Lect 07 fin221

Lect 07 fin221 - Managerial Finance Lecture 7 Interco 1...

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1 Managerial Finance Lecture 7 Interco
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2 Class 6: Summary Valuation of securities (bonds, stocks…): (a) Identify the relevant CFs (b) Identify the discount rate (c) Discount (a) Identify the relevant CFs, (b) Identify the discount rate, (c) Discount! Stock valuation: uncertain cash-flows Cash flows: dividends, share repurchases and selling price (capital gain) Discount rate risk-free rate Discount rate = risk-free rate +risk premium that depends on equity risk (next week!) Valuation methodologies Valuation : Value is determined by the quality of investment projects (NPVs) 1. The dividend discount model: Stock price = PV(future dividends per share) 2. The total payout model: Equity value = PV(future dividends and repurchases) Stock price = equity value / # of shares 3 The discounted free cash flow model 3. The discounted free cash flow model: Steps: (a) Forecast FCFs for a number of years (5-10 years) (b) Estimate a terminal value at the end of the forecasting period (c) Get equity value Equity value = PV(future FCF) + cash – debt Stock price = equity value / # of shares 2
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3 Interco August 1988 Board of Directors meet to discuss merger proposal City Capital (Rales Brothers) have offered $70 per share Interco’s financial advisors (Wasserstein, Perella & Co.) evaluate the company’s value at $ 68 80 per share the company s value at $ 68-80 per share Based on this, the board votes to reject the offer Goal : Understand alternative approaches to valuation Discounted Cash Flow (DCF) 3 Valuation using Multiples or Comparable Firms
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5 The Offer 5
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6 Discounted Free Cash Flow (DCF) Valuing the Enterprise Valuing the Free Cash Flow in year t is calculated as FCF t = EBIT t (1- ) + Dep t CapEx t NWC t = EBIT t (1- ) – ( CapEx t Dep t ) NWC t net CapEx Enterprise Value : Explicit Forecasting: 1 () (1 ) t t t FCF EV PV FCF r  6 Takes advantage of specific knowledge regarding future FCF Allows incorporation of changing investment opportunities , etc No need to directly consider dividend policy or financing
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7 DCF in practice Discounted Free Cash Flow (DCF) Split valuation. Two steps : (a) forecasting period, (b) terminal value Continuation or Terminal Value 10 10 12 0 21 0 1 0 ...
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Lect 07 fin221 - Managerial Finance Lecture 7 Interco 1...

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