Company Valuation

Applied project Mcdonald’s

Professor: Benedicto Lukanima

Group:

Hollman Villanueva - 200108418

Emanuel Saurith - 200112125
Carlos Hernández - 200106626
Daniel Torres Támara - 200104487

Mcdonald's

30/05/2020

Barranquilla - Atlántico
 ABOUT THE PROJECT

GENERAL OBJECTIVE
To develop a company valuation activity that comprehensively integrates this
subject’s applicable knowledge and skill in conjunctions with four previous financial
courses: financial accounting, cost accounting and budgeting, financial planning and
financial management.

Key Aspects:
More specifically, the project will be assessed on the ability of students to use
technical terms and to show ability in communicating the results of the analysis. This
will include, but not limited to the following aspects:

1. Ability to search for relevant information and apply that information

appropriately in company valuation. You are expected to use several sources
of information to gather data.

2. Ability to estimate and forecast the required variables for company valuation.
You are expected to show expertise in applying multiple methods and make
judgment about the most appropriate methods.

3. Ability to make relevant assumptions about your estimations and be able to

provide critical reasoning and evidence to support the assumptions.

4. Ability to present data and information and the quality of your presentation. All
data must be attached in Excel. You are expected to show all the workings in
Excel and define all the information and data. Evidence of data sources is
required.

5. Ability to make extensive reading in search for solutions about the project and
address the challenges that you encounter in valuing the company. Here, you
will be required to indicate all the reference materials you have read by
presenting a full reference list.

6. Ability to use the technical terms in all aspects of valuation from data
presentations, definitions, analysis, interpretation and decision-making.

7. Ability to prepare and present a valuation report in a clear and understandable

manner. Here, you are expected to show acquired skills and knowledge in
report writing. Take into account that readers such as investors, analysts, and
the general public should understand your valuation report.
ABBREVIATIONS:

● V = Value
● CF = Cash Flows
● r = Discount rate
● t = Time
● TC = Terminal cash flow
● FCF = Free cash flow to the firm
● FCFE = Free cash flow to the equity
● Ke = Cost of equity
● Kd = Cost of debt
● rf = Risk free rate
● g = Grow
● NCS = Number of common shares
● B = Beta, Systematic Risk
● rm = Market Return
● TB = Treading Bond
● CDS = Country Default Spread
● COV = Covariance
● Var = Variance
● rs = Stock Return
● C = Market Stock Index
● Ef = Error tery
● F = Interest Rate
● D = Debt Value
● CDR = Corporate default Risk
● CFT = Casf Flow at the end of the growth phase
● WACC = Weighted Average Cost of Capital
● g = Growth Rate
● ROIC = Return on Interested Capital
● ROE = Return of Equity capital employed
● NOPAT = Not operative profit of less tax
● ECE = Economic capital employed
● EPS = Earning per Share and taxes
● BVE = Book value of equity
● EBIT = Earning before Interest and Taxes
● Tc = Corporate Tax Rate
● EAC = Earnings available to common Share
● Wd = Weighted Debt
● We = Weighted Equity
LIST OF TABLES

Table 1. Cost of equity 6

Table 2. Cost of debt 8

Table 3. Capital Structure 9

Table 4. WACC 9

Table 5. Growth FCF 10

Table 6. Growth FCFE 11

Table 7. Terminal Growth 13

Table 8. Single Stage Firm Value 14

Table 9. Firm Value Single Stage 15

Table 10. Single Stage Equity Value 16

Table 11. Comparison Equity Value 18

Table 12. APV Approach Single Stage Model 20

Table 13. Comparison Firm Value APV Approach 21

Table 14. Peer groups of McDonalds 22

Table 15. Collection valuation data of McDonalds 23

Table 16. Collection valuation data of McDonalds 23

Table 17. Collection valuation data of McDonalds 24

Table 18. Collection valuation data of McDonalds 24

Table 19. Liquid Risk of McDonalds 24

Table 20. Market Risk of McDonalds 26

Table 21. Credit Risk of McDonalds 26

Table 22. Financial Risk of McDonalds 28

Table 23. Operational Risk of McDonalds 29

LIST OF FIGURES

Figure 1 Estimation of CAPM Beta for McDonalds 6

Figure 2 Behavior Growth rate CC Approach 16

Figure 3 Behavior Growth rate CC Approach 18

Figure 4 Behavior Growth rate APV Approach 21

EXECUTIVE SUMMARY

The purpose of this applied work is to put into practice all the knowledge learned in
class, in addition to making estimates, assumptions and calculations as if you were
really making a negotiation. In the case of McDonalds, the objective of the valuation
was to buy, taking into account the lowest prices. In this report, we are going to
describe the company in terms of valuation methods, Cost of Capital, Adjusted
Present Value, Equity Value Multiples, Enterprise Value Multiples, also we look at
the company deeper, analyzing risks. Finally, after analyzing all the calculations of all
method, we are going to give some conclusions and recommendations.
TABLE OF CONTENTS

