chap 14 - The Free Cashflow to Equity Model Aswath...

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Aswath Damodaran 1 The Free Cashflow to Equity Model Aswath Damodaran
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Aswath Damodaran 2 Sony: Background on Japanese firms n Japanese firms have proved to be among the most difficult to value for several reasons: The earnings in 1999 for most Japanese firms was depressed relative to earnings earlier in the decade and in the 1980s, reflecting the Japanese economy Japanese accounting standards tend to understate earnings and overstate book value of equity, as firms are allowed to set aside provisions for unspecified expenses The earnings of many export oriented Japanese firms tends to be heavily influenced by exchange rate movements The cross holdings that Japanese firms have in other firms, and the lack of transparency in these holdings, makes it difficult to value these holdings.
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Aswath Damodaran 3 Valuing Sony: August 2000 n Sony had net income of 31 billion JPY in 1999, down from 76 billion JPY in 1997 and 38 billion in 1998. The return on equity at Sony dropped from 5.25% in 1997 to 2.13% in 1999. The firm paid out dividends of 21 billion JPY in 1999. n Capital expenditures in 1999 amounted to 103 billion JPY, whereas depreciation is 76 billion JPY. n Non-cash working capital at Sony in 1999 was 220 billion JPY on revenues of 2593 billion yet, yielding a non-cash working capital to revenue ratio of 8.48%. n The long term government bond rate in Japan was 2% at the time of this valuation.
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Aswath Damodaran 4 Sony: Rationale for Model n We will normalize earnings to reflect the fact that current earnings are depressed. To normalize earnings, we will use the return on equity of 5.25%, which is the return on equity that Sony had last year and is close to return on equity it used to earn in the early 1990s. n We will assume that the firm’s dominant market share will keep it from posting high growth. Over the last 5 years, the growth rate in revenues has been 3.5%. We will assume a long term stable growth rate of 3% (higher than the Japanese economy due to global exposure) n We will assume that the net capital expenditures will grow at the same rate and that non-cash working capital will stay at 8.48% of revenues n Sony’s current book debt to capital ratio is 25.8%; we will assume that they will finance reinvestment with this ratio (rather than the market value) n We will use a beta of 1.10, to reflect the unlevered beta of electronic firms (globally) and Sony’s market value debt to equity ratio (16%)
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5 Estimating the Inputs n Normalized Earnings: Book Value of Equity (3/1999) = 1795 billion JPY Estimated Return on Equity = 5.25% Normalized Net Income next year = 1795 billion * .0525 = 94.24 billion n Reinvestment Needs Current Net Capital Expenditures = (103 - 76) = 27 billion JPY Expected Net Capital Expenditures = 27 billion (1.03) = 27.81 billion Current Revenues = 2593 billion Expected Revenues next year = 2593(1.03) = 2671 billion Expected Change in non-cash Working Capital = (2671 - 2593)*.0848
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This note was uploaded on 03/01/2012 for the course FINS 3641 taught by Professor Hyip during the Three '11 term at University of New South Wales.

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chap 14 - The Free Cashflow to Equity Model Aswath...

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