wk 4 - Estimating Growth and Terminal Value_2011s2

wk 4 - Estimating Growth and Terminal Value_2011s2 -...

Info iconThis preview shows pages 1–5. Sign up to view the full content.

View Full Document Right Arrow Icon
FINS3641 SAV Week 4: Estimating Growth and Terminal Value 1 FINS3641 SECURITY ANALYSIS AND VALUATION PART 2: DISCOUNT CASH FLOW VALUATION MODELS Week 4: Estimating Growth and Terminal Value Topics: Estimating the growth rates for cash flows to equity and to the firm Estimating the terminal value of a firm Learning Outcomes: Learn the techniques to estimate the growth rate of earnings Learn the techniques to arrive at the terminal value of a firm for the DCF models Reading: Damodaran Chapter 11-12
Background image of page 1

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
FINS3641 SAV Week 4: Estimating Growth and Terminal Value 2 A. Estimating Growth in Earnings Ways to Estimate Growth in Earnings Use historical data on growth in earnings per share Use analysts’ forecasts of earnings growth Use fundamental variables including the percentage of earnings retained for investments and the return from these investments.
Background image of page 2
FINS3641 SAV Week 4: Estimating Growth and Terminal Value 3 1 Estimating Growth on the basis of Historical Earnings Data Historical growth rates can be estimated in a number of different ways 1.1 Arithmetic and Geometric Averages of “Discrete Returns” Revenues % Change EBITDA % Change EBIT % Change Hypothetical 1994 $22,245 $4,151 $2,604 1995 $27,037 21.54% $4,850 16.84% $2,931 12.56% 10% 1996 $27,973 3.46% $4,268 -12.00% $1,960 -33.13% 10% 1997 $29,794 6.51% $4,276 0.19% $1,947 -0.66% 10% 1998 $29,398 -1.33% $3,019 -29.40% $822 -57.78% 10% 1999 $30,931 5.21% $5,398 78.80% $3,216 291.24% 10% Arithmetic Avg 7.08% 10.89% 42.45% 50%/5= 10% Geometric Avg 6.82% 5.39% 4.31% √1.1 – 1 =10% Std dev 8.61% 41.56% 141.78% 0 EBIT > EBITDA > Revenue Why is that? GA-AA = f(volatility) What is the implication? Do we need to the path of earnings to arrive at the historical growth rate? Historical earnings growth estimates are noisy and subject to window dressing by discretionary accounting choices – historical growth in revenue is a more useful estimate. GA is the more accurate measure of historical earnings growth, especially when the firm past earnings were volatile. But I would argue that Damodaran has mismatched the averaging method and the type of return. Had CCRs been used, AA would be an accurate measure of historical earnings growth. The difference between the AR of CCRs and the GA of DRs is due solely to the underlying frequency of compounding: continuously versus discreetly. Consider an investment of P 0 today and P t after t periods. How would you express/measure the average return?
Background image of page 3

Info iconThis preview has intentionally blurred sections. Sign up to view the full version.

View Full DocumentRight Arrow Icon
FINS3641 SAV Week 4: Estimating Growth and Terminal Value 4 1.2 Linear versus Log-linear Regression Models on Cisco’s historical EPS Year t EPS ln(EPS) 1991 1 $0.01 -4.6052 1992 2 $0.02 -3.9120 1993 3 $0.04 -3.2189 1994 4 $0.07 -2.6593 1995 5 $0.08 -2.5257 1996 6 $0.16 -1.8326 1997 7 $0.18 -1.7148 1998 8 $0.25 -1.3863 1999 9 $0.32 -1.1394 EPS t = -.066 + 0.0383 t EPS grows by $ 0.0383 a year or $0.0383/$0.13 = 30.5% a year
Background image of page 4
Image of page 5
This is the end of the preview. Sign up to access the rest of the document.

Page1 / 22

wk 4 - Estimating Growth and Terminal Value_2011s2 -...

This preview shows document pages 1 - 5. Sign up to view the full document.

View Full Document Right Arrow Icon
Ask a homework question - tutors are online