VAluation_Damodran

# VAluation_Damodran - Valuation Aswath Damodaran Aswath...

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Aswath Damodaran 1 Valuation Aswath Damodaran

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Aswath Damodaran 2 First Principles n Invest in projects that yield a return greater than the minimum acceptable hurdle rate. The hurdle rate should be higher for riskier projects and reflect the financing mix used - owners’ funds (equity) or borrowed money (debt) Returns on projects should be measured based on cash flows generated and the timing of these cash flows; they should also consider both positive and negative side effects of these projects. n Choose a financing mix that minimizes the hurdle rate and matches the assets being financed. n If there are not enough investments that earn the hurdle rate, return the cash to stockholders. The form of returns - dividends and stock buybacks - will depend upon the stockholders’ characteristics. Objective: Maximize the Value of the Firm
Aswath Damodaran 3 Discounted Cashflow Valuation: Basis for Approach where, n = Life of the asset CF t = Cashflow in period t r = Discount rate reflecting the riskiness of the estimated cashflows Value = CF t (1+ r) t t =1 t = n

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Aswath Damodaran 4 Equity Valuation versus Firm Valuation n value just the equity stake in the business n value the entire firm, which includes, besides equity, the other claimholders in the firm
Aswath Damodaran 5 I.Equity Valuation n The value of equity is obtained by discounting expected cashflows to equity, i.e., the residual cashflows after meeting all expenses, tax obligations and interest and principal payments, at the cost of equity, i.e., the rate of return required by equity investors in the firm. where, CF to Equityt = Expected Cashflow to Equity in period t ke = Cost of Equity n The dividend discount model is a specialized case of equity valuation, and the value of a stock is the present value of expected future dividends. Value of Equity = CF to Equity t (1+ k e ) t t=1 t=n

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Aswath Damodaran 6 II. Firm Valuation n The value of the firm is obtained by discounting expected cashflows to the firm, i.e., the residual cashflows after meeting all operating expenses and taxes, but prior to debt payments, at the weighted average cost of capital, which is the cost of the different components of financing used by the firm, weighted by their market value proportions. where, CF to Firmt = Expected Cashflow to Firm in period t WACC = Weighted Average Cost of Capital Value of Firm = CF to Firm t (1+ WACC) t t=1 t=n
7 Equity versus Firm Valuation n It is often argued that equity valuation requires more assumptions than firm valuation, because cash flows to equity require explicit assumptions about changes in leverage whereas cash flows to the firm are pre-debt cash flows and do not require assumptions about leverage. Is this true?

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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.

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VAluation_Damodran - Valuation Aswath Damodaran Aswath...

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