Capital leases when calculating for Enterprise Value and Equity Value

Guys, help!

I've moved from VC to PE as an analyst - essentially, from valuating small startups w/o debt, NWC, capex to DCF valuation of large capex, debt, NWC comps.

Currently, on PE side I'm doing DCF for a university-startup which will start operating from next year. It has just signed $25mln worth capital lease agreements with payments starting in 2 years. Also, some part of investor's money, circa $7mln, is going to be invested in constructing 1 more building. There's no existing debt or cash atm. 

1) Am I doing it right when substructing/accounting for the interest part of my capital lease from operating cash flows and then substracting principal payments of my capital lease (which are in my investing cash activities) as capex when arriving to my FCFF? 

2) Do I need to include $7mln new capex in my FCFF calculation for pre-money valuation? As there's no cash to finance this at this stage and the investor's money is not in, does it even make sense? 

3) How do I arrive to Equity Value if I don't have debt and what part of lease liability is substracted from EV if any should be substracted? Since I already accounted for lease interest in my operating cash flow and my lease principal as capex when arriving to FCFF, what part of lease is substracted from EV if any? Once I identify what I need to substract from my EV, do I need to discount it before substracting? 

Guys, I know these questions may sounds absolutely obvious to some of you but it's my first experience with any capital lease. Will appreciate a prompt response from you all.

Thank you!

Comments (7)

  • Analyst 2 in IB - Cov
Nov 14, 2021 - 6:52am

Last time I did this (recently) we just treated everything pre-IFRS 16, I.E. all leases were expensed as rent payments to the P&L and not considered to be capitalised. I'd do that if I were you, IFRS 16 sucks

Most Helpful
Nov 15, 2021 - 6:59pm

The idea is that the pre- and post- IFRS16 cash flows should be the same. This article… does a good job of explaining this. I think maybe subtracting the interest part of your capital lease in addition to the "capex" would be double counting. I think either you remove the effective new IFRS16 lease expense or you remove the capex in your cash flow for financing, but don't remove both.

Not sure I get your second question - by investor do you mean the PE you work for? Is the US$7m primary?

For question 3 - if the business is cash free debt free then there is no bridge. However, we treat the new lease liabilities as a debt item. So the full US$25m would be a debt-like item. This can be explained here (basically the new lease in the cap structure lowers the WACC, which raises the NPV of DCF cash flows, so you need to subtract the lease liability to account for this):

Hope this helps!

Nov 15, 2021 - 11:09pm

Thank you so much for your response, man!! 

So, my lease interest sits in the cash from operating activities and it's substracted from it, right? Then, I have non-lease CapEx like furniture fixing and repairing works and some equipment bought outright and it shows on my investing cash, so I substract it, too.

Then, I have "capex" which is my lease - this is another sum that shows on my investing cash: it's my lease's principal. I substract it and arrive to my FCFF. 

To make the bridge to FCFE I need to substract lease in the form of debt and here I'm stuck - if I've substracted my principal and interest when arriving to FCFF, what part of the lease should I substract here? Isn't it double counting. 

Thanks a lot for the links! In the first link the guy has smth on its financing activities for the lease - where does it come from? If I've already substracted my interest and principal (from operating cash flow and from investing activities) then I'm really confused - if it's the lease liability (which is, essentially, the remaining lease from year one to the repayment date (which I haven't added on my financing cash flow yet), then should I discount it at some discount rate? To me, substracting both principal and lease liability seems like double counting and I feel here I'm going south and doing smth totally wrong.  

thank you so much!

Nov 16, 2021 - 12:53am

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