Transcript VALUATION - Bilkent University

VALUATION
Five Categories of Valuation
Methods
1.
2.
3.
4.
5.
Discounted cash-flow
Market-based
Mixed models
Asset-based methods
Option-based methods
Discounted Cash-Flow
Approach
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Estimated future cash flows are
discounted back to present value based
on the investor’s required rate of return
Discounted dividend valuation
Discounted operating cash-flow models
Discounted Dividend Valuation
Most straightforward approach
Explicit cash flows received by equity
investors
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Dividends
Terminal value when shares are sold
Firm is expected to have an infinite life
Discounted Dividend Valuation
Theoretical Model
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No-growth, constant dividend
D
P0 
r
Dividends are growing at rate g
D1
P0 
rg

D 0( 1  g)
rg
Discounted Dividend Valuation
Required rate of return (r)
r is the rate of return demanded on a
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specific investment
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Based on investor’s assessment of risk
CAPM
r  rf   (rm  rf )
CAPM -- Example
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rf, Risk-free (30-year Treasury bond) =
5%
rm, Expected stock market return =
10%
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Risk premium = (rm – rf)
Beta = 1.5
r = 5% + 1.5(10%-5%)
r = 12.5%
Discounted Dividend Valuation
Required rate of return (r)
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For nonpublic companies, use a buildup
model and historical sources for data
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Begin with risk-free rate
+ Equity risk premium
+ Small company premium
+ Company specific risk premium
= Required rate of return
Discounted Dividend Valuation
Growth rate (g)
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Top-Down analysis
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Begin with growth of economy
Adjust for industry, sector and company
factors
Sustainable growth = ROE(1-Payout
rate)
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ROE = Earnings/Average equity
Payout rate: proportion of earnings used to
pay dividends or repurchase shares
Discounted Dividend Valuation
- example
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Company A
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Annual dividend = $0.16
Beta = 1.35
ROE = 13%
Payout ratio = 20%
Economic
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20-year Treasury bond = 4.75%
Historical market risk premium = 5.4%
Discounted Dividend Valuation
- example
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r = .0475+1.35(.054) = .120
g = .13(1-.20) = .104
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Value = $11.04…
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$0.16 (1  .104 )
.120  .104
Discounted Dividend Valuation
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Assumes a single, constant growth rate
(g)
What if growth rates differ?
Use a multi-stage model to calculate
future dividends
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Calculate future stock value based on
future dividend
Calculate present value of stock and
dividends
Discounted Operating Cash-Flow Models
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Most applicable in the event of a
takeover
Free cash flow (FCF) is operating cash
flows less necessary investments in
working capital and property, plant and
equipment
FCF1
V0 
rg
FCFF or FCFE
EBITDA
Less: Depreciation and Amortization
EBIT
Less: Interest Paid
EBT
Less: Taxes
Net Income
Plus: Depreciation and amortization
Less: Increase in Working Capital
Operating Cash Flow
Plus: Interest Expense*(1-tax rate)
Less: Increase in Fixed Capital
Free Cash Flows to the Firm (FCFF)
Less: Interest Expense*(1-tax rate)
Plus: New debt borrowing
Less: Debt Repayment
Free Cash Flows to the Equity (FCFE)
Discount Rate
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FCFF
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Weighted Average Cost of Capital
FCFE
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Cost of Equity (required rate of return)
Discounted Operating Cash-Flow Models
Other considerations
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Growth
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Can use a multi-stage model to accommodate
rate changes
Forecasting cash flows requires judgment
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Begin with reported, historical cash flow and
earnings
Make company-appropriate adjustments
Special Issues
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Loss generating firm valuation
Closed Firm Valuation
Start-up companies
Valuation Of GAP Retail Stores
Revenues
Operating Income
Capital Expenditures
Depreciation
Total value of Debt
Market value of Equity
Tax rate
Return on Capital (will be maintained
till perpetuity)
High Growth period-5 years
Stable Growth
Beta-high growth
Beta- stable growth
