Chapter_05 - Accrual Accounting and Valuation: Accrual...

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Unformatted text preview: Accrual Accounting and Valuation: Accrual Accounting and Valuation: Pricing Book Values Pricing Book Values Chapter 5 Chapter 5 Accrual Accounting and Valuation: Accrual Accounting and Valuation: Pricing Book Values Pricing Book Values Chapter 4 showed how accrual accounting modifies cash accounting to produce a balance sheet that reports shareholders equity. However, Chapter 2 also explained that the book value in the balance sheet does not measure the value of shareholders equity, so firms typically trade at price-to- book ratios different from 1.0. This chapter shows how to estimate the value omitted from the balance sheet and thus how to estimate intrinsic price-to-book ratios. Chapter 6 compliments this chapter. While Chapter 5 shows how to price the book value of equity, the bottom line of the balance sheet, Chapter 6 shows how to price earnings, the bottom line of the income statement Go to the web page for more applications of the techniques in this chapter How does the analysts infer the markets assessment of fundamentals? How are strategies evaluated? How is the firm valued by forecasting income statements and balance sheets? How are premiums over book value determined? Link to previous chapter This Chapter Link to next chapter Link to web page What you will Learn from this Chapter 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 The difference between a Case 1, 2 and 3 residual earnings valuation How the residual earnings model applies to valuing bonds, projects, strategies as well as equities How the residual earnings model captures value added in a strategy The advantages and disadvantages of using the residual earnings model and how it contrasts to dividend discounting and discounted cash flow analysis How dividends, share issues and share repurchases affect residual earnings How residual earnings valuation protects the investor from paying too much for earnings added by investment How residual earnings valuation protects the investor from paying for earnings that are created by accounting methods How the residual earnings model is used in reverse engineering Valuing a One-Period Project (1) Valuing a One-Period Project (1) Investment $400 Required return 10% Revenue forecast $440 Expense forecast $400 Earnings forecast $ 40 This is a zero NPV project: DCF Valuation: 400 1.10 400 Value 400) x (0.10- 40 ) Investment return x Required ( Earnings earnings Residual 1 1 = + = = =- = This is a zero-residual earnings project 400 10 . 1 440 = = V Valuing a One-Period Project (2) Valuing a One-Period Project (2) Investment $400 Required return 10% Revenue forecast $448 Expense Forecast $400 Earnings forecast $ 48 407.27 1.10 8 400...
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This note was uploaded on 10/07/2010 for the course ECTCS ec12947322 taught by Professor Johnathayeri during the Spring '10 term at Life.

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Chapter_05 - Accrual Accounting and Valuation: Accrual...

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