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Chapter 12

Chapter 12. Valuation: Accounting-Based Earnings. Valuation: Earnings-Based. As opposed to Discounted Cash Flows Derived from PV of dividends Dividends from cash flow to the firm Therefore, Leveraged FCF So, substitute earnings for FCF Why?. Why Earnings?. Long-term approximates Lev FCF

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Chapter 12

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  1. Chapter 12 Valuation: Accounting-Based Earnings

  2. Valuation: Earnings-Based • As opposed to Discounted Cash Flows • Derived from PV of dividends • Dividends from cash flow to the firm • Therefore, Leveraged FCF • So, substitute earnings for FCF Why?

  3. Why Earnings? • Long-term approximates Lev FCF • Either no growth, or • Constant earnings growth multiple • Accrual reflect EVA • Therefore, P0 =PV of Earnings

  4. Valuation • P-E ratio • examine relationship of “P” to “E” • understand limitations: • risk • growth • permanent earnings • accounting impact

  5. More Valuation • Price to Book Value P0 = sum[(Exp ROCEt x BVt)/(1 + r)t] • If a company can generate an excess return over its cost of capital forever, P/BV = 1 + (Exp ROCEt-1 – r)/(r - g) where g is growth rate of earnings Thus, P/BV is a function of expected level of profitability relative to the required rate of return and growth in the BV of common shareholders’ equity

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