MAIN BODY 7

INTRODUCTION 7

COST OF CAPITAL 7

COST OF EQUITY 7

COST OF DEBT 9

CAPITAL STRUCTURE 11

WACC 12

GROWTH 13

GROWTH RATE 13

TERMINAL GROWTH 15

INTRINSIC VALUATION 16

CC APPROACH (FCF) 16

CC APPROACH (FCFE) 19

APV APPROACH (FCF) 21

RELATIVE VALUATION 25

EQUITY VALUE 25

ENTERPRISE VALUE 27

RISK-RETURN ANALYSIS 29

LIQUID RISK 29

MARKET RISK 30

CREDIT RISK 30

FINANCIAL RISK 31

OPERATIONAL RISK 33

CONCLUSIONS AND RECOMMENDATIONS 35

REFERENCE LIST 3​6

MAIN BODY

INTRODUCTION:

McDonald's, known as the largest restaurant franchise (fast food) in the world, was founded
on May 15, 1940 by the brothers Dick and Mac McDonald in San Bernardino California had
about 20 products on the menu and that's when in 1953 the McDonald brothers decided to
expand and begin to put franchises around the United States and then expand around the
world, it should be noted that McDonald's today has more than 35. The McDonald's brothers
have more than 35,000 restaurants and more than 40 products on their menu, and it is
known that their flavor is unique and equal in all their franchises. This is due to the great
investment they have made in farms and factories where they decide to grow and produce
their own food in order to achieve and maintain their original flavor.

In the following work we will talk a little about the cost of capital of McDonald's, about the
market return, risk return, equity value and among other analyses that were made to the
largest restaurant chain in the world, all this in order to know a little more about how the
years have been and how well or badly they have done over time to this company, it seeks
to give a point of view of how they have been successful years for McDonald's and to
analyze how its operations have been positioned as the preferred fast food brand of many.

COST OF CAPITAL

Cost of capital of McDonald's is the minimum rate of return that a business must
earn before generating value. This consists of both the cost of debt; related to debt
holders, bank or other entities who have given loans to Mcdonalds and the cost of
equity; is related to the shareholders of the company, used for financing a business.
A company’s cost of capital depends, to a large extent, on the type of financing the
company chooses to rely on its capital structure. The choice of financing makes the
cost of capital a crucial variable for every company, as it will determine the
company’s capital structure.The most common approach to calculating the cost of
capital is to use the Weighted Average Cost of Capital (WACC).

A) COST OF EQUITY

The cost of equity capital is the required rate of return on common stock and, as
such, represents the minimum acceptable rate of return on the equity-financed
portion of a firm.

To calculate the cost of equity we will use the Capital Assets Pricing Model (CAPM)
this model have a four assumptions to consider:
 ➔ Investors are well diversified: This assumption implies investors can diversify
risk on individual assets (unsystematic risk) though portfolio investments. s.

➔ Single-period transaction horizon: This assumption means that all investors

are myopic: have only one and the same holding period.
➔ Investors can borrow and lend at the risk-free rate of return: This is an
assumption implies that the minimum level of return required by investors
should be the risk-free rate.

➔ Perfect capital market: This assumption means that all securities are priced
correctly and that their returns will not strain from the Security Market Line.

The historical information will allow us to calculate the beta and the market risk that
suits us best. this is why we will take the information from yahoo finance.

Step 1: To calculate the beta, the S&P 500 is used which is the market behavior and
the closing of the company in the market in the last 2 years with weekly closing
intervals and is calculated with the division of variance of rm and the covariance of
rm and rs. We calculate the stock return by using the formula (1), with the data
found.

(1)

Where: rs is stock return.

INSERTAR GRÁFICA HERE

Figure 1 Estimation of CAPM Beta for McDonalds

Source: Excel Sheet 2 (Cost of Equity)

Step 2: To calculate this return, the company's market closure in the last four years
was taken and the RM is calculated and then RM+1 is calculated, which is to add 1
to the RM. After this, the product is calculated as 1 divided by the number of periods,
in this case months, and to this, 1 is subtracted and the result is a geometric market
return, and the geometric is used because it is the one that shows real data. The
return offered by the market and the minimum that investors who invest in
McDonald's expect to receive is 9.78% per year and 0.78% per month
Step 3: With the previous data of the stock return and the market return, we
calculate β the following formula (2)

(2)
Where: β is levered beta, rm is market return, rs is stock return.
Beta < 1 then individual return less volatile than the market , stock has lower
systematic risk. The market where McDonalds is located is less volatile than the
price of this company's shares because the Beta of 0.869107 is less than 1 which
means that the price of McDonald's’ shares in the market is stable and the market
behavior is less volatile.

Step 4: The other variable to be calculated is risk free rate this last one is determined
by the government bond yield and it is calculated by the formula (3)

(3)
Where: rf is the risk free rate return,yg is bond yield government, CDRP is country
default risk premium.

The Risk - free rate is calculated Bond yield less country default spread - USA than
the country where the company's parent company is located and is listed on the
NYSE.

