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loosendsMod - Loose Ends in Valuation Stop the Garnishing...

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Aswath Damodaran Loose Ends in Valuation… Stop the Garnishing Aswath Damodaran www.damodaran.com
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Aswath Damodaran Some Overriding Thoughts The biggest reason for bad valuations is not bad models but bias . Building a better valuation model is easy, but getting the bias out of valuation is difficult. Allowing analysts to add premiums and discounts to estimated value makes it easy to bring bias into valuation and to hide it. Analysts who fault their models for not being more precise are not only missing the real reason for imprecision (which is that no one can forecast the future with certainty) but are also setting themselves up for false alternatives. Using an arbitrary premium or discount as a substitute for estimating uncertain cashflows does not make uncertainty go away. Valuation is simple. We choose to make it complex . Complexity always come with a cost….
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Aswath Damodaran So, you’ve valued a firm… Free Cashflow to Firm EBIT (1- tax rate) - (Cap Ex - Depreciation) - Change in non-cash WC = Free Cashflow to firm Cost of Capital Cost of Equity Cost of Debt Expected Growth during high growth Length of high growth period: PV of FCFF during high growt Stable Growth Value of Operating Assets today
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Aswath Damodaran But what comes next? Value of Operating Assets + Cash and Marketable Securities + Value of Cross Holdings + Value of Other Assets Value of Firm - Value of Debt = Value of Equity - Value of Equity Options = Value of Common Stock / Number of shares = Value per share Operating versus Non-opeating cash Should cash be discounted for earning a low return How do you value cross holdings in other companies? What if the cross holdings are in private businesses? What about other valuable assets? How do you consider under utlilized assets? What should be counted in debt? Should you subtract book or market value of debt? What about other obligations (pension fund and health care What about contingent liabilities? What about minority interests? What equity options should be valued here (vested versus non-vested)? How do you value equity options? Should you divide by primary or diluted shares? Should you discount this value for opacity or complexity? How about a premium for synergy? What about a premium for intangibles (brand name)? Should there be a premium/discount for control Should there be a discount for distress Should there be a discount for illiquidity/ marketability? Should there be a discount for minority interests?
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1a. The Value of Cash The simplest and most direct way of dealing with cash and marketable securities is to keep it out of the valuation - the cash flows should be before interest income from cash and securities, and the discount rate should not be contaminated by the inclusion of cash. (Use betas of the operating assets alone to estimate the cost of equity). Once the operating assets have been valued, you should add back the value of
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This note was uploaded on 12/01/2011 for the course FINANCE 350 taught by Professor Aswath during the Summer '10 term at NYU.

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loosendsMod - Loose Ends in Valuation Stop the Garnishing...

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