Discount Cash Flow Model

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To select comparable firms for the target firm with the similar characteristics, we cross-check a list of main competitors of European postal operators(Austrian Post, Bpost, Post NL and Deutsche Post-DHL). Figure2. Group revenue of selected companies
We can clearly see that the most of group revenue from Austrian Post, Bpost and Post NL are dependent on the domestic mail, which these firms have similar business models with the Royal Mail. And as the German mail and logistics giant, although Deutsche Post-DHL’s main revenue resource is from the logistics business. However, its market cap is generally several times larger than the other European postal operators which this firm’s performance will likely to affect the Royal Mail pricing locally.
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The Discount Cash Flow Model
We find that the most of analyst reports has the cash flow analysis for financial forecasting. And this particular financial statement is not only concerned on the volumes of cash flows but the timing of flows which therefore the DCF model might be more fairly reflects these flows on the share prices. The DCF model is based on the equity value equals to the enterprise value minus the debt value. Especially the enterprise value is the present value of the future free cash flow. We shows the computational formula of equity value per ordinary share by the following equation:

We applied for the relevant data of free cash flow from the UBS analyst report(2013) around the IPO date. And also use the ratios on the weighted average cost of capital(WACC) and terminal growth rate is 8.3% and 0.5% respectively. Additionally, we applied for the amount of average diluted shares of 1,000m.
Therefore, in the end, we use DCF model to replicate the offer price and this yields an equity value per share of £4.13. And the detailed calculations for this discounted model shows in the Appendix B.

Evaluation of key
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At first, we can clearly see that these forecasted free cash flows is improved gradually. The analyst said that the Royal mail’s cash flows were performed weak historically. But it can be increased in recent years with better profitability. There are quite a lot factors(UBS, 2013) affected the future free cash flow performance. For example, due to the +£150m change in working capital in 2014 and the future years’ working capitals are more likely to be changed slightly. Moreover, the lower capital expenditure in future years also can be an evidence of improved trend of free cash flow. Therefore, if we applied for this series of free cash flow in the discount model, these inputs can effectively show the intrinsic value of Royal mail. Terminal value
In my discount model, the terminal growth rate is 0.5% and the WACC rate is 8.3%, with the group EBIT margin of 6.5%. For the estimation of terminal value, we applied for a constant growth formula which equals to the 2017FYE’s forecasted FCF divided by the difference between discount rate and terminal growth rate(g). Except the justified estimated FCF in 2016, the UBS Research thinks that the WACC and g are both not out of line, which compares the assumptions with RMG’s postal competitors. Thus, this calculation of terminal value can close to the offer

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