Step 5: With all the previous data we use the Cost of Equity formula (4) to calculate
the Cost of Equity of Coca Cola as it is shown in table 1.

Table 1. Cost of equity

Source: Excel sheet 2 (Cost of equity: levered and unlevered)

McDonald's

Bond yield 0,780%

cds - USA 0,000%

Risk - free rate 0,780%

Beta 0,8691

Market Return 9,78%

 Cost of Equity 8,60%

Finally, The cost of equity is 8.60%, this is the minimum that McDonald's investors
expect to receive.

B) COST OF DEBT

The cost of debt is the return that a company provides to its debtholders and
creditors. These capital providers need to be compensated for any risk exposure that
comes with lending to a company. Since observable interest rates play a big role in
quantifying the cost of debt, it is relatively more straightforward to calculate the cost
of debt than the cost of equity. Not only does the cost of debt reflect the default risk
of a company; it also reflects the level of interest rates in the market.

Step 1: Cost of debt refers to the effective rate a company pays on its current debt.
Here, we refer to the after-tax cost of debt in the formula (4) .

(​ 4)
Where: kd is the pre-tax cost of debt to be estimated, Tc is corporate tax rate.

Step 2: The Cost of debt can be estimated and making the assumption that we are
buying McDonalds the approach 1, Effective Interest Rate formula (5),in this
approach, the pre-tax cost of debt (kd) is estimated as the ratio of interest expenses
to total debt based on the most current financial statements of Mcdonalds.

(5)

Where: Kd pre-tax cost of debt to be estimated

Step 3: Then we estimated the corporate tax rate by dividing the tax expenses with
the earning Before taxes, source data: financial statement of Mcdonalds with formula
(6).
 (6)
Where: Tc is corporate tax rate

Step 4: Finally, we calculate the cost of debt after tax with formula 1. We can see
table 2 summary for the cost of debt

The cost of debt is calculated with Interest Expenses, ST Debt + LT Portion and
Long Term Debt of the last 4 years in this case, is added (ST Debt + LT Portion) and
the Long Term Debt and results in the total amount of debt per year and after this is
divided Interest Expenses divided with the total debt and the result is the cost of debt
per year and to these is calculated the average and the result is the average cost of
debt, then to the average cost of debt is subtracted the average interest rate.

Table 2. Cost of debt

Source: Excel sheet 3 (Cost of debt)

The cost of McDonald’s after tax debt is 2.11% this is possible because the company
in the years 2017 and 2018 its ST Debt + LT Portion was 0 and this decreases the
total debt. Then McDonald's has a low debt cost and this is very attractive for
investment because the company pays little interest on the debt which represents a
large percentage of the company's capital.

C) CAPITAL STRUCTURE

The capital structure is the particular combination of debt and equity used by a
company to finance its overall operations and growth. Debt comes in the form of
bond issues or loans, while equity may come in the form of common stock, preferred
stock, or retained earnings.

The capital structure of McDonald's is 73,73% financing for equity is related to the
shareholders of the company, consists of ownership rights in the company, without
the need to pay back any investment while the 26,27% for debt is related to the debt
holders or banks, consists of borrowed money that is due back to the lender,
commonly with interest expense. In the table 3 we found capital structure.

Table 3. Capital Structure

Source: Excel Sheet 4 (WACC)

D) WACC

A firm’s Weighted Average Cost of Capital (WACC) represents its blended cost of
capital across all sources, including common shares, preferred shares, and debt.The
weighted average cost of capital (Wacc) Is calculated with the weight of equity and
debt in the total value and the cost of equity and the cost of debt. the calculation is
the weight of equity multiplied with the cost of equity + the weight of debt multiplied
with the cost of debt and the formula is (7):

W ACC = K dat * W d + Ke * W e (7)

Where: Kdat* is the after-tax cost of debt, Ke is the cost of common stock, Wd and
We is the proportions of debt, preferred, and common stock in the capital structure.

In the table 4. we found wacc for Mcdonalds

 Table 4. WACC
Source: Excel Sheet 4 (WACC)

The weighted average cost of capital is 6,90%, with kd being the largest percentage.
This percentage number is low because the amount of the company's equity is less
than the amount of the debt. From the company's point of view, this makes it
attractive to incur debt. From the point of view of the capital providers it is attractive
because the company has debt capacity and for the investor it represents a minimal
risk because the company has a stable net equity, which means that the company
owes more than it has. On the other hand, this wacc shows that the company has a
high value because the less the wacc is the more value the company has.

GROWTH
The growth variable is very important when calculating forecast for fcff and fcfe. But
it is even more important in choosing the growth rate according to the objectives that
the company wants. Next we will see with more details the Mcdonalds growth.

A) GROWTH RATE

Growth rates refer to the percentage change of a specific variable within a specific
time period. Growth rates are used to express the annual change in a variable as a
percentage, such as revenues or investments. Growth rates can be beneficial in
assessing a company’s performance and to predict future performance.Growth rates
are utilized by analysts, investors, and a company's management to assess a firm's
growth periodically and make predictions about future performance.

