WEEK 10 .pptx

# WEEK 10 .pptx - Financial Statement Analysis and Security...

• 45

This preview shows page 1 - 9 out of 45 pages.

Financial Statement Analysis and Security Valuation Pricing Book Values May 3, 2018

Subscribe to view the full document.

What You Will Learn From This Chapter What “ residual earnings ” is How forecasting residual earnings gives the premium over book value and the P/B ratio What is meant by a “normal price-to- book ratio” How residual earnings are driven by return on common equity (ROCE) and growth in book value How residual earnings valuation protects the investor from paying too much for earnings added by investment 5-2
Price-to-Book Ratio The value of the shareholders’ investment – and the value of the net assets- is based on how much the investment is expected to earn in the future. P/B ratio: the higher the expected earnings relative to book value, the higher the P/B ratio. The rate of return on book value, or profitability, is a measure that features in the determination of P/B ratio. P/B ratios should increase only if earnings from investment yield a return that is greater than the required return on book value.

Subscribe to view the full document.

The Big Picture for the Chapter Value = Anchor + Extra Value The Anchor is Book Value: Value = Book Value + Extra Value The Principle for adding extra value to book value: Add extra value if the rate of return of book value is expected to be greater than the required return 5-4
Valuing a One-Period Project (1) 5-5 Investment \$400 Required return 10% Revenue forecast \$440 Expense forecast \$400 Forecasted earnings \$40 Residual earnings 1 = earnings 1 – (required return x investment) = 40 (0.10 x 400) = 0 Value = 400 + 0/1.10 This is a Zero-residual earning (RE) project = 400 DCF Valuation: Discount cash flow (s c h p d n nhà đ u t ) ư 400 10 . 1 440 V

Subscribe to view the full document.

Valuing a One-Period Project (2) Investment \$400 Required return 10% Revenue forecast \$448 Expense forecast 400 Earnings forecast \$ 48 The project adds value 5-6 1 Residual earnings 48 - (0.10 x 400) = 8 8 Value Project 400 407.27 1.10 27 . 407 1.10 448 value DCF
Valuing a Savings Account (or stock) p.143 Value = Book Value + Present Value of Residual Earnings = 100 + 0 = 100 Forecast Year ________________________________________ 2012 2013 2014 2015 2016 2017 Earnings withdrawn each year (full payout) Earnings 5 5 5 5 5 Dividends 5 5 5 5 5 Book value 100 100 100 100 100 100 Residual earnings 0 0 0 0 0 ______________________________________________________________________________________ No withdrawals (zero payout) Earnings grows 5% (required rate of return) every year Earnings 5 5.25 5.51 5.79 6.08 Dividends 0 0 0 0 0 Book value 100 105 110.25 115.76 121.55 127.63 Residual earnings 0 0 0 0 0 ______________________________________________________________________________________ 5-7 Required rate=5% t t t t d ea rn B B  1

Subscribe to view the full document.

Lessons from the Savings Account 1. An asset is worth a premium or discount to its book value only if the book value is expected to earn non- zero residual earnings. 2. Residual earnings techniques recognize that earnings growth does not add value if that growth comes from investment earning at the required return.
• Fall '16
• Jane

{[ snackBarMessage ]}

### What students are saying

• As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

Kiran Temple University Fox School of Business ‘17, Course Hero Intern

• I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

Dana University of Pennsylvania ‘17, Course Hero Intern

• The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

Jill Tulane University ‘16, Course Hero Intern