wk 4 - Estimating Growth and Terminal Value_2011s2

For example if we expect motorolas roc to rise to

This preview shows page 12 - 16 out of 22 pages.

each period. For example, if we expect Motorola’s ROC to rise to 17.22% over the next 5 years, and new investment will start making 17.22% immediately, then g 1 = g 2 = … g 5 = b *ROC 5 +[ 5 (ROC 5 /ROC 0 ) – 1] =0.5299*0.1722+ [ 5 (0.1722/0.1218) – 1] = 16.30% g 6 , g 7 , … = 0.5299 *0.1722 = 9.12% the growth in return on new investment is gradual and equal to 5 (ROC 5 ROC 0 ) – 1 or 7.17% per year, then g 1 = b *ROC 0 *(1.0717) 1 +[ 5 (ROC 5 – ROC 0 ) – 1] = 0.5299*0.1218(1.0717) 1 + [ 5 (0.1722/0.1218) – 1] = 14.08% g 2 = 0.5299*0.1218(1.0717) 2 + [ 5 (0.1722/0.1218) – 1] = 14.58%, The above is equally applicable to firms expecting a downturn.
Image of page 12

Subscribe to view the full document.

FINS3641 SAV Week 4: Estimating Growth and Terminal Value 13 iii) Estimating Growth when Operating Income is Negative When a firm is losing money with –ve OI (typically young and high growth), the fundamental growth rate, g t , doesn’t make sense given the negative reinvestment rate: ܾ ൌ ஼௔௣௜௧௔௟ ௥௘௜௡௩௘௦௧௘ௗ ೟షభ ா஻ூ் ೟షభ ሺଵି௧௔௫ ௥௔௧௘ሻ negative ROC: EBIT t (1 - tax rate)/( Debt BV,t-1 + Equity BV, t-1 ) Solution: use a three step process to estimate growth: Estimate growth rates in revenues over time may use past revenue growth for guidance of future growth revenue growth rate tends to decrease with the level of revenue Decrease the growth rate as the firm becomes larger Keep track of dollar revenues to make sure that the growth is reasonable, given the size of the market in which the firm operates and its share of the market Estimate expected operating margins each year Set a target margin towards which the firm will eventually achieve Yearly estimates should be consistent with the estimated revenue growth rates, the firm’s age, the business in which the firm operates, … Estimate the capital that needs to be invested to generate revenue growth and expected margins Estimate a sales to capital ratio that you will use to generate reinvestment needs each year.
Image of page 13
FINS3641 SAV Week 4: Estimating Growth and Terminal Value 14 iv) An Example of Estimating Growth for Firms with –ve Operating Income Commerce One: Revenues and Revenue Growth Year Growth Rate Revenues AT Operating Margin AT Operating Income R t = R t-1 *(1+g t ) AT OI t = R t *OM t Current $537 -79.62% -$428 1 50.00% $806 -48.17% -$388 2 100.00% $1,611 -27.21% -$438 3 80.00% $2,900 -13.23% -$384 4 60.00% $4,640 -3.91% -$182 5 40.00% $6,496 2.30% $149 6 35.00% $8,770 6.44% $565 7 30.00% $11,401 9.20% $1,049 8 20.00% $13,681 11.04% $1,510 9 10.00% $15,049 12.27% $1,846 10 5.00% $15,802 13.08% (ind. Avg) $2,068 the growth and margin estimates are justified by the life cycle argument Note the inverse relation between rev. growth rate and operating margin
Image of page 14

Subscribe to view the full document.

FINS3641 SAV Week 4: Estimating Growth and Terminal Value 15 Commerce One: Reinvestment Needs & ROC One last step: Check if the revenue growth and operating margin estimates are reasonable, we need to infer the reinvestment needs to support projected revenue growth, which in turn is needed to arrive at the yearly estimates of ROC for comparison to the industry average.
Image of page 15
Image of page 16
You've reached the end of this preview.

{[ snackBarMessage ]}

What students are saying

  • Left Quote Icon

    As a current student on this bumpy collegiate pathway, I stumbled upon Course Hero, where I can find study resources for nearly all my courses, get online help from tutors 24/7, and even share my old projects, papers, and lecture notes with other students.

    Student Picture

    Kiran Temple University Fox School of Business ‘17, Course Hero Intern

  • Left Quote Icon

    I cannot even describe how much Course Hero helped me this summer. It’s truly become something I can always rely on and help me. In the end, I was not only able to survive summer classes, but I was able to thrive thanks to Course Hero.

    Student Picture

    Dana University of Pennsylvania ‘17, Course Hero Intern

  • Left Quote Icon

    The ability to access any university’s resources through Course Hero proved invaluable in my case. I was behind on Tulane coursework and actually used UCLA’s materials to help me move forward and get everything together on time.

    Student Picture

    Jill Tulane University ‘16, Course Hero Intern