13-49 Other Comparative Valuation Ratios Price-to-book Price-to-cash flow Price-to-sales Be creative
13-50 Figure 13.7 Valuation Ratios for the S&P 500
13-51 13.5 Free Cash Flow Valuation Approaches
13-52 Free Cash Flow Free cash flow for the firm (FCFF) is used to calculate the amount available to BOTH debt and equity holders. - Useful for firms that don’t pay dividends, - Helpful to understand sources and uses of cash • EBIT = earnings before interest and taxes • Tc = the corporate tax rate • NWC = net working capital = Current assets – current liabilities NWC in Increase es Expenditur Capital on Depreciati ) T EBIT(1 FCFF C - - + - =
13-53 FCFF, Firm Value & Equity Value The free cash flow methods discount year to year cash flows plus some estimate of the terminal value PT where WACC = Weighted average cost of capital = wd x rd x (1-t) + we x re g = estimate of long run growth in free cash flow T = time period when the firm approaches constant growth g WACC FCFF P 1 T T - = + T T T 1 t t t ) WACC 1 ( P ) WACC 1 ( FCFF Value Firm + + + = =
13-54 Free Cash Flow (cont.) Another approach calculates the free cash flow to the equity holders (FCFE) and discounts the cash flows directly at the cost of equity, kE. Equity value can then be estimated as: Debt Net in Increase ) T Expense(1 Interest FCFF FCFE C + - - = g k FCFE P E 1 T T - = + T E T T 1 t t E t ) k 1 ( P ) k 1 ( FCFE Value quity E + + + = =
13-55 Input Year 2006 2007 Working capital 5505 5660 Profits (after tax) 5460 Interest (after tax) 452.9 Depreciation 2675 Capital Spending 5278 Long-term debt 15000 13500 Cash flow Calculations EBIT(1-Tc) Increase in NWC FCFF FCFE
Input Year 2006 2007 Working capital 5505 5660 Profits (after tax) 5460 Interest (after tax) 452.9 Depreciation 2675 Capital Spending 5278 Long-term debt 15000 13500 Cash flow Calculations EBIT(1-Tc) 5912.9 Profits (after tax) + Interest (after tax) Increase in NWC 155 WC(2007) - WC(2006) FCFF 3154.9 EBIT(1-tc) + Depreciation - Capital Spending - Increase in NWC FCFE 1202 FCFF - Interest expense(1-tc) + Increase in Net debt
13-57 Comparing the Valuation Models In theory free cash flow approaches should provide the same estimate of intrinsic value as the dividend growth model In practice the various approaches often differ substantially • Simplifying assumptions are used in all models • The models establish ranges of likely intrinsic value • Using multiple models forces rigorous thinking about the inputs
13-58 13.6 THE AGGREGATE STOCK MARKET
13-59 Earnings Multiplier Approach STEP 1: Forecast corporate profits for the coming period. Corporate Profits = Earning per share = EPS STEP 2: Derive an estimate for the aggregate P/E (Price/Earning) ratio using long-term interest rates.
13-60 Figure 13.8 Earnings Yield of the S&P 500 Versus 10-year Treasury Bond Yield
13-61 Earnings Multiplier Approach
13-62 Earnings Multiplier Approach Example: The early 2007 forecast for 12-month forward earnings per share for the S&P 500 portfolio was about $86. The 10-year Treasury bond yield at this time was about 4.8%. What would be the forecast for the level of the S&P 500 index?
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- Summer '15
- Valuation, P/E ratio