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Chap013_New - Chapter 13 - Equity Valuation CHAPTER 13...

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Chapter 13 - Equity Valuation CHAPTER 13 EQUITY VALUATION 1. Theoretically, dividend discount models can be used to value the stock of rapidly growing companies that do not currently pay dividends; in this scenario, we would be valuing expected dividends in the relatively more distant future. However, as a practical matter, such estimates of payments to be made in the more distant future are notoriously inaccurate, rendering dividend discount models problematic for valuation of such companies; free cash flow models are more likely to be appropriate. At the other extreme, one would be more likely to choose a dividend discount model to value a mature firm paying a relatively stable dividend. 2. It is most important to use multi-stage dividend discount models when valuing companies with temporarily high growth rates. These companies tend to be companies in the early phases of their life cycles, when they have numerous opportunities for reinvestment, resulting in relatively rapid growth and relatively low dividends (or, in many cases, no dividends at all). As these firms mature, attractive investment opportunities are less numerous so that growth rates slow. 3. The intrinsic value of a share of stock is the individual investor’s assessment of the true worth of the stock. The market capitalization rate is the market consensus for the required rate of return for the stock. If the intrinsic value of the stock is equal to its price, then the market capitalization rate is equal to the expected rate of return. On the other hand, if the individual investor believes the stock is underpriced (i.e., intrinsic value < price), then that investor’s expected rate of return is greater than the market capitalization rate. 4. MV = 10 + 90 = 100 mil BV = 10 + 60 – 40 = 30 mil MV / BV = 100 / 30 = 3.33 5. g = .6 x .10 = .06 price = 2 / (.08 - .06) = 100 P/E = 100 / 5 = 50 6. k = .04 + .75 (.12-.04) = .10 Price = 4 / (.10 - .04) = 66.66 7. Price with no growth = 6 / .10 = 60 g = .60 x .15 = .09 Price with growth = 2.40 / (.10 - .09) = 240 PVGO = 240 – 60 = 180 13-1

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Chapter 13 - Equity Valuation 8. 300 EBIT 105 -Taxes 195 Net Income 20 + depreciation 60 - CapEx 30 - increase in WC 125 FCF 9. FCFE = 205 – 22 x (1 - .35) + 3 = 193.70 Value = 193.70 / (.12 - .03) = \$2,152.22 10. P = \$2.10/0.11 = \$19.09 11. High-Flyer stock k = r f + β (k M – r f ) = 5% + 1.5(10% – 5%) = 12.5% Therefore: 41 . 29 \$ 04 . 0 125 . 0 50 . 2 \$ 1 0 = - = - = g k D P 12. a. False. Higher beta means that the risk of the firm is higher and the discount rate applied to value cash flows is higher. For any expected path of earnings and cash flows, the present value of the cash flows, and therefore, the price of the firm will be lower when risk is higher. Thus the ratio of price to earnings will be lower. b.
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This note was uploaded on 04/22/2010 for the course BUS BUS 136 taught by Professor Sukwonthomaskim during the Spring '10 term at UC Riverside.

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Chap013_New - Chapter 13 - Equity Valuation CHAPTER 13...

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