How do you adjust the DCF valuation for non-operating assets and liabilities?

1 Identify non-operating items

The first step is to identify which assets and liabilities on the balance sheet are non-operating. You can use the financial statements, notes, and disclosures of the company or the project to find out the nature and amount of these items. You can also compare them with the industry benchmarks and norms to see if they are above or below the average. Generally, non-operating items are those that do not affect the operating income or the free cash flow of the company or the project.

2 Calculate net non-operating assets

The second step is to calculate the net non-operating assets (NNOA) of the company or the project. This is the difference between the total non-operating assets and the total non-operating liabilities. You can use the following formula to calculate NNOA:

NNOA = Non-operating assets - Non-operating liabilities

For example, if a company has $100 million of non-operating assets, such as investments and excess cash, and $50 million of non-operating liabilities, such as deferred taxes and pensions, then its NNOA is $50 million.

3 Add or subtract NNOA from enterprise value

The third step is to add or subtract NNOA from the enterprise value (EV) of the company or the project. EV is the sum of the present value of the free cash flows and the terminal value of the company or the project. You can use the following formula to adjust EV for NNOA:

EV adjusted = EV + NNOA

For example, if the EV of a company is $500 million and its NNOA is $50 million, then its EV adjusted is $550 million.

4 Calculate equity value and per share value

The fourth step is to calculate the equity value and the per share value of the company or the project. Equity value is the difference between the EV adjusted and the net debt of the company or the project. Net debt is the difference between the total debt and the cash and cash equivalents of the company or the project. You can use the following formula to calculate equity value:

Equity value = EV adjusted - Net debt

For example, if the EV adjusted of a company is $550 million and its net debt is $100 million, then its equity value is $450 million.

To calculate the per share value, you need to divide the equity value by the number of shares outstanding. You can use the following formula to calculate per share value:

Per share value = Equity value / Shares outstanding

For example, if the equity value of a company is $450 million and its shares outstanding are 50 million, then its per share value is $9.

5 Compare with market value and sensitivity analysis

The fifth step is to compare the per share value with the market value of the company or the project. Market value is the current price of the shares multiplied by the number of shares outstanding. You can use the following formula to calculate market value:

Market value = Share price x Shares outstanding

For example, if the share price of a company is $10 and its shares outstanding are 50 million, then its market value is $500 million.

You can also perform a sensitivity analysis to see how different assumptions and scenarios affect the per share value. You can vary the inputs, such as the discount rate, the growth rate, the cash flow projections, and the NNOA, and observe the outputs, such as the EV adjusted, the equity value, and the per share value.

6 Interpret the results and make recommendations

Interpreting the results is the sixth step in the DCF valuation process, which should be adjusted for non-operating assets and liabilities. You can use the per share value to evaluate the valuation; if it's higher than the market value, then the company or project is undervalued and represents a buying opportunity. Conversely, if it's lower than the market value, then it's overvalued and represents a selling opportunity. If it's equal to or close to the market value, then it's fairly valued and represents a holding opportunity. Additionally, other factors such as strategic fit, competitive advantage, growth potential, and risk profile should be considered before making any investment decisions.

7 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?