I am currently valuing a company with a large inventory. I realize the DCF takes into account the changes in inventory in the working capital number, but what about the rest of the inventory that was not part of the change/just lying around? If I sell this company for the DCF value, do I separately price and sell the rest of the inventory, or does everything go with the sale?
Appreciate any insight. Thanks.
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Inventory is used to generate cash which the company is valued on. Inventory should have turnover so if you had 100 inventory in one period and 100 in the other period, it doesn't necessarily means nothing moved because for example, you could have sold 100 and bought back 100. So for your question, the company would sell for DCF value because without inventory, they couldn't make money. Let me know if this doesn't make sense to you because I tried to make it revolve around your question on inventory.
If I sell you my car, do I get to keep the gas that's in the tank and sell that to someone else separately?
The DCF is a valuation methodology meant to capture the entire value of a company, including its inventory at time of sale.
To clarify my question, let's say I project inventory to be 50 in 2014, 100 in 2015, 150 in 2016, and so on for 2 more years. The change in inventory each year is +50, which goes into my unlevered free cash flow calculation via change in working capital. What about that original 50 inventory? What happens to the inventory that isn't bought and sold and is just laying around? Does it just get shuffled into the valuation, or do I need to sell that separately?
if your inventory goes up 50 each year you're basically saying you had an increase in WIP each year, a use of 50 cash. The inventory you didn't sell is eventually written off after a given amount of time as stagnant, excess or obsolete. Your overall inventory number would have taken that into account.
If you sold 50 in COGS and inventory went from 50 to 100, that would mean you purchased / created 100 in inventory for that year. If you sold 40, had 10 in write-offs because you couldn't sell it for whatever reason, it would mean you still created 100 in inventory. Does that make sense?
Yes, that makes sense. This company in particular is a tile/stone manufacturer and so has a lot of inventory available for showrooms and for sale, where maybe only a portion of the inventory on the books is sold and bought each year. In this case, I'm not sure exactly if inventory is just "written-off" and no longer has value. But when selling the company, I think it makes sense that the DCF value includes all of the inventory, because inventory is so integral in their operations.
Assuming I know how much inventory was bought and sold in the changes in inventory number each year, should I separately price and sell the excess inventory that is not part of that number?
No. Counting the value of your inventory would be double counting when you do your DCF. A DCF is the entire value of the asset. If you want to value the company in terms of liquidation value, then you would take account the market value of the assets that you could sell it for which would include your inventory.
I think you are misunderstanding what a DCF is used for and its applications. Lets say you have a building that gives that costs you $X to buy. It generates cash of $10 a year in perpetuity. Assuming a 10% rate that would mean the DCF value would be $100. It did not matter how much it cost me to buy, only the cash it generates which is the ultimate decider of how much it is worth.
I think your view on inventory may just be tied with terminal value part of a DCF which is why you may be confused. As part of a DCF, you have to consider the terminal value which you could do in various ways such as the gordon growth method or multiple method or liquidation value which would include value of inventory.
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