lec13-14-DCF-3pp

lec13-14-DCF-3pp - Fin406 Spring 2010 Smeal College of...

Info iconThis preview shows pages 1–4. Sign up to view the full content.

View Full Document Right Arrow Icon
Fin406 – Spring 2010 Smeal College of Business Penn State University 2/24/2010 ©2010 JingZhi Huang 1 Lectures 13 and 14: Discounted Cash Flow Models Fin 406 - Spring 2010 Professor Jingzhi Huang Smeal College of Business Penn State University Copyright © 2010 JZH I. Equity Valuation Models Balance sheet models Company Industry Economy Market •Strategy •Products •Valuation •Financial Fundamental Analysis Technical Analysis Quantitative Analysis •GDP •Employment •Inflation •FX •Stock •Bonds •Life Cycle •Cyclical? •Competition EmIC Framework 2 Book value Liquidation value Tobin’s Q = firm’s market value/replacement cost The discounted cash flow (DCF) approach Dividend discount models Free cash flow models The relative valuation approach The option pricing approach Discounted Cash Flow Valuation In DCF valuation, the (intrinsic) value of an asset is the present value of the expected CFs on the asset t 1 t t t t 0 k 1 CF V value) (intrinsic 3 Intrinsic vs. market value Trading signals Three components of DCF models The life cycle of asset (one- or multi-stage models) Future cash flows to asset ( CF t is the cash flow in period t) Rates used to discount the future CFs ( k t is the discount rate for CF t ) and usually estimated by the CAPM
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Fin406 – Spring 2010 Smeal College of Business Penn State University 2/24/2010 ©2010 JingZhi Huang 2 II. Dividend Discount Models In DDM, CFs to equity are assumed to be dividend payments One limitation of DDMs : dividends are not a good measure of CFs for many firms 4 Dividends are often estimated by using a dividend-growth model E.g. dividends grow at a constant rate during a particular stage of the firm Use different growth rates for different stages A. One-Stage DDMs Assumptions of the model: One discount rate, denoted k Dividends grow at a constant rate g. also called the Gordon model or constant/stable growth models 5 The equity value at time-0 is given by D 0 : estimated based on financial statements k: estimated using the CAPM g: the most difficult one to estimate here (2) g k g ︶︵ 1 D g k D V 0 1 0 Applications Stock paying constant dividends (zero growth) E.g. preferred stock k D V 0 0 6 Suppose a preferred stock pays a $1.00 DPS and the stock has a required return of 10%. The value of the preferred stock = $1/0.1=$10 Stock of a mature firm (in stable growth), with the following characteristics The beta, leverage, and dividends are reasonably stable over time
Background image of page 2
Fin406 – Spring 2010 Smeal College of Business Penn State University 2/24/2010 ©2010 JingZhi Huang 3 Example 1: Con Ed (2003) This is a stable company and probably one of the few cases where the use of a DDM can be justified Data on Con Ed on 12/31/2003: Dividends/share (for last 4 quarters) D 2003 = $2.24
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
Image of page 4
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 12

lec13-14-DCF-3pp - Fin406 Spring 2010 Smeal College of...

This preview shows document pages 1 - 4. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online