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Unformatted text preview: Click to edit Master subtitle style Prof Irvine FINA 4310 Lecture 27: Valuation 2 Comparable ratios Valuation methods Prof Irvine FINA 4310 FINA 4310 Valuation of Common Stock Two approaches are common 1. Discounted cashflow valuation Present value of some measure of cash flow, including dividends, operating cash flow, and free cash flow 2. Relative valuation technique Value estimated based on its price relative to significant variables, such as earnings, cash flow, book value, or sales Prof Irvine FINA 4310 FINA 4310 Valuation Approaches and Specific Techniques Approaches to Equity Valuation Discounted Cash Flow Techniques Relative Valuation Techniques Present Value of Dividends (DDM) Present Value of Free Cash Flow Free Cash Flow Free Cash Flow to Equity Residual Income Price/Earnings Ratio (PE) PEG Price/Cash flow ratio (P/CF) Price/Book Value Ratio (P/BV) Price/Sales Ratio (P/S) Prof Irvine FINA 4310 FINA 4310 Discounted CashFlow Valuation Techniques = = + = n t t t t j k CF V 1 ) 1 ( Where: V j = value of stock j n = forecastable horizon CF t = cash flow in period t k = the discount rate Prof Irvine FINA 4310 FINA 4310 The Dividend Discount Model (DDM) The value of a share of common stock is the present value of all future dividends = + = + + + + + + + + = n t t t j k D k D k D k D k D V 1 3 3 2 2 1 ) 1 ( ) 1 ( ... ) 1 ( ) 1 ( ) 1 ( Where: V j = value of common stock j D t = dividend during time period t k = required rate of return on stock j Prof Irvine FINA 4310 FINA 4310 Computation of DDM for company with above average growth Discount Present Growth Year Dividend Factor Value Rate 1 2.50 $ 0.8772 2.193 $ 25% 2 3.13 0.7695 2.408 $ 25% 3 3.91 0.6750 2.639 $ 25% 4 4.69 0.5921 2.777 $ 20% 5 5.63 0.5194 2.924 $ 20% 6 6.76 0.4556 3.080 $ 20% 7 7.77 0.3996 3.105 $ 15% 8 8.94 0.3506 3.134 $ 15% 9 10.28 0.3075 3.161 $ 15% 10 11.21 9% 224.20 $ a 0.3075 b 68.943 $ 94.365 $ a Value of dividend stream for year 10 and all future dividends, that is $11.21/(0.14  0.09) = $224.20 b The discount factor is the ninthyear factor because the valuation of the remaining stream is made at the end of Year 9 to reflect the dividend in Year 10 and all future dividends. Prof Irvine FINA 4310 The Building Blocks of Valuation Prof Irvine FINA 4310 FINA 4310 Problem  2stage DDM l Fastgro Inc. just paid a dividend of $2.00 per share. Dividends are expected to grow at 16% per year for the next three years. After that time, dividend growth is expected to slow to 5%. If the appropriate cost of equity capital for Fastgro is 12% what is the DDM intrinsic value of Fastgro? Prof Irvine FINA 4310 FINA 4310 Generic DCF Valuation Model Cash flows Firm: Predebt cash flow Equity: After debt cash flows Expected Growth Firm: Growth in Operating Earnings Equity: Growth in Net Income/EPS CF 1 CF 2 CF 3 CF 4 CF 5 Forever Firm is in stable growth: Grows at constant rate forever Terminal Value CF n ............
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This note was uploaded on 06/05/2011 for the course FINA 4310 taught by Professor Staff during the Fall '08 term at University of Georgia Athens.
 Fall '08
 Staff
 Valuation

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