Another Example:ABC stock has an expected ROE of 12% per year, expected earnings per share of $2, and expected dividends of $1.50 per share. Its market capitalization rate is 10% per year.What are its expected growth rate, price, P/E, and PEG ratio?
Price-to-book ratio
Price-to-cash flow ratio
Price-to-sale ratio
22
Other Comparative Valuation
Ratios
23
Free Cash Flow Model
An alternative approach to the DDM for firm valuation is to use free cash flow.
This approach is particular useful for
firms that pay no dividends
.
Free Cash Flow for the Firm (FCFF):
(
29
FCFF
EBIT
1
Depreciation
Capital expenditures
Increase in NWC
c
t
=
-
+
-
-
(
29
(
29
1
FCFF
Firm value
1
WACC
1
WACC
T
t
T
t
T
t
P
=
=
+
+
+
∑
EBIT = earnings before interest and taxes
where
= the corporate tax rate
NWC = net working capital
c
t
1
FCFF
, assuming a constant-growth model
WACC
estimate of terminal value
where
WACC
weighted average cost of capital
T
T
T
P
g
P
+
=
-
=
=
Example:The EBIT of a firm is $300, the tax rate is 35%, the depreciation is $20, capital expenditures are $60 and the increase in net working capital is $30. What is the free cash flow to the firm?
25
Comparing the Valuation Models
Value by comparable
q
P/E, P/B, P/Cash, Tobin’s Q
Value by expected dividend growth
q
DDM
q
Constant-growth DDM
(Gordon Model)
q
Two-stage DDM
Value by P/E ratio
q
Price= (expected P/E) * (expected E)
q
P/E ratio
measures
growth opportunity (PVGO)
Value by expected cash flow
q
Free Cash Flow model
26
Summary
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- Fall '08
- Staff
- Time Value Of Money, Debt, Valuation, Dividend yield, P/E ratio, PEG ratio, dividend growth rate