For McDonalds, To calculate the free cash flow growth we used the last 7 years, this
company shows unstable FCF growth because it has big changes in growth where it
has an annual average growth of 14.15% this marks that the general trend of the
company's FCF in time is to increase to level and this shows that the company has
good liquidity after having covered its operational costs.To observe the average
growth of McDonald's FCF we used the geometric growth because it is the one that
shows figures closer to reality and because the arithmetic growth is distorted by the
abrupt changes of the growth for example from 2013 to 2018 the FCF has a growth
range between -1.4% and 13.5% and in 2019 it was 34.1 these high changes make
the arithmetic average of an erroneous result for the analysis of the company. In the
table 4.

Table 5. Growth FCF

Source: Excel Sheet 5 (Growth rates)

To calculate the free cash flow growth we used the last 5 years, this company shows
unstable FCFE growth because it has big changes in growth where it has an annual
average growth of 15.65%. The growth rate in free cash flows to equity is greater
than the growth rate in the free cash flow to the firm because of the leverage effect.
In table 5.

Table 6. Growth FCFE

Source: Excel Sheet 5 (Growth rates)

Finally, the decision to choose the growth rate depends on our objective for
Mcdonalds which in this case is to buy, taking into account the conditions for the
wacc and for the ke.
Choice of growth rate:
Condition:
g<wacc for FCF 2,78%<6,90%
g<Ke for FCFE 3,89% <8,60%
The decision will depend on the objective of valuation :
to sell->high value(price) -> high growth rate
to buy>low value(price) -> low growth rate
For FCF Mcdonald choice of 2,78%, our objective is to buy, so we want to make vf
smaller. And for FCF the company choice 3, 89%, our objective is to buy, so we want
to make vf smaller​, ​as we saw it in table 4 and 5

B) TERMINAL GROWTH

The terminal growth rate is a constant rate at which a firm’s expected free cash flows
are assumed to grow, indefinitely. This growth rate is used beyond the forecast
period in a discounted cash flow model, from the end of forecasting period until
perpetuity, we will assume that the firm’s free cash flow will continue to grow at the
terminal growth rate, rather than projecting the free cash flow for every period in the
future.

The terminal growth rate is widely used in calculating the terminal value of a firm.

The “terminal value” of a Mcdonald's is the net present value of its cash flows at
points of time beyond the forecast period. The calculation of a firm’s terminal value is
an essential step in a multi-staged discounted cash flow analysis and allows for the
valuation of said firm.

In a Discounted Cash Flow DCF Model the terminal value usually makes up the
largest component of value for a company (more than the forecast period).
We need to keep in mind that the terminal value found through this model is the
value of future cash flows at the end of the forecasting period. In order to calculate
the present value of the firm, we must not forget to discount this value to the present
period. This step is critical and yet often neglected.
For the development of the future cash flows for the firm and for the capital, we will
calculate the terminal growth in the cc approach and adjusted present value two,
only instead of the wacc, you put ku. In this case of firm value formula (8).

(8)
Where gT is growth terminal, Ve is equity of market value, Vd is debt of market
value, WACC denotes weighted average cost of capital, FCF is current free cash
flow.

And in the case of equity value we will only calculate it by the cost of capital
approach as follows (9)

(9)

Where gT is growth terminal, Ve is equity of market value, Ke is the cost of equity,

FCFE is current free cash flow to equity.

We can calculated in table 6.

Table 7. Terminal Growth
Source: Excel Sheet 4 (WACC)

It is important to choose correctly the first growth rate since that is the one we will
use to calculate the terminal growth rate.

INTRINSIC VALUATION
This is value derived from discounting future cash flows.
❏ The philosophical basis: ​main determinants of value are cash flows, growth
and risk.
❏ Required information: ​cash flow projections, estimated lifetime of asset, and
appropriate discount rate.
❏ Value to be estimated:
Equity Value: from discounted FCFE or Dividend
Firm Value: from discounting FCF.

A) CC APPROACH (FCF)
We will estimate the value of Mcdonalds by forecasting the free cash flow to the
company with the CC Approach or cost capital approach. For this model it is
necessary to assume that the WACC is constant. Cash flows are expected to grow
at a constant growth rate indefinitely. In the Cost of Capital Approach there are two
different growth models.

The first is the Single Stage Growth Model; in this model we assume that the growth
of the cash flows is constant over the life of the business.

The formula for calculate single stage growth model in CC Approach is (10)

(10)

Where: Vfirm denotes firma value, FCF0 is current free cash flow, g1 is growth rate
at period 1, and wacc is weighted average cost of capital.

In the single stage growth model, the firm market value is overvalued for 18, 90%
because is lower than the firm value that we estimated, this is reflected in Table 7.

