applied hw 6 - Siming Zhu AEM 4230 Applied Finance November...

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Siming Zhu AEM 4230 – Applied Finance November 6, 2008 Homework #6 4. Was the technique HP executives used the same or comparable to traditional DCF analysis? Do you believe that HP paid a reasonable price for Compaq? Are there any valuation implications attached to HP’s P/E ratio being 16 rather than 20? The valuation technique used by HP executives was comparable to traditional DCF analysis. In valuing a company using traditional DCF analysis, one would first project the future cash flows generated and then discount the cash flow projections to obtain the present value by using the weighted average cost of capital as the discount rate. HP executives started off their valuation by projecting a combined net income of $4.2 billion and a perpetual after tax cost savings of $1.5 billion per year. The $1.5 billion annual cost saving was then capitalized using a P/E ratio of 20 (HP’s historic P/E) to arrive at a future value of $29.4 billion. The $29.4 billion future value was then discounted using a discount rate of 15% to arrive at the present value of net after-tax cost savings of $21.2 billion. HP’s valuation method was similar to traditional DCF in that HP took account of
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applied hw 6 - Siming Zhu AEM 4230 Applied Finance November...

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