAPEX - MAINTCAPEX
Adjusted total assets = Revenue /Production assets to revenue
23. Equity
24. Change in equity
Change in equity = Equity - Previousyear equity
EQUITYCHG = EQUITY - EQUITYprev
26. Change in liabilities
Change in liabilities = Adjusted total liabilities - Previous year adjusted total liabilities
27. Issuance of new debt
Issuance of new debt = Change in liabilities
NEWDEBT = LIABILCHG
28. Total cash flow
Total cash flow = Free cash flow + Issuance of new debt
TOTALCF = FCF + NEWDEBT
29. Cash flow adjustment (for real cost of stock options, for example)
This is the entry for any cash flow adjustments, such as for the real cost of stock option compensation plan used by the company, for example.
Adjusted total cash flow = Total cash flow + Cash flow adjustment
31. Cash for distribution 1
Before cash could be distributed to shareholders, it is used, if needed, for equity increase - see the change in equity calculation above. Conversely, if the change in equity is negative, such change could be distributed to shareholders, too.
Cash for distribution 1 = Adjusted total cash flow - Change in equity
32. Issuance of new equity
If Cash for distribution 1 calculated above is negative, then the company needs to issue new equity (i.e. sell its shares to shareholders).
If CFD1 is negative:
Issuance of new equity= -CFD1
NEWEQUITY = -CFD1
If CFD1 is non-negative:
Issuance of new equity = 0
NEWEQUITY = 0
33. Cash for distribution 2
Cash for distribution 2 = Cash for distribution 1 - Issuance of new equity
CFD2 = CFD1 - NEWEQUITY
34. Proportional claim of current shareholders on cash flows
If new equity is issued (i.e. if new shares are sold by the company to investors), the stake of the current shareholders on the company’s assets and cash flows is diluted (assuming that they do not purchase newly-issued shares).
Proportional claim of current shareholders on cash flows = Previous year proportional claim of current shareholders on cash flows x (Equity - Issuance of new equity) / Equity
PORTION = PORTIONprev x (EQUITY - NEWEQUITY) / EQUITY
35. Cash for distribution 3
Cash for distribution 3= Cash for distribution 2 x Proportional claim of current shareholders on cash flows
CFD3 = CFD2 x PORTION
36. Present value (PV) of cash for distribution
PV of cash for distribution = Cash for distribution 3/(1+Discount rate) ^ Year
PVCFD = CFD3 / (1+ DR) ^ Year
37. Next year’s discount rate
Next year’s discount rate = Discount rate x Discount rate multiplier
DRnext = DR x DRMULT

# Calculation of intrinsic value

The intrinsic value of the company is calculated by summing up the present values of the cash flows available for distribution in each of the future years that were estimated in the calculation loop. We impose a restriction on the lower magnitude of the intrinsic value: it cannot be less than the company’s Tangible net worth.

By dividing the company’s intrinsic value by the number of outstanding shares, we find the intrinsic value per share. The latter is compared with the current market share price to estimate the company’s stock upside or downside potential.

### Valuation algorithm

1. Introduction

2. Model input parameters

3. Calculation of intrinsic value