Table 8. Single Stage Firm Value

Source: Excel Sheet 5 (Intrinsic Valuation: Approach (CC)
Single-stage growth model: Firm Value and Equity Value WACC)

The second one is two stage growth model, a two-phase model is applied to values
firms that exhibit two stages of growth. The first phase is usually a short-term with
high growth rate. The second phase follows with long-term steady growth at low rate,
indefinitely.

Assumptions of the growth rate

Stage 1: The growth rate of each year can be calculated towards the terminal period
using the linear extrapolation method that covers a period of 5 years.
Stage 2: the growth rate is the same from the terminal period indefinitely, since after
the fifth year the growth rate is the same.

Step 1: Determine the terminal growth rate : gt = g5

We have already explained the terminal growth for this model in the formula 8, so we
already know that the growth rate is 3,53%.

Step 2: determine growth rate in stage 1

The methods for calculate growth g2 to g4 is linear extrapolation, with the following
formula (11).

(11)
Where: gn is the growth rate at determine period, gT is the growth terminal, g1 is the
growth rate at period 1, tn is the time at period n, t1 is the time at period 1, tT is the
terminal time.

In the following figure 2 you can see the growth behaviour for this model.

Figure 2 Behavior Growth rate CC Approach

Source: Excel Sheet 7 Intrinsic Valuation: Approach (CC)
Two-stage growth model: Firm Value and Equity Value

Step 3: Use growth rates to forecast cash flows with the formula (12)

(12)
Where: FCF t denotes free cash flow at period t, FCF t-1 is previous FCF and gt is
growth rate at period t.

Step 4: Calculate terminal cash flow or value with the formula (13)

(13)

Step 5: Calculate present value of FCF and Sum together with the formula (14)
 (14)
Where, Σ denotes summation, pvfcf is present value of free cash flow, Wacc is
weighted average cost of capital, t is determine a period.

Finally, calculating the firm value of the company and compare with market value, we
have the following table 8.

Table 9. Firm Value Single Stage

Source: Excel Sheet 5 (Intrinsic Valuation: Approach (CC)
Single-stage growth model: Firm Value and Equity Value)

Being the lowest market value than intrinsic value shows that the company is
undervalued for -5,82 although the difference is very small between the intrinsic
value and market value.

For the purpose of buying Mcdonalds, the valuation of the company and based on
the information that was found, we selected the single stage growth model because
shows that the market value is 146,816 millions that the intrinsic value is 181,025
millions. The real value is lowest that perception market so investors choose the
lowest value to buy.

B) CC APPROACH (FCFE)

For CC approach for free cash flow equity is similar to free cash flow, with the
difference that instead of wacc, we put ke as shown in the following formula (15)

​ (15)
Where: V Equity is Equity value; FCFF0 is the current free cash flow; g is the
expected constant growth rate of FCFF and; Ke is cost of equity.

Equity value is the value of the company's shares and loans that the shareholders
have made available to the company in this case the value is 126,281. Equity value
is overvalued too for 5,39%. In this case the investors would prefer to sell stocks
rather than buying. We can see in the table 9.

Table 10. Single Stage Equity Value

Source: Excel Sheet 5 (Intrinsic Valuation: Approach (CC)
Single-stage growth model: Firm Value and Equity Value WACC)

In the two stage growth model we calculating taking into account the following steps.
Step 1: Determine the terminal growth rate, as we already know the terminal growth
rate of free cash flow to equity is 4,13% we continue with the other steps.

Step 2: Determine growth rates in stage 1, we use the same formula (11)
The following figure show the behavior of growth rate.

Figure 3 Behavior Growth rate CC Approach

Source: Excel Sheet 7 Intrinsic Valuation: Approach (CC)
Two-stage growth model: Firm Value and Equity Value

Step 3: Use growth rates to forecast cash flows with formula (16)

F CF E t = F CF E t−1 (1 + g t ) (16)

Where, FCFE t denotes free cash flow to equity at period t, FCFE t-1 is previous free
cash flow to equity and gt is growth rate at period t.

Step 4: Calculate terminal cash flow or value with formula (17)

 (17)
Where: FCFE is free cash flow to equity at period 5, g5 is terminal growth rate, Ke is
cost of equity.

Step 5: Calculate present value of FCFE and Sum together with formula (18)

(18)
Where, denotes summatory, FCFEt is present value of free cash flow to equity to
determine t, Ke is cost of equity, t is determine a period.
Finally, we can calculate the equity value by comparing the two models of the CC
approach FCFE and analyze the equity value per share. The latter is calculated
divided by the number of common shares of McDonald's getting the Equity Value per
share that we compared with the stock price of Mcdonald's in the market. We can
see table 10.
Table 11. Comparison Equity Value
Source: Excel Sheet 5 (Intrinsic Valuation: Approach (CC)
Single-stage growth model: Firm Value and Equity Value)

The equity is overvalued for 5,39% for single stage growth model and the two stage
is undervalued for -3,73%. In the case of the equity valuation estimated by the use of
the cost of capital approach, we selected the single Stage Growth Model because
the estimation of this model considered variables required for objective valuation as
it was mentioned before, and the value of the Equity is overvalued for 5,39%. We
can see table

C) APV APPROACH (FCF)

Adjusted present value (APV) refers to the net present value (NPV) or investment
adjusted for the interest and tax advantages of leveraging debt provided that equity
is the only source of financing.The APV measures the profitability of a project or
investment in which tax deductions apply on the basis of debt financing through an
un-leveraged equity cash flow.

