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val2hr - Twelve Myths in Valuation Aswath Damodaran...

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Aswath Damodaran 1 Twelve Myths in Valuation Aswath Damodaran http://www.damodaran.com
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Aswath Damodaran 2 Why do valuation? " One hundred thousand lemmings cannot be wrong" Graffiti
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Aswath Damodaran 3 1. Valuation is a science that yields precise answers… n Reality 1: Valuations are always biased… Truth 1.1: All valuations are biased. The only questions are how much and in which direction. Truth 1.2: The direction and magnitude of the bias in your valuation is directly proportional to who pays you and how much you are paid. n Reality 2: Equity valuations are always imprecise but they are most valuable when they are most imprecise. Truth 2.1: There are no precise valuations Truth 2.2: The payoff to valuation is greatest when valuation is least precise. n Reality 3: Complex valuations do not yield better estimates of value. Truth 3.1: One’s understanding of a valuation model is inversely proportional to the number of inputs required for the model. Truth 3.2: Simpler valuation models do much better than complex ones.
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Aswath Damodaran 4 2. Valuation is complicated and there are hundreds of models out there… Cash flows Firm: Pre-debt 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 ........ Discount Rate Firm:Cost of Capital Equity: Cost of Equity Value Firm: Value of Firm Equity: Value of Equity DISCOUNTED CASHFLOW VALUATION Length of Period of High Growth
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Aswath Damodaran 5 Cashflow to Firm EBIT (1-t) - (Cap Ex - Depr) - Change in WC = FCFF Expected Growth Reinvestment Rate * Return on Capital FCFF 1 FCFF 2 FCFF 3 FCFF 4 FCFF 5 Forever Firm is in stable growth: Grows at constant rate forever Terminal Value= FCFF n+1 /(r-g n ) FCFF n ........ Cost of Equity Cost of Debt (Riskfree Rate + Default Spread) (1-t) Weights Based on Market Value Discount at WACC= Cost of Equity (Equity/(Debt + Equity)) + Cost of Debt (Debt/(Debt+ Equity Value of Operating Assets + Cash & Non-op Assets = Value of Firm - Value of Debt = Value of Equity Riskfree Rate : - No default risk - No reinvestment risk - In same currency and in same terms (real or nominal as cash flows + Beta - Measures market risk X Risk Premium - Premium for average risk investment Type of Business Operating Leverage Financial Leverage Base Equity Premium Country Risk Premium DISCOUNTED CASHFLOW VALUATION
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Aswath Damodaran 6 Current Cashflow to Firm EBIT(1-t) : 4,607 - Nt CpX 1,405 - Chg WC 79 = FCFF 3,123 Reinvestment Rate =32.21% Expected Growth in EBIT (1-t) .3221*.2515= .081 8.10 % Stable Growth g = 5%; Beta = 0.90; ROC= 15% Reinvestment Rate=33.33% Terminal Value 5 = 4760/(.0861-.05) = 131,716 Cost of Equity 8.42% Cost of Debt (5.1%+0.75%)(1-.35) = 3.80% Weights E =98.34% D = 1.66% Discount at Cost of Capital (WACC) = 8.42% (.9834) + 3.80% (0.0166) = 8.34% Firm Value: 103,742 + Cash 3,385 - Debt: 1,498 =Equity 105,241 -Options 2,300 Value/Share $52.97 Riskfree Rate : Riskfree rate = 5.1% (10-year T.Bond rate) + Beta 0.83 X Risk Premium 4.00% Unlevered Beta for Sectors: 0.82 Firm’s D/E Ratio: 1.69% Mature risk premium 4% Country Risk Premium 0% Bristol Myers: Status Quo Reinvestment Rate 32.21% Return on Capital 25.15% Term Yr 7140 2380 4760
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