Risk free rate
Market Premium
Pretax cost of debt
13.763,00
1.851,00
1.650,00
524,00
7.460,38
28.795,00
35,00%
13,61%
12,73%
5,00%
1,20
1,00
5,40%
4,00%
7,20%
High Growth Stable Growth
Debt Ratio
21%
21%
Equity Ratio
79%
79%
Beta
1,20
1,00
Risk free rate
5,40%
5%
Risk Premium
4,00%
4%
Pretax debt rate
7,20%
7%
Tax rate
35,00%
35%
Cost of debt
4,68%
4,68%
Cost of equity
10,20%
9,40%
WACC
9,06%
8,43%
Years
0
1
2
3
4
5
Total
EBIT(1-t)
1.203
1.356
1.529
1.723
1.943
2.190
Reinvestment FCFF
1.126
1.269
87
1.431
98
1.613
110
1.818
124
2.050
140
Disc. Rate Present Value
9,06%
9,06%
9,06%
9,06%
9,06%
80
82
85
88
91
426
FCFF-Stable Growth
Reinvestment Rate =g/ROC
36,74%
FCFF6
EBIT5(1-t)*(1+g)*(1-R)
Terminal Value
FCFF6/(WACC-g)
Disc.terminal value
28.310
Value of
Operating Assets
28.736
Value of Equity
1.455
42.429
1.455/(8,43%-5%)
28.310+426
Value of Operating Assets+Cash and MS-Debt
Market-based Models
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Compare subject company to other similar
companies for which market prices are
available
Simple computations but require a great
deal of professional judgment
P/E Model
P/B Method
P/S Model
P/E Model
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Assumes a company is worth a certain
multiple of its current earnings
Assumes each share is worth the same
multiple of EPS
Derived from the dividend discount models
Requires judgment regarding
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Peer firms and their prices
Historical (average) data
P/E Model
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Firms with no internal growth prospects,
paying out 100% of earnings
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Current P/E = 1/r
Constant growth, Leading P/E
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P0/E1 = (D1/E1)/(r-g)
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D = annual dividends, E = EPS
P/E Model - Example
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Consensus analyst forecast EPS = $0.46
P/E of 23 is appropriate
Value = 23*$0.46 = $10.58
If the current price is $10.22, there is
limited upside to this investment
Mixed Models
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Because the previous models are linked
(discounted dividend model) a combined
approach can be used
May use discounted cash flow
approach to forecast cash flows then use
market multiple to derive terminal value
Residual income approaches are linked to
the dividend discount model
Asset-Based Models
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Used when a company is going to be
liquidated
Valuation is based on underlying assets
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Market value of balance sheet items
Assets and liabilities
Also called cost or adjusted book value
approach
Options-Based Models
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Theoretically elegant but practical
application is difficult
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Analyst must have information about
opportunities (and their value) available to
a firm
Equity ownership is viewed as an option
call on the firm
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Limited downside, unlimited upside
Selecting a Model
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Consider characteristics of the firm
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Dividend paying
Growing
Likely to be liquidated
Consider data availability of data
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Publicly available or closely held
Dividend Discount Model
Discounted cash Flow
Model
Market Based Models
Asset Based Models
Option Based Models
o The company is dividend paying
o The company’s dividend policy has a consistent
relationship with earnings.
o The investor takes a non-control perspective
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The company does not pay a dividend or dividends
do not exhibit a consistent relationship with earnings
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Free cash flow align with profitability and can be
forecast
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The investor takes a control perspective
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Publicly traded peer companies exist
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A proxy of value such as earnings is positive and has
a consistent relationship with the value of the firm
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The analyst is confident about the valuation in the
market and the peers
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The company is not viewed as a going concern
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The liquidation value of assets and liabilities can be
determined
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The analyst has information about opportunities or
projects that are available to the firm
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Sufficient data is available to value those
opportunities in an option framework