The APV approach intends to address two things:

1. One of the main drawbacks in the cost of capital model: that is WACC is constant.
But, WACC tends to be sensitive to variation in capital structure, new issue of debt
and tax rate.
2. Consider the benefit arising from debt finance separately: the interest-tax shield.

This approach also has two models, single stage growth model and two stage
growth model wich we will explain below.
Assumption of the ​single stage growth model​: value of unlevered firm assumes a
single stage constant growth of FCF. The approach is the same as the CC model,
except that WACC is replaced by but the cost of unlevered firm (ku).

Step 1: Estimate Value of Unlevered firm (Vu) with formula (19)

(19)
Where: Vu is the value of unlevered firm. g is growth rate, ku is the unlevered cost of
capital.

But before we can calculate the value firm, we need the unlevered cost of capital
(Ku) which we'll find with the unlevered beta ( β u ) with formula (20)

Step 1a:

​ (20)
Where: β u unlevered beta, is levered beta, Tc is corporate tax rate, D is debt of
market value, E is equity of market value.

And now we can calculate unlevered cost of capital with formula (21)

Step 1b:

(21)

Where: Ku is unlevered cost of capital or equity, rf is risk free rate, β u is unlevered

beta, rm is market return.

Once we have the results for the β u and Ku we can calculate the Vu as it is in the
formula (19) less common.

Step 2: Estimate Value of Debt Benefits with formula (22)

V d * Tc (22)
Where. Vd is the debt of market value, Tc is corporate tax rate

Step 3: Estimate Value of Bankruptcy Cost with formula (23)

dB = P robability to def ault + V u + B ankruptcy cost (23)

Where: dB is probability to default and Bankruptcy cost, Vu is value of unlevered of

firm.

Step 4: Calculate Firm Value with formula (24)

(24)

Where the Vu is the value of unlevered firm, Vd is the Market Value of Debt, Tc is
the corporate tax rate, d is the probability of default and the B is the present value of
Bankruptcy cost.

Table 12. ​APV Approach Single Stage Model

Source: Excel Sheet 8 (​Intrinsic Valuation: Adjusted Present Value Approach (APV)
Single-stage growth model: Firm Value)

The net present value of a project is 151,418 financed solely by equity plus the
present value of financing benefits. Reveals how much a business is worth, which is
useful in comparing firms with different capital structures since the capital structure
doesn't affect the value of a firm. The appropriate model is the single stage APV
because it shows the real value of the company, excluding unlevered, and also we
have been explaining that it is the right one through the decisions.

In the ​two stage growth model​; assumption the value of unlevered firm is based on
cash flow forecasts for both stages. Stage 1 with a defined period. Stage 2 with
indefinite period.
1. Cash flow in stage 1 will grow at varying rates for 5 years.
2. Cash flow in stage 2 will grow at a constant rate indefinitely.

Step 1: Determine the terminal growth rate, as we already know the terminal growth
rate of free cash flow to equity is 3,67% we continue with the other steps.

Step 2: Determine growth rates in stage 1, we use the same formula (11) and use
growth rates to forecast cash flows how formula 12.
The following figure show the behavior of growth rate.
 Figure 4 Behavior Growth rate APV Approach
Source: Excel Sheet 9 (Intrinsic Valuation: Adjusted Present
Value Approach (APV) Two-stage growth model)

Step 3: Calculate terminal cash flow or value with formula (25)

Value Terminal=​ ​ (25)

Where: FCFT is terminal free cash flow, g is growth rate, Ku is unlevered cost of
capital.

Step 4: Calculate present value of FCF and Sum together with formula (26)

(26)
Where: Σ is summatory, PVFCFt is prevent value of determine t, Ku is unlevered
cost of capital.

For the next two steps, they are calculated in the same way as we did in the single
stage growth model with formula 22 and 23.

Step 5: Calculate Firm Value with the same formula in the single stage growth model
(24). Finally we can compare both models in the approach as show in the table 12.
 Table 13. Comparison Firm Value APV Approach
Source: Excel Sheet 9 (Intrinsic Valuation: Adjusted Present Value
Approach (APV) Two-stage growth model: Firm Value)

The value firm for this model is 191,401 million. Compare intrinsic and market value
we can see the apv two stage is undervalued. Is for this reason than we choice the
single stage growth model is better for objective valuation which is buy. We can see
the intrinsic value is lowest than the two stage growth model, compare with the
market valued is overvalued for 16,36%.

