Sensitivity Analysis

According to the multi-staged DCF model applied in this thesis, the valuation of a company is determined by the present value of future cash flow. Therefore, only the free cash flow to the firm, WACC and the terminal growth rate affect the valuation. Our decision to use a reverse-engineered model lets us avoid the difficulties of forecasting future cash flow which is given by the unlevered free cash flow as of 01.01.2021. However, WACC and the terminal growth rate (g) are underlying parameters that had to be assumed, and therefore involve a degree of uncertainty. The sensitivity analysis in this section aims to display consequences of how changes in these factors will affect the valuation and subsequently, the implied growth rate.

As the provided literature review suggests, changes in interest rates will affect valuations indirectly through the risk-free rate in WACC. At time of writing, investors are particularly worried about how an increase in interest rates will affect the equity market. A higher risk-free rate will increase the cost of equity (as calculated using CAPM), which influences WACC. As discussed, growth stocks are especially sensitive to such changes because a significant share of the stock’s valuation is in its future investments. The growth rate in the terminal period, which may be estimated by past

96 GDP-levels, is an indication of overall economic growth in the terminal period, and the parameter is therefore highly affected by macroeconomic factors.

Tables 11 and 12 display sensitivity analyses of the WACC and terminal growth rate and shows how different levels of these variables affect the implied growth rates of our case companies, given a constant growth rate during the forecast period and the share prices as of 01.01.2021. The row input cells contain different levels of WACC and changes by 0,25 percentage points in both directions. Similarly, in the columns are terminal growth rates with the same variations. A lower implied growth rate must be viewed positively in the reverse-engineered model, as the requirement for future growth is reduced.

In Appendix 5, we include a sensitivity matrix illustrating the effect of various levels of these variables on the fundamental share prices of our case companies, assuming a constant implied growth rate equal to the share prices on 01.01.2021.

6.4.1 Microsoft

WACC

$ - 5,51 % 5,76 % 6,01 % 6,26 % 6,51 % 6,76 % 7,01 % 7,26 %

Terminal Growth

Rate

3,75 % -1,75 % -0,34 % 0,93 % 2,10 % 3,19 % 4,20 % 5,15 % 6,06 % 3,50 % -0,56 % 0,71 % 1,88 % 2,96 % 3,98 % 4,93 % 5,83 % 6,69 % 3,25 % 0,50 % 1,66 % 2,74 % 3,75 % 4,70 % 5,61 % 6,46 % 7,28 % 3,00 % 1,44 % 2,52 % 3,53 % 4,46 % 5,38 % 6,23 % 7,05 % 7,84 % 2,75 % 2,30 % 3,31 % 4,26 % 5,15 % 6,01 % 6,82 % 7,61 % 8,36 % 2,50 % 3,09 % 4,03 % 4,93 % 5,78 % 6,59 % 7,38 % 8,13 % 8,85 % 2,25 % 3,81 % 4,70 % 5,55 % 6,37 % 7,15 % 7,90 % 8,62 % 9,32 %

Table 11: WACC and Terminal Growth Rate – Impact on Implied Growth Rate Source: Bjørnson & Hauer (2021)

Table 11 illustrates that by decreasing WACC with 0,5 percentage points, all else being equal, the implied growth rate decreases by 1,94 percentage points. The interpretation of this is that Microsoft is required to generate an annual growth in FCFF of 1,94 percentage points less if this change in WACC is applied in the model.

97 In a worst-case scenario – if WACC increases by 1 percentage point and g reduces by 0,75 percentage point – Microsoft must grow its FCFF annually by 9,32% which is 4,86 percentage points higher than what the original assumptions suggest. In the opposite corner of the matrix, a low WACC and a high terminal growth rate imply an annual growth rate of -1,75%. In this case, Microsoft may be able to withstand an annual decline in FCFF and still defend the valuation's fundamentals in this scenario.

