Damodaran_FCF - WHY ARE DIVIDENDS DIFFERENT FROM FCFE The...

Info iconThis preview shows pages 1–5. Sign up to view the full content.

View Full Document Right Arrow Icon
1 WHY ARE DIVIDENDS DIFFERENT FROM FCFE? The FCFE is a measure of what a firm can afford to pay out as dividends. Dividends paid are different from the FCFE for a number of reasons -- Desire for Stability Future Investment Needs Tax Factors Signalling Prerogatives I. THE CONSTANT GROWTH FCFE MODEL The Model The value of equity, under the constant growth model, is a function of the expected FCFE in the next period, the stable growth rate and the required rate of return. P 0 = FCFE 1 r - g n where, P 0 = Value of stock today
Background image of page 1

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

View Full Document Right Arrow Icon
2 FCFE 1 = Expected FCFE next year r = Cost of equity of the firm g n = Growth rate in FCFE for the firm forever This model is appropriate when The firm has to be in steady state. This also implies that. (1) Capital expenditure is not significantly greater than depreciation. (2) The beta of the stock is close to one or below one. The firm has FCFE which are significantly different from dividends, or dividends are not relevant. The leverage is stable. Illustration 7: FCFE Stable Growth Model: Telefonica de Espana Rationale for using Model Given that the market that is serves (Spain) is reaching maturity (40.5 phone lines per 100 people), and the regulations on local pricing, it is unlikely that Telefon. Espana will be able to register above-normal growth. It is expected to grow about 10% a year in Spanish peseta terms. Telefonica pays out much less in dividends than it generates in FCFE. Dividends in 1995 = 54 Pt / share
Background image of page 2
3 FCFE per Share in 1995 = 86.53 Pt / share The leverage is stable Background Information Current Information: Earnings per Share = 154.53 Pt Capital Expenditures per share = 421 Pt Depreciation per share = 285 Pt Change in Working Capital / Share = None Debt Financing Ratio = 50% Earnings, Capital Expenditures and Depreciation are all expected to grow 10% a year The beta for the stock is 0.90, and the Spanish long bond rate is 9.50%. A premium of 6.50% is used for the Spanish market. Valuation Cost of Equity = 9.50% + 0.90 (6.50%) = 15.35% Expected Growth Rate = 10.00% Base Year FCFE
Background image of page 3

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

View Full Document Right Arrow Icon
4 Earnings per Share = 154.53 - (Capital Expenditures - Depreciation) (1 - Debt Ratio) = (421-285)(1-.5) = - 68.00 - (Change in Working Capital) (1 - Debt Ratio) = 0 (1-.5) = - 0.00 = FCFE = 86.53 Value per Share = 86.53 (1.10)/ (.1535 - .10) = 1779 Pt The stock was trading for 1788 Pt in January 1996. Illustration 8: Valuing a firm with depressed earnings: Daimler Benz A rationale for using the FCFE Stable Model As one of the largest firms in a mature sector, it is unlikely that Daimler Benz will be able to register super normal growth over time. Like most German firms, the dividends paid bear no resemblance to the cash flows generated. The leverage is stable and unlikely to change.
Background image of page 4
Image of page 5
This is the end of the preview. Sign up to access the rest of the document.

{[ snackBarMessage ]}

Page1 / 34

Damodaran_FCF - WHY ARE DIVIDENDS DIFFERENT FROM FCFE The...

This preview shows document pages 1 - 5. Sign up to view the full document.

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