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Unformatted text preview: CH. 8 CH. PROSPECTIVE ANALYSIS: PROSPECTIVE VALUATION IMPLEMENTATION VALUATION Computing a Discount Rate Computing Weighted average cost of capital (WACC): Weighted weighting the costs of debt and equity capital according to their respective market values according Market value for debt: use book value Market value of equity: “insert” target ratios of debt to Market capital and equity to capital. capital Estimating the cost of debt: interest rate on the debt Estimating (net-of-tax) (net-of-tax) Estimating the cost of equity: use Capital Asset Estimating Pricing Model (CAPM) Pricing Terminal Values Terminal Remain constant Grow at the assumed sales growth rate Using multiple Selecting terminal years: usually 5-10 year Selecting forecast horizon forecast Dealing with Accounting Distortions Dealing Self correcting nature of double-entry Self bookkeeping, estimated values will not be affected by accounting choices, as long as the analysts recognizes the accounting distortions analysts Dealing with Negative Book Values Dealing Makes it difficult to use the accounting-based Makes approach to value a firm’s equity approach Approach to handle this problem: Value the firm’s assets rather than equity “Undo” accountants’ conservatism by capitalizing Undo” the investment expenditures written off the Start from the observed stock and work backwards ...
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