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Unformatted text preview: Aswath Damodaran 1 Discounted Cashfow Valuation: Equity and Firm Models Aswath Damodaran Aswath Damodaran 2 Summarizing the Inputs In summary, at this stage in the process, we should have an estimate of the • the current cash Fows on the investment, either to equity investors (dividends or free cash Fows to equity) or to the ¡rm (cash Fow to the ¡rm) • the current cost of equity and/or capital on the investment • the expected growth rate in earnings, based upon historical growth, analysts forecasts and/or fundamentals The next step in the process is deciding • which cash Fow to discount, which should indicate • which discount rate needs to be estimated and • what pattern we will assume growth to follow Aswath Damodaran 3 Which cash fow should I discount? Use Equity Valuation (a) For ¡rms which have stable leverage , whether high or not, and (b) iF equity (stock) is being valued Use ¢irm Valuation (a) For ¡rms which have leverage which is too high or too low , and expect to change the leverage over time, because debt payments and issues do not have to be Factored in the cash fows and the discount rate (cost oF capital) does not change dramatically over time. (b) For ¡rms For which you have partial inFormation on leverage (eg: interest expenses are missing..) (c) in all other cases, where you are more interested in valuing the ¡rm than the equity. (Value Consulting?) Aswath Damodaran 4 Given cash fows to equity, should I discount dividends or FCFE? Use the Dividend Discount Model • (a) For ¡rms which pay dividends (and repurchase stock) which are close to the Free Cash Flow to Equity (over a extended period) • (b)For ¡rms where FCFE are di¢¡cult to estimate (Example: Banks and Financial Service companies) Use the FCFE Model • (a) For ¡rms which pay dividends which are signi¡cantly higher or lower than the Free Cash Flow to Equity. (What is signi¡cant? ... As a rule o¢ thumb, i¢ dividends are less than 80% o¢ FCFE or dividends are greater than 110% o¢ FCFE over a 5 year period, use the FCFE model) • (b) For ¡rms where dividends are not available (Example: Private Companies, IPOs) Aswath Damodaran 5 What discount rate should I use? Cost of Equity versus Cost of Capital • If discounting cash Fows to equity > Cost of Equity • If discounting cash Fows to the ¡rm> Cost of Capital What currency should the discount rate (risk free rate) be in? • Match the currency in which you estimate the risk free rate to the currency of your cash Fows Should I use real or nominal cash Fows? • If discounting real cash Fows> real cost of capital • If nominal cash Fows> nominal cost of capital • If inFation is low (<10%), stick with nominal cash Fows since taxes are based upon nominal income • If inFation is high (>10%) switch to real cash Fows Aswath Damodaran 6 Which Growth Pattern Should I use?...
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This note was uploaded on 12/04/2011 for the course ECON 001 taught by Professor Tnaga during the Spring '11 term at Abant İzzet Baysal University.
 Spring '11
 tnaga

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