RELATIVE VALUATION

Relative valuation is an approach of valuing a company by comparing that

company’s valuation multiples to those of its peers.The basic idea is that companies
with similar characteristics (same peer group) should trade at similar multiples, all
other things being equal.
For McDonalds we chose the following peer group, given the similar characteristic
different companies that also trades in the US stock market and are in the fast food
business as well as McDonalds.

Source of valuation data:

Market information: Stock markets and company databases for information about
stock prices and enterprise values.
Financial information: derived from financial statements (i.e.income statements,
balance sheets, cash flow statements) for value drivers.

Types of valuations multiples:

➢ Equity Value Multiples: used to estimate equity value.
➢ Enterprise Value Multiples: used to estimate firm value.

A) EQUITY VALUE

Equity multiples (also called Price Multiples) are valuation ratios that are based on
firm’s performance in generating returns to shareholders.

The structure of equity multiples is:

Numerator: Stock Price (Market information)
Denominator: Value drivers (Financial information)

Determine peer group as show in the table 13.

Table 14. Peer groups of McDonalds

Source: Excel Sheet 10 (Relative Valuation: Equity Value)

Value drivers:
Earnings per share (EPS)
Sales per share (SPS)
Book value per share (BPS)

The Equity Value information of McDonalds and its peer companies using Current
data is summarised in Table 14.

Table 15. Collection valuation data of McDonalds

Source: Excel Sheet 10 (Relative Valuation: Equity Value)

● Stocks of McDonalds on May 25th, 2020 were overvalued according to

valuation drivers of EPS, SPS the market price should be between $16,28
and $7,63 compared to market price of $186,32 per share.
● Stocks of KFC on May 25th, 2020 were undervalued according to valuation
drivers EPS, SPS, BPS the market price should be between $185,83 and
$2,13 compared to a market price of $1,98 per share.
● Stocks of Pizza Hut on May 25th, 2020 were overvalued according to
valuation drivers EPS and SPS the market price should be between $18,7
and $3,58 compared to a market price of $89,73 per share.
 ● Stock of Starbucks on May 25th, 2020 were overvalued according to valuation
drivers of EPS and SPS the market price should be between $3,04 and
$14,71 compared to a market price of $54,56 per share.
● Stock of Coca Cola on May 25th, 2020 were overvalued according to
valuation drivers of EPS and SPS the market price should be between $2,08
and $8,68 compared to a market price of $385,84 per share.
● Stock of Chipotle mexican grill on May 25th, 2020 were undervalued
according to valuation drivers of EPS, SPS and BPS, the market price should
be between $11,95 and $115,35 compared to a market price of $1,03 per
share.

We recommend the SPS is not BPS suitable due to negative earnings in McDonalds,
pizza hut and domino's pizza. For other hand, recommendation: Buy or hold for its is
focus is earnings and investment. McDonalds stocks should trade between $1,40
and $119,78 on 25th May 2020 based on PS and PB multiples ​(current and
average metrics)

Table 16. Collection valuation data of McDonalds

Source: Excel Sheet 10 (Relative Valuation: Equity Value)

B) ENTERPRISE VALUE

Enterprise value (EV) is a measure of a company's total value, often used as a more
comprehensive alternative to equity market capitalization. EV includes in its
calculation the market capitalization of a company but also short-term and long-term
debt as well as any cash on the company's balance sheet. Enterprise value is a
popular metric used to value a company for a potential takeover. The Enterprise
Value information of McDonalds and its peer companies using current data is
summarised in Table 18.

Table 17. Peer Group of enterprise value

Source: Excel Sheet 11 (Relative Valuation: Enterprise Value)
 Table 18. Collection valuation data of McDonalds
Source: Excel Sheet 11 (Relative Valuation: Enterprise Value)

McDonalds: should value between $119,307M and $222,640M on average on 24th

May 2020, based on EV/EBITDA and EV/Sales multiples (current and average
metrics).

McDonalds Undervalued
Market value: $185,47M
Relative Value
Minimum: $119,307M (Overr)
Maximum: $222,604(Under)
Average: $170,955 (Under)
Majority (Over-Under)
EBITDA (Under)

RISK-RETURN ANALYSIS
Is the relationship between the amount of return earned on an investment and the
amount of risk undertaken in that investment. The more return sought, the more risk
that must be undertaken. If the risk is higher the rate of return for the investor will be
higher too. The following risk helped McDonalds investors to determine the Rates of
Return for the money they invest.To have a more complete analysis on risk return, it
is necessary to calculate all the variables involved how: liquid, market, financial and
operational risk.

A) LIQUID RISK
Is the risk that a company or bank may be unable to meet short term financial
demands. This usually occurs due to the inability to convert a security or hard asset
to cash without a loss of capital and/or income in the process.

