**Unformatted text preview: **valuation software such as BallPark
Business Valuation and VALUware.
These programs offer buyers and
sellers a quick way to estimate the
business’s value and to answer
such questions as:
• How much cash will my business generate or consume? • What will my balance sheet,
income statement, and cash
flow statement look like in 5
years?
• Should I seek debt or equity
to finance growth?
• What impact will capital purchases have on my venture?
• How much ownership in my
business should I give up for a
$2 million equity contribution?
Once the negotiators decide
to move forward, however, they
usually should hire an experienced
valuation professional to develop a
formal valuation.
Sources: “About Ballpark Business Valuation,” Bullet Proof Business Plans, downloaded from www.bulletproofbizplans.com/
BallPark/About_/about_.html; Jill Andresky
Fraser, “Business for Sale: Southeastern
Seafood Distributor,” Inc. (October 1, 2000),
downloaded from www.inc.com ; VALUware,
www.bizbooksoftware.com/VALUWARE.
HTM. Although dividend valuation models are widely used and accepted, in these situations it is preferable to use a more general free cash flow valuation model.
The free cash flow valuation model is based on the same basic premise as
dividend valuation models: The value of a share of common stock is the present
value of all future cash flows it is expected to provide over an infinite time horizon. However, in the free cash flow valuation model, instead of valuing the
firm’s expected dividends, we value the firm’s expected free cash flows, defined
in Equation 3.3 (page 106). They represent the amount of cash flow available to
investors—the providers of debt (creditors) and equity (owners)—after all other
obligations have been met.
The free cash flow valuation model estimates the value of the entire company
by finding the present value of its expected free cash flows discounted at its
weighted average cost of capital, which is its expected average future cost of
funds over the long run (see Chapter 11), as specified in Equation 7.7.
VC FCF1
(1 ka)1 FCF2
(1 ka)2 ... FCF∞
(1 ka)∞ where
VC
FCFt
ka value of the entire company
free cash flow expected at the end of year t
the firm’s weighted average cost of capital (7.7) CHAPTER 7 331 Stock Valuation Note the similarity between Equations 7.7 and 7.2, the general stock valuation
equation.
Because the value of the entire company, VC, is the market value of the entire
enterprise (that is, of all assets), to find common stock value, VS, we must subtract the market value of all of the firm’s debt, VD, and the market value of preferred stock, VP, from VC.
VS VC VD VP (7.8) Because it is difficult to forecast a firm’s free cash flow, specific annual cash
flows are typically forecast for only about 5 years, beyond which a constant
growth rate is assumed. Here we assume that the first 5 years of free cash flows
are explicitly forecast and that a constant rate of free cash flow growth occurs
beyond the en...

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