6 Free Financial Modeling Lessons...and More.

Points)

on 8/15/12 at 2:20pm

Model out NOLs and show taxes through projections

Also your perpetual tax rate

ladubs111

(Senior Orangutan, 432

Points)

on 8/15/12 at 2:27pm

Also your perpetual tax rate is assuming 100% of their business is in the US. If they have good international exposure effective tax rates are generally in the low to mid 20%s

If they have international

Points)

on 8/15/12 at 2:52pm

If they have international business, I would separate if possible. I am sure they are considered separate reporting units.

The issue is that even in the

thecrazybaboon

(Chimp, 10

Points)

on 8/15/12 at 3:16pm

The issue is that even in the terminal year, they're still not profitable on the Net Income basis...modeling out for 10 years becomes problematic as the assumptions that far into the future are not as relevant/correct. We don't have the detail about the NOL's expiration schedule either, so this creates an additional layer of complications. Majority of their business is in the US.

I was going to do the following: 1. use two WACC's; 1st take WACC for the projected year using company guidance in terms of taxes (y1-y5) and use a low tax rate in the WACC calcuation; 2. In the terminal year (y5) assume a marginal tax rate, which would create a diff. WACC and discount the Terminal Value by that WACC. Is this biforcated approach a common/acceptable practice for these type of situations?

Its bit different from what I'm used to but sorta makes logical sense; unless I'm missing something?

You have to push the model

Points)

on 8/15/12 at 3:25pm

You have to push the model out if there are still not profitable. You are essential saying, if you leave a negative net income in the terminal year, that the company will never be profitable. Doesn't make sense. Also, I hope you have a very large WACC considering you are forecasting negative earnings for at least 10 years.

So what about the WACC

thecrazybaboon

(Chimp, 10

Points)

on 8/15/12 at 3:44pm

So what about the WACC situation? Can I have two different discount rate? One for the forecasted period and one for the terminal year?

thecrazybaboon: So what about

Points)

on 8/15/12 at 3:52pm

thecrazybaboon:

So what about the WACC situation? Can I have two different discount rate? One for the forecasted period and one for the terminal year?

I am not sure. Perhaps someone else can chime in on this. I have heard of people doing it, but I have also heard it is an incorrect method.
Regardless, you still have a negative net income in the terminal year. You can increase the WACC for projection risk and just build out the model past 10 years.

http://www.wallstreetoasis.com/forums/dcf-with-ope...

http://www.wallstreetoasis.co

Oreos

(Neanderthal, 2,450

Points)

on 8/15/12 at 4:36pm

this may help, from a quick skim it doesn't address the wacc issue. but lets be honest, dcf is bull, use one wacc at the marginal, trying to defend your assumptions on your double wacc approach could get tricky.

further:

"Full Question:
How do you factor net operating losses (NOLs) in valuation? I try to determine the NOL present value and add it to the enterprise value. This approach is very speculative, so I try to exclude NOLs from my valuation analysis unless I feel fairly confident the company/acquiror could use these assets.

WST Expert Response:
NOLs are trickier - they are not typically factored directly as an asset with value in the sense of equity, debt and enterprise value, but rather, decreases the cash taxes paid, increasing free cash flow and thereby increasing overall value. Of course, NOLs can be valued separately by modeling out future cash flows with and without NOLs, then taking the differences in PV. However, in an M&A context, it gets trickier because if there's a change of control, you are limited to the amount of NOLs you may use each year, roughly estimated as the risk-free rate times beginning NOL balance. So if you had $100 NOL and the 10-yr treasury is 5%, you can only use $5 NOL each year until depleted (20 yrs in this case). A tax attorney should be consulted!! Either way, I don't think I would advise adding NOLs to enterprise value as they are related to operations and not financing. However, if they are significant, then perhaps you would increase purchase price since that means higher expected future cash flows. In general, you just take the balance sheet as is. The same idea applies to accounts receivable - you wouldn't add that to enterprise value. Of course, there are exceptions, as in K-Mart's case when it was bought for it's real estate.

Follow-on Question:
My company (a TLC operator) has a huge amount of tax losses carried forward expected to be used in the forthcoming 4 - 5 years. In my DCF valuation, I have discounted in the Unlevered Free Cash Flows, the income taxes at 33% (ires rate for Italy) as if the Co. has no NOLs to offsed the taxable income base. I computed the savings for NOLs, equal to the PV of the tax shields on the next 4 -5 years EBT, as a surplus assets (adding it to the Enterprise Value). The issue is: which actualisation rate should I use to discount the tax shields? WACC or K(e)? I would exclude the K(d).

Response:
The way we would account for NOLs in a DCF analysis is to reduce the "cash taxes" paid, thereby increasing Free Cash Flow to Firm and thus, increasing the PV of FCFF in the 4-5 year projection period. If there are significant NOLs still remaining after that, we would treat the PV of the tax shields as if it were cash, so it would affect the Net Debt calculation and thus, Equity Value, but not Enterprise Value. In short, the question of which discount rate to use (WACC or Ke) is not required. Logic: if you have two companies that are exactly the same and generates the exact same future cash flows, except one has NOLs and one doesn't, the overall value of the firm is still the same - only the equity value is affected => meaning that if you were absolutely certain the NOLs would be utilized, it is like having cash in your pocket and so, Equity Value is increased (source of funds) but not Enterprise Value."

#1 - you can have different

ampeypua

(Senior Monkey, 79

Points)

on 8/15/12 at 4:30pm

#1 - you can have different taxes (and WACCs) for different time periods (including your perpetuity year)

#2 - you should project out profit before tax by jurisdiction if possible so that you can see where NOLs will continue to build due to negative earnings (and thus, no cash taxes will be paid) vs. other jurisdictions which are profitable and where you will pay cash taxes

#3 - somewhat of a non sequitor (sp?), but fyi . . . doesn't sound as if the NOLs will be of use. The NOLs should have created a deferred tax asset on the balance sheet equal to the NOLs times your marginal tax rate. Practically, you should take an allowance reserve to show that you won't even really be using them (that's the proper thing to do when you're saying you're expecting negative profit before tax for the next 10 years). I do not believe that NOLs created in a loss making jurisdiction can be applied to a separate profit making jurisdiction (you should verify).

#4 - per someone else's comment before, use a weighted average tax rate for your perpetuity, based on different tax jurisdictions.

#5 - believe NOLs have a 2 year lookback and 20 year carryforward but you should double check

like Oreos said, model out

Points)

on 8/15/12 at 4:38pm

like Oreos said, model out the NOLs

ampeypua: #1 - you can have

Points)

on 8/15/12 at 4:42pm

ampeypua:

#1 - you can have different taxes (and WACCs) for different time periods (including your perpetuity year)

#4 - per someone else's comment before, use a weighted average tax rate for your perpetuity, based on different tax jurisdictions.

#5 - believe NOLs have a 2 year lookback and 20 year carryforward but you should double check

+1. Good Stuff.