Brailsford3eSM_Ch11

Brailsford3eSM_Ch11 - Chapter 11 Equity valuation models...

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Copyright © 2006 Nelson Australia Pty Limited Chapter 11 Equity valuation models Learning objectives After the completion of this chapter, you should be able to: understand the basic principles of equity valuation understand and be able to apply the present value (PV) model to equity valuation understand the development of the dividend discount model, earnings capitalisation model, and free cash flow model explain the importance of key assumptions underpinning the dividend discount model, earnings capitalisation model, and free cash flow model comprehend the issues associated with the practical implementation of equity valuation models understand and apply asset backing models. explain the different types of forecasts of economic and company specific financial variables and the advantages and disadvantages of the different forecasting procedures Key points 1 The price of a share is dependent of the discounted future value (ie. present value) of the cash flows accruing to the shareholder. 2 The models presented in the chapter are all variants of the present value model. The models differ in terms of the underlying assumptions about the cash flows accruing to the shareholder. Chapter outline 11.1 Introduction 1 A key issue in investment is the determination of the correct price of a security. 2 This valuation is relevant to many areas of finance; portfolios, trading strategies, mergers and acquisitions, valuation of private corporations and in situations where a market price is unavailable or unreliable. 11.2 Present value analysis 1 Present value of equity found by discounting value of future cash flows. 11.3 Present value and ordinary equity 1 In the case of equity, the cash flows that accrue to the shareholder are dividends. 2 The value of equity is therefore the present value of future dividends.
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2 Investments: Concepts and Applications Solutions Manual Copyright © 2006 Nelson Australia Pty Limited 11.4 The dividend discount model 1 The dividend discount model builds on the present value model, by making an assumption regarding the relationship between current and future dividends. 2 The time-series relationship is known as the growth rate in dividends. 3 The model is operationalised by assuming the firm is a going concern and hence applying the perpetuity form of the present value model. 11.5 The earnings capitalisation model 1 Identical to the present value model, except that earnings are paid as dividends. Those earnings that are retained are assumed to generate a return equal to the equity cost of capital. 2 Under the above assumptions, the DDM is equivalent to discounting the future value of earnings. 3 The ECM is typically operationalised by estimating the zero growth and growth opportunities separately.
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This note was uploaded on 02/06/2011 for the course FINM 3402 at Queensland.

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Brailsford3eSM_Ch11 - Chapter 11 Equity valuation models...

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