Chapter 13 Equity Valuation Valuation by Comparables Book Value o Value of common equity on balance sheet o Based on historical values of assets and liabilities o Not always favorable for market value of equity Market Value o Current market value of assets minus current market value of liabilities o Market value based on stock price o Better than book value Liquidation Value Replacement cost o Net amount realized from sale of assets and paying off all debt o Replacement cost of the assets minus liabilities o Tobin s Q market value replacement cost o Tobin should almost equal 1 MV should be almost the same as RC Intrinsic Value vs Market Price gains or losses Expected Holding Period Return return on a stock investment compromises cash dividends and capital o Expected HPR E r E d E P1 P0 P0 o Expected HPR expected dividend expected price current price current price Required Return with CAPM o k Rf B Rm Rf o If stock is priced correctly required return should equal expected return k HPR Intrinsic Value o V0 E D1 E P1 1 k k E r use CAPM to find k o Value expected dividend expected price 1 expected return o If V0 P0 Buy V0 P0 Sell V0 P0 Hold Dividend Discount Models Basic Dividend Discount Model V0 Dt 1 k t V0 D0 1 k D2 1 k 2 D3 1 k 3 Value sum of dividend in time t divided by 1 required return No Growth Model perpetuity V0 D k Value constant dividend required return Constant Growth Model V0 D0 1 g k g or V0 D1 k g use CAPM to find k Comparing Value Returns o No growth stock given V0 and D find k V1 V0 k V1 V0 D V0 o Constant growth stock given V0 and D0 find V1 then k V1 Dx 1 g 2 k g k V1 V0 D V0 Stock Prices and Investment Opportunities growth rate ROE x b ROE x retention rate retention rate 1 payout ratio will be given o Cash Cow company not expected to grow Given E1 D1 b k g Find VCC D1 k g Given E1 D1 b k Find g ROE x b VGP D1 k g Present Value of Growth Opportunities PVGO o Growth Prospects company expected to grow and pay dividends o PVGO is the difference between V with growth and V without growth o PVGO D1 k g D k Multi Stage Growth Rate Model Finding the value of a firm with two different growth rates Given D0 g1 g2 k T T number of periods of growth at g1 2 DT k g2 1 k T o V0 D1 1 k D2 1 k o If given ROE and b find g o use CAPM to find k o lower b lower k lower V P E Ratio Growth Opportunities With positive growth o g ROE x b o Constant growth P0 E1 1 b k g o No Growth P0 E1 1 k V0 P E xE1 Free Cash Flow Valuation Approaches FCF EBIT 1 T depreciation capex NWC Equity Value firm value MV of Debt o Firm Value CF1 1 k CF2 1 k 2 TV 1 k T o TV FCFFT 1 k g
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