india - Value Enhancement Back to Basics Aswath Damodaran...

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Aswath Damodaran 1 Value Enhancement: Back to Basics Aswath Damodaran http://www.damodaran.com
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Aswath Damodaran 2 Price Enhancement versus Value Enhancement
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Aswath Damodaran 3 Discounted Cash Flow Valuation: The Four Key Inputs n Estimate the discount rate or rates to use in the valuation Discount rate can be either a cost of equity (if doing equity valuation) or a cost of capital (if valuing the firm) Discount rate can be in nominal terms or real terms, depending upon whether the cash flows are nominal or real Discount rate can vary across time. n Estimate the current earnings and cash flows on the asset, to either equity investors (CF to Equity) or to all claimholders (CF to Firm) n Estimate the future earnings and cash flows on the asset being valued, generally by estimating an expected growth rate in earnings. n Estimate when the firm will reach “stable growth” and what characteristics (risk & cash flow) it will have when it does.
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Aswath Damodaran 4 The Cost of Equity Cost of Equity = Riskfree Rate+ Beta * (Risk Premium Has to be in the same currency as cash flows, and defined in same terms (real or nominal) as the cash flows Preferably, a bottom-up beta, based upon other firms in the business, and firm’s own financial leverage Historical Premium 1. Mature Equity Market Premium: Average premium earned by stocks over T.Bonds in U.S. 2. Country risk premium = Country Default Spread* ( σ Equity / σ Country bond ) Implied Premium Based on how equity market is priced today and a simple valuation model or The rate of return that is required by the marginal investor in the equity. For a private firm, this is the owner. For a public firm, it is the institution o individual most likely to trade
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Aswath Damodaran 5 Estimating Betas E.I.D. Parry Tube Inv. Carborandum Coromandel Comparable firms Food + Auto Parts Manufacturers Fertilizers Chemicals Unlevered Beta 0.71 (Weighted 0.75 0.88 0.82 Average) D/E Ratio (Mkt) 282% 79% 82% 129% Levered beta 2.11 1.17 1.38 1.56 Levered Beta = Unlevered Beta ( 1 + (1- tax rate) (Debt/Equity Ratio))
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Aswath Damodaran 6 Risk Premium for a Mature Market (U.S) n Historical Premium (Stocks - Government Bond) = 6.60% n Implied Premium (at current stock prices) = 2.50% n Risk Premium used = 4%
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Aswath Damodaran 7 Country Risk Premium for India n Country rating for India = Ba2 n Default spread based on rating = 3% n Country ratings measure default risk. While default risk premiums and equity risk premiums are highly correlated, one would expect equity spreads to be higher than debt spreads. One way to adjust the country spread upwards is to use information from the US market. In the US, the equity risk premium has been roughly twice the default spread on junk bonds. Another is to multiply the bond spread by the relative volatility of stock and bond prices in that market. For example, Standard Deviation in BSE = 47.6% Standard Deviation in Indian Govt Bond = 27.3% Adjusted Equity Spread = 3.00% (47.6/27.3) = 5.23%
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Aswath Damodaran 8 From Cost of Equity to Cost of Capital Cost of Capital = Cost of Equity (Equity/(Debt + Equity)) + Cost of Borrowing (1-t)
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