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00 p2006 d2007 210 2100 ks g2 015 005 the zero

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Unformatted text preview: ar 2005 2006 D2005 = $1.82 D2006 = $2.00 $ 1.44 1.38 1.32 13.82 P2003 = $17.96 PVIF15%, 1 × $1.65 = 0.870 × $1.65 PVIF15%, 2 × $1.82 = 0.756 × $1.82 PVIF15%, 3 × $2.00 = 0.658 × $2.00 PVIF15%, 3 × $21.00 = 0.658 × $21.00 P2006 = D2007 $2.10 = = $21.00 ks – g2 0.15 – 0.05 The zero-, constant-, and variable-growth valuation models provide useful frameworks for estimating stock value. Clearly, the estimates produced cannot be very precise, given that the forecasts of future growth and discount rates are themselves necessarily approximate. Furthermore, a great deal of measurement error can be introduced into the stock price estimate as a result of the imprecise and rounded growth and discount rate estimates used as inputs. When applying valuation models, it is therefore advisable to estimate these rates carefully and round them conservatively, probably to the nearest tenth of a percent. Free Cash Flow Valuation Model As an alternative to the dividend valuation models presented above, a firm’s value can be estimated by using its projected free cash flows (FCFs). This approach is appealing when one is valuing firms that have no dividend history or are startups or when one is valuing an operating unit or division of a larger public company. 330 PART 2 Important Financial Concepts FOCUS ON e-FINANCE For many people, owning their own business represents the dream of a lifetime. But how much should this dream cost? To get an idea of how to value a small business, check out the “Business for Sale” column in Inc., a magazine that focuses on smaller emerging businesses. Each month the column describes the operations, financial situation, industry outlook, price rationale, and pros and cons of a small business offered for sale. For example, columns featured in 2000 and 2001 included such diverse companies as a distributor of semiprecious stones, a software developer, a Christmas tree grower, a small chain of used-book stores, and a baseball camp, with prices ranging from $200,000 to $9 million. Most valuations are based on a multiple of cash flow or annual sales, with accepted guidelines for different industries. That number is free cash flow valuation model A model that determines the value of an entire company as the present value of its expected free cash flows discounted at the firm’s weighted average cost of capital, which is its expected average future cost of funds over the long run. In Practice What’s the Value of the American Dream? just a starting point, however, and must be adjusted for other factors. For example, food distributors typically sell for about 30 percent of annual sales. A Southeastern seafood distributor was recently offered for $2.25 million, a discount from the $3.9 million price you’d get strictly on the basis of annual sales. The reason? The new owner would have to buy or lease a warehouse facility, freezers, and other equipment. Because valuing a small business is difficult, many owners make use of reasonably priced...
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