1 / 20

Valuation Equations

Valuation Equations. or what’s happening inside the computer. forecasted financial statements. Define net dividends D t so that CE t = CE t-1 + NI t – D t , or D t = NI t – (CE t – CE t-1 ). Value is determined by your forecasts!. DCF to Common Equity Model where

ingrid-brewer
Download Presentation

Valuation Equations

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Valuation Equations or what’s happening inside the computer

  2. forecasted financial statements Define net dividends Dt so that CEt = CEt-1 + NIt – Dt, or Dt = NIt – (CEt – CEt-1). Value is determined by your forecasts!

  3. DCF to Common Equity Model where Dt is the net cash distributions to equity holders, or free cash flow to common equity, computed as NIt – (CEt – CEt-1), and re is the cost of equity capital.

  4. Four Models – One Value

  5. Define residual income RI = NI – r CE . (NI = RI + r CE ) t t e t - 1 t t e t - 1 Start with D = NI – (CE – CE ) and substitute in RI to get t t t t - 1 t D = CE – CE + RI + r CE . t t - 1 t t e t - 1 future D Substitute this for all in the dividend discount model to get t ¥ å ( ) - t . = + - + + P ( 1 r ) CE CE RI r CE - - e e t 1 t t e t 1 = t 1 ¥ CE CE CE CE å - t 1 1 2 2 = + + - + - + - P ( 1 r ) RI CE ..... e e t 0 + + 2 2 + + 1 r 1 r ( 1 r ) ( 1 r ) e e = e e t 1 ¥ å - t . = + + P CE ( 1 r ) RI e 0 e t = t 1 Residual Income to Common Equity Model

  6. Price equals the current book value plus the discounted sum of expected future residual income (abnormal earnings). • Advantages over cash flow models: • business, accounting and financial analysis are all in terms of accounting numbers. • 2) avoids having to "undo" the accounting to get to dividends or free cash flow - estimate value using the accounting numbers directly.

  7. DCF to All Investors Free Cash Flow to All Investors can be computed from Income statement and Balance sheet data as Ct = NOIt – (NOAt – NOAt-1). Free Cash Flow to All Investors can be computed from Statement of cash flow data as Ct = Dt + It(1-txt) - DLt + PDt - DPSt. To common equity holders To debt holders (net of tax shield) To preferred stockholders

  8. …and the two equations are equivalent! Ct = NOIt – (NOAt – NOAt-1). = NIt + It(1-txt) + PDt – (CEt +Lt+PSt – CEt-1 –Lt-1-PSt-1) = NIt – (CEt – CEt-1) + It(1-txt) - DLt + PDt – DPSt = Dt + It(1-txt) - DLt + PDt - DPSt.

  9. 3 ways to compute FCF • NOI – DNOA is easy • from the SCF, note that • CFO + CFI + CFF = Dcash (CFI and CFF usually negative) • compute FCF = CFO + CFI – Dcash + I(1-t). • compute FCF = – CFF + I(1-t). • See Cash Flow Analysis sheet in eVal. • OR use the “traditional” approach…

  10. The Traditional FCF recipe for the DCF model is NOI DNOA But it works out to be exactly the same as my accounting-based formula.

  11. DCF to All Investors Value to Common Equity Pe = Pf – Pd – Pps Value to all investors Value to debtholders Value to preferred stockholders

  12. Where did all the money go? Ct = Dt + It(1-txt) - DL + PDt - DPSt.

  13. RI to All InvestorsRNOIt = NOIt – rwNOAt-1. Value to Common Equity Pe = Pf – Pd – Pps Value to all investors Value to debtholders Value to preferred stockholders

  14. Discount Rates and Present Value Computations • What is the cost of equity capital, debt capital and preferred capital? • What is the after-tax weighted average cost of capital? • How do we compute the present value of a perpetuity?

  15. The Cost of Equity Capital • Must capture time value of money and risk • CAPM re = rf + B(rm-rf) rf between 4% and 6% rm-rf between 5% and 8% B from http://finance.yahoo.com/ under key statistics • SIZE model re = rf + rsize

  16. Size Model re = rf + rsize

  17. One standard deviation variation in risk premium and beta, assuming rf = 5.2% • risk premium 2.5%, beta=.88 re = 7.4% • risk premium 7.9%, beta = 1.12 re = 14.0% maybe we should just use 10%!

  18. WACC • tx is the firm’s estimated effective tax rate, • re is the firm’s estimated cost of equity capital, • rd is the firm's estimated cost of debt capital, • rps is the firm's estimated cost of preferred stock capital, • Pe is the resulting value of the firm’s common equity, • Pd is the resulting value of the firm’s debt, and • Pps is the resulting value of the firm’s preferred stock.

  19. So you think you understand the perpetuity formula??? But which sequence does this apply to? t0 t1 t2 t3 t4 pmt pmt(1+g) pmt(1+g)2 ………………….. pmt pmt(1+g) pmt(1+g)2 ….. pmt(1+g) pmt(1+g)2 pmt(1+g)3 …..

  20. DCF to equity using perpetuity formula finite horizon value terminal value = PV at of time 0 of perpetuity of payments, growing at rate g, starting with DT+1 .

More Related