Table 19. Liquid Risk of McDonalds

Source: Excel Sheet 12 (Risk-return analysis)

An accounting ratio that indicates in the table 19 how good the liquidity or solvency
of the company is in the short term, using current assets and current liabilities, which
are the shortest term items on the balance sheet. If the acid test is less than one, it
would indicate excessively high current liabilities in relation to assets, and it would be
advisable to sell stocks to better cope with short-term debts how is the case of
Mcdonalds.
We can see that McDonald's by 2019 will decrease its surrounding assets compared
to its surrounding liabilities. This means that its percentage of financing is high The
Current Reason of McDonald's says that the company cannot pay its debt because
the current liabilities are more than its current assets in the 2019, as well as its
reflected in the result of the Net Working Capital. Also, the Acid test says that
McDonald's will need to use the inventories to pay the total of its current liabilities..

B) MARKET RISK

Market risk is the risk that the value of an investment will decrease due to changes in
market factors. These factors will have an impact on the overall performance on the
financial markets and can only be reduced by diversification into assets that are not
correlated with the market – such as certain alternative asset classes.

Market risk is sometimes called “systematic risk” because it relates to factors, such
as a recession, that impact the entire market.

Table 20. Market Risk of McDonalds

Source: Excel Sheet 12 (Risk-return analysis)

The beta of McDonalds, as it is shown on Table 20 is 0,86 when the β is between 0

and 1, it means that McDonalds moves in the same direction as the market, so it
has less volatility, all of the above says that McDonalds is not heavily affects by
changes such as recession, inflation, and interest rates changes.

C) CREDIT RISK
Credit risk is the risk of loss that may occur from the failure of any party to abide by
the terms and conditions of any financial contract, principally, the failure to make
required payments on loans due to an entity. Credit risk allows a company to
analyzed that it is not necessary for the company to finance their entire activities with
their own resources, but can leverage on other resources, such as loans.

The total indebtedness company indicates the amount of company assets being
transferred to company debts, which in the case of Mcdonalds decreased compared
to 2018. On the other hand their long term debts also decreased of 1,583 to 1,446.
In the table 21 you can see more variables involved in this risk.

Table 21. Credit Risk of McDonalds

Source: Excel Sheet 12 (Risk-return analysis)

D) FINANCIAL RISK

Financial risk can be defined as the probability of some event occurring with negative
financial consequences for the organization. From an investor's point of view,
financial risk refers to the lack of security conveyed by future returns on investment.
The gross profit margin of McDonalds indicates that after discounting the operational
expenses we got a 52,7 of the Sales as the gross profit.The Return on assets is a
profitability ratio that provides how much profit a company is able to generate from its
assets. In other words, return on assets (ROA) measures how efficient a McDonald's
management is in generating earnings from their economic resources or assets on
their balance sheet. In the 2019 decrease this return of asset. However, the
operating profit margin is at 43% thanks to the profits of the operation and its sales.
In the table 22 you can see more variables involved in this risk.

Table 22. Financial Risk of McDonalds

Source: Excel Sheet 12 (Risk-return analysis)
 E) OPERATIONAL RISK

The operational risk of a company relates to its day to day activities. In the Case of
McDonalds the collection period is 38 days and they spend 1839 days to sell all their
inventories and transform into cash or receivables, so by the time they are going to
pay to its suppliers the company already rotate the inventory many times, so that
mean they wont have problem to pay to the suppliers decrease the days of payable
rotations from 43 to 36. And the operational cycle increase a little with respect 2018.
The data can be seen in Table 23
 Table 23. Operational Risk of McDonalds
Source: Excel Sheet 12 (Risk-return analysis)

CONCLUSIONS AND RECOMMENDATIONS

To start, McDonalds is a company that has a high market value and is commonly
expected in companies as large as these. the company is very competitive in its
home market, where it is financially outperformed only by Domino's pizza company
and by Coca-Cola. Going deeper into the financial issue of McDonalds, this company
has a relatively low WACC because it has a low cost of debt. The cost of equity is
very beneficial to both the company's financing and to investors.

McDonalds is a good company to invest in because it has financial stability. The

market in which it operates has a low volatility. The market risk is moderate. The
company has good profitability and cash flows that can guarantee profits for
investors.
Based on the above data, McDonalds has proven to be a great company. Looking at
its history, since its inception it has had great public acceptance and it has continued
to stand up to strong competition such as those mentioned above. For this reason,
investors continue to look to make their large investment in this franchise.

In the recommendations At 2.78% of the FCF our objective is to buy, because the
growth rate is low, which means that the shares are cheaper in the stock market,
making them more affordable for us as investors and because we want to increase
the value of the firm. In the 6.69% of the FCFE our objective is to sell, because the
growth rate is high, which translates into a higher profit on the sale of the stock as an
investor. On the other hand, to stabilize the high value of the firm. On the other hand,
this company is attractive for investment because the value of the firm without
leverage is high based on the results obtained in the APV Approach and also
because it shows a better plane for decision making based on free cash flow
forecasts and the time of recovery of the investment. Finally, we recommend that
McDonalds take advantage of the low WACC and campaign to attract investors and
to take on more debt for the growth and momentum of the company. This will make
the company more competitive in the marketplace and outperform the competitors
that outperform the company.

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