The Dividend Decision
If there are not enough
investments
that earn the
hurdle rate, return the cash
to
the owners
Current
EBIT(1t) =
$3,558 million
Return on Capital
20.00%
Reinvestment Rate
50%
Expected Growth = ROC * RR
= .50 * 20%= 10%
Cost of Capit
12.22%
Determine the business risk of the firm (Beta, Default Risk)
Equity:
Beta=1.25
In stable growt
Reinvestment
Return on Cap
Beta = 1.00
Debt Ratio = 3
Cost of Capita
Transition to
stable growth
inputs
Year
EBIT(1t)
Reinvestment
FCFF
Terminal Value PV
1
3,914
$
1,947
$
1,966
$
1,752
$
2
4,305
$
2,142
$
2,163
$
1,717
$
3
4,735
$
2,356
$
2,379
$
1,682
$
4
5,209
$
2,343
$
2,866
$
1,649
$
5
5,730
$
2,851
$
2,879
$
1,616
$
6
6,344
$
2,974
$
3,370
$
1,692
$
7
6,957
$
2,762
$
4,196
$
1,773
$
8
7,558
$
3,006
$
4,552
$
1,849
$
9
8,132
$
2,904
$
5,228
$
1,920
$
10
8,665
$
2,708
$
5,957
$
120,521
$
42,167
$
57,817
$
$11,180
46,637
$
69.08
$
Value of Disney =
= Value of Equity
 Value of Debt =
Value of Disney/share =
Aswath Damodaran
60
Relative Valuation
n
In relative valuation, the value of an asset is derived from the pricing
of 'comparable' assets, standardized using a common variable such as
earnings, cashflows, book value or revenues. Examples include 
•
Price/Earnings (P/E) ratios
–
and variants (EBIT multiples, EBITDA multiples, Cash Flow multiples)
•
Price/Book (P/BV) ratios
–
and variants (Tobin's Q)
•
Price/Sales ratios
Aswath Damodaran
61
MULTIPLES AND DCF VALUATION
n
Gordon Growth Model:
n
Dividing both sides by the earnings,
n
Dividing both sides by the book value of equity,
n
If the return on equity is written in terms of the retention ratio and the
expected growth rate
n
Dividing by the Sales per share,
P
0
=
DPS
1
r

g
n
P
0
EPS
0
=
PE =
Payout Ratio*(1
+
g
n
)
rg
n
P
0
BV
0
=
PBV =
ROE  g
n
rg
n
P
0
BV
0
=
PBV =
ROE*Payout Ratio*(1
+
g
n
)
rg
n
P
0
Sales
0
=
PS =
Profit Margin*Payout Ratio*(1
+
g
n
)
rg
n
Aswath Damodaran
62
Disney: Relative Valuation
Company
PE
Expected Growth
PEG
King World Productions
10.4
7.00%
1.49
Aztar
11.9
12.00%
0.99
Viacom
12.1
18.00%
0.67
All American Communications
15.8
20.00%
0.79
GC Companies
20.2
15.00%
1.35
Circus Circus Enterprises
20.8
17.00%
1.22
Polygram NV ADR
22.6
13.00%
1.74
Regal Cinemas
25.8
23.00%
1.12
Walt Disney
27.9
18.00%
1.55
AMC Entertainment
29.5
20.00%
1.48
Premier Parks
32.9
28.00%
1.18
Family Golf Centers
33.1
36.00%
0.92
CINAR Films
48.4
25.00%
1.94
Average
27.44
18.56%
1.20
Aswath Damodaran
63
Is Disney fairly valued?
n
Based upon the PE ratio, is Disney under, over or correctly valued?
o
Under Valued
o
Over Valued
o
Correctly Valued
n
Based upon the PEG ratio, is Disney under valued?
o
Under Valued
o
Over Valued
o
Correctly Valued
n
Will this valuation give you a higher or lower valuation than the
discounted CF valutaion?
o
Higher
o
Lower
Aswath Damodaran
64
Relative Valuation Assumptions
n
Assume that you are reading an equity research report where a buy
recommendation for a company is being based upon the fact that its PE
ratio is lower than the average for the industry. Implicitly, what is the
underlying assumption or assumptions being made by this analyst?
o
The sector itself is, on average, fairly priced
o
The earnings of the firms in the group are being measured consistently
o
The firms in the group are all of equivalent risk
o
The firms in the group are all at the same stage in the growth cycle
o
The firms in the group are of equivalent risk and have similar cash
flow patterns
o
All of the above
Aswath Damodaran
65
First Principles
n
Invest in projects that
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 Spring '11
 tnaga
 Corporate Finance, Net Present Value, Generally Accepted Accounting Principles, Aswath Damodaran