CH. 8 PROSPECTIVE ANALYSIS: VALUATION IMPLEMENTATION

1. CH. 8PROSPECTIVE ANALYSIS: VALUATION IMPLEMENTATION

2. Computing a Discount Rate • Weighted average cost of capital (WACC): weighting the costs of debt and equity capital according to their respective market values • Market value for debt: use book value • Market value of equity: “insert” target ratios of debt to capital and equity to capital. • Estimating the cost of debt: interest rate on the debt (net-of-tax) • Estimating the cost of equity: use Capital Asset Pricing Model (CAPM)

3. Terminal Values • Remain constant • Grow at the assumed sales growth rate • Using multiple • Selecting terminal years: usually 5-10 year forecast horizon

4. Dealing with Accounting Distortions • Self correcting nature of double-entry bookkeeping, estimated values will not be affected by accounting choices, as long as the analysts recognizes the accounting distortions

5. Dealing with Negative Book Values • Makes it difficult to use the accounting-based approach to value a firm’s equity • Approach to handle this problem: • Value the firm’s assets rather than equity • “Undo” accountants’ conservatism by capitalizing the investment expenditures written off • Start from the observed stock and work backwards