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Chapter_07

# Chapter_07 - Primer on Cash Flow Valuation Course Layout...

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Primer on Cash Flow Valuation

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Course Layout: M&A & Other Restructuring Activities Part IV: Deal Structuring & Financing Part II: M&A Process Part I: M&A Environment Payment & Legal Considerations Public Company Valuation Financial Modeling Techniques Business & Acquisition Plans Search through Closing Activities Part V: Alternative Strategies Accounting & Tax Considerations Business Alliances Divestitures, Spin-Offs & Carve-Outs Bankruptcy & Liquidation Regulatory Considerations Motivations for Part III: M&A Valuation & Modeling Takeover Tactics and Defenses Financing Strategies Private Company Valuation Cross-Border Transactions
Learning Objectives Primary learning objectives: To provide students with an understanding of business valuation using discounted cash flow valuation techniques and the importance of understanding assumptions underlying business valuations Secondary learning objectives: To provide students with an understanding of discount rates and risk as applied to business valuation; how to analyze risk; alternative definitions of cash flow and how and when they are applied; the advantages and disadvantages of the most commonly used discounted cash flow methodologies; and the sensitivity of terminal values to changes in assumptions.

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Required Returns: Cost of Equity (ke) Capital Asset Pricing Model: ke = R f + ß(R m – R f ) + FSP Where R f = risk free rate of return ß = beta R m = expected rate of return on equities R m – R f = 5.5% (i.e., its historical average since 1963) FSP = firm size premium
Estimates of Size Premium Market Value (000,000) >\$12,400 \$5,250 to \$12,400 \$2,600 to \$5,250 \$1,650 to \$2,600. \$700 to \$1,650 \$450 to \$700 \$250 to \$450 \$100 to \$250 \$50 to \$100 <\$50 million Percentage Points Added to CAPM Estimate 0.0 .3 .6 .8 1.2 1.3 1.9 2.4 3.5 9.2 Source: Adapted from estimates provided by Ibbotson Associates.

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Required Returns: Cost of Capital Weighted Average Cost of Capital (WACC): WACC = ke x E + i (1-t) x D + kpr x __PR__ (E+D+PR) (E+D+PR) (E+D+PR) Where E = the market value of equity D = the market value of debt PR = the market value of preferred stock ke = cost of equity kpr= cost of preferred stock i = the interest rate on debt t = the firm’s marginal tax rate
Analyzing Risk Risk consists of a diversifiable and non-diversifiable component Beta (ß) is a measure of non-diversifiable risk Beta is estimated by regressing stock returns (R j ) against market returns (R m ). The intercept provides a measure of Rj’s performance vs. market relative to what CAPM would have predicted. R

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Chapter_07 - Primer on Cash Flow Valuation Course Layout...

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