Valuation of Common Stock

Valuation of Common Stock - Valuation of Common Stock •...

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Unformatted text preview: Valuation of Common Stock • Two General Approaches – Discounted Cash-Flow Techniques • – Relative Valuation Techniques • – Present value of some measure of cash flow, including dividends, operating cash flow, and free cash flow Value estimated based on its price relative to significant variables, such as earnings, cash flow, book value, or sales See Exhibit 11.2 11-1 Exhibit 11.2 11-2 Valuation of Common Stock • Both of these approaches and all of these valuation techniques have several common factors: – – All of them are significantly affected by investor’s required rate of return on the stock because this rate becomes the discount rate or is a major component of the discount rate; All valuation approaches are affected by the estimated growth rate of the variable used in 11-3 the valuation technique Why Discounted Cash Flow Approach • These techniques are obvious choices for valuation because they are the epitome of how we describe value—that is, the present value of expected cash flows – – – • Dividends: Cost of equity as the discount rate Operating cash flow: Weighted Average Cost of Capital (WACC) Free cash flow to equity: Cost of equity as the discount rate 11-4 Dependent on growth rates and discount • Why Relative Valuation Techniques how the Provides information about market is currently valuing stocks – – alternative industries – • aggregate market individual stocks within industries No guidance as to whether valuations are appropriate – best used when have comparable entities – aggregate market and company’s industry 11-5 Discounted Cash-Flow Valuation Techniques • The General Formula t =n CFt Vj = ∑ t t =1 (1 + k ) Where: Vj = value of stock j n = life of the asset CFt = cash flow in period t k = the discount rate that is equal to the investor’s required rate of return for asset j, 11-6 ...
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Valuation of Common Stock - Valuation of Common Stock •...

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