The WACC and terminal growth rate are subject to uncertainty, and margins of error must be considered. By adding a margin of +- 0,75 percentage points to the terminal growth rate and use a WACC range of 5,51% to 7,26%, we estimate that Microsoft's "actual" implied growth rate is between -1,75% and 9,32%. This range is quite large and demonstrates the model's sensitivity to changes in the variables. Figure 25 illustrates the impact of these scenarios on the FCFF in absolute dollars, demonstrating that in the worst-case scenario, Microsoft would need to generate an FCFF of USD 107,6 billion in 2030 to justify its current share price, compared to just USD 37,019 billion in the best-case scenario.

Figure 25: Microsoft Scenario Analysis Source: Bjørnson & Hauer (2021)

98 6.4.2 ZOOM

WACC

$ - 5,51 % 5,76 % 6,01 % 6,26 % 6,51 % 6,76 % 7,01 % 7,26 %

Terminal Growth

Rate

3,75 % 12,51 % 14,17 % 15,68 % 17,06 % 18,35 % 19,56 % 20,69 % 21,77 % 3,50 % 13,93 % 15,43 % 16,81 % 18,10 % 19,30 % 20,44 % 21,51 % 22,53 % 3,25 % 15,18 % 16,56 % 17,85 % 19,05 % 20,18 % 21,25 % 22,27 % 23,25 % 3,00 % 16,31 % 17,59 % 18,79 % 19,90 % 20,99 % 22,01 % 22,19 % 23,92 % 2,75 % 17,34 % 18,54 % 19,67 % 20,74 % 21,75 % 22,73 % 23,66 % 24,56 % 2,50 % 18,28 % 19,41 % 20,48 % 21,49 % 22,47 % 23,40 % 24,30 % 25,16 % 2,25 % 19,15 % 20,22 % 21,23 % 22,20 % 23,14 % 24,03 % 24,90 % 25,74 %

Table 12: WACC and Terminal Growth Rate – Impact on Implied Growth Rate Source: Bjørnson & Hauer (2021)

By decreasing WACC with 0,5 percentage points, all else being equal, the implied growth rate decreases by 2,31 percentage points. The interpretation of this is that Zoom is required to generate an annual growth in FCFF of 2,31 percentage points less if this change in WACC is applied in the model. The analysis also shows that in worst case – if WACC increases by 1 percentage point and g reduces by 0,75 percentage point – Zoom must grow its FCFF annually by 25,74% which is 5,84 percentage points higher than what the original assumptions suggest. Contrary, in the opposite corner of the matrix, is the best-case scenario which implies an annual growth rate of 12,51% – 7,39 percentage points less than original assumptions.

There is evidence that the fundamental share price and consequently the implied growth rate are quite sensitive to changes in both WACC and the terminal growth rate. With all the uncertainty associated with the underlying assumptions, it is reasonable to believe that the “correct” implied growth rate lies anywhere within the attached matrix. That being said, we think it is more likely that it is in the right half of the table, i.e., somewhere between 17,06% and 25,74%. The uncertainty connected to the WACC-calculation is primarily related to the cost of equity which is calculated using the CAPM. The risk-free rate used in the calculation is at historic low levels, and the calculated beta of Zoom is based on an industry average of 0,8632. Due to Zoom's characteristics of being a young company experiencing rapid growth, the company is riskier than value stocks such as Microsoft because their value is strongly linked to the uncertainty of future opportunities (Miller & Modigliani, 1961). Based on this reasoning, we think the Zoom’s long-term WACC is more likely to be higher than our base-case, rather than lower.

99 Nevertheless, figure 26 illustrates the impact of these scenarios on the FCFF in absolute dollars, demonstrating that in the worst-case scenario, Zoom would need to generate an FCFF of USD 7,44 billion in 2030 to justify its current share price, compared to just USD 2,45 billion in the best-case scenario.

Figure 26: Zoom Scenario Analysis Source: Bjørnson & Hauer (2021)

100