Burgos 1Jeguiris BurgosProfessor Hugo WalterENG331.docx

Burgos 1
Jeguiris Burgos
Professor Hugo Walter
ENG3316
19 February 2020
American Civil War
American Civil War was a battle between the Northern and
Southern United States,
which occurred between 1861 and 1865 (Adams). The war was
triggered by the persistent
disagreement over the enslavement of African people. The
southerners, who practiced large-
scale farming, were in support of slavery owing to their high
demand for slave labor. The
Northern people, on the other hand, were against the
enslavement of the blacks because they
were not dependent on slave labor. Considering that the
Northerners' economy was industry-
based, slave labor was not a necessity. This difference in the
need for slave labor between the

northern and southern states created a long-standing
controversy, which, in turn, led to the
American Civil War.
After winning the 1860 presidential elections, Abraham
Lincoln, who led the
Republicans, showed great support for the abolition of slavery
in all states within the US
(Keegan). The southerners considered this as an infringement of
their rights and an initial step to
ultimately ban slavery. As such, the southern states decided to
secede from the Union just before
Lincoln's inauguration and instead form the confederacy. The
secession began with seven slave
states comprising Alabama, South Carolina, Florida, Texas and
Mississippi which kept the
highest proportion of slaves. Other remaining southern states
continued to discard the calls for
When you quote directly from a source please be sure to put
quotation
marks around the quoted passage.
Burgos 2
withdrawal since they had viewed it as illegal. In an effort to

calm the fear that southern states
had in regard to the abolition of slavery, Lincoln reaffirmed in
his inaugural address that he had
no intention to obstruct the institution of slavery.
In the same year of presidential elections, four more southern
states withdrew from the
Union to join the confederacy. The continual session by the
southern states triggered the issuance
of the emancipation proclamation, which stated that all slaves
held in the southern states will be
freed by January 1863 (Hummel). However, the president did
not free all the enslaved blacks in
the US because the declaration was only targeting those who
were within the confederacy. The
document did not apply to those states that had maintained their
loyalty to the Union. Although it
was offered as a military decree, the emancipation proclamation
indicated a significant shift in
Lincoln's opinion on slavery. In particular, the declaration
redefined the Civil War by turning it
into a fight that was intended to end slavery.
Based on Lincoln's view, slavery was immoral; hence, it was
supposed to be abolished.

However, Lincoln did not realize that the constitution had
afforded the government the right to
ban slavery in some regions. He, instead, thought that the
constitution had prevented its
expansion to western territories that would have ultimately
became states. Therefore, Lincoln
insisted that the fight is not about freeing the enslaved blacks
within the southern states, but
maintaining the Union. Following the secession, four slave
states which stayed in the Union
included, but not limited to, Maryland, Missouri, Delaware, and
Kentucky. After noticing the
efforts made by the southern states, one of the generals named
John C. Fremont declared that the
states that rejected secession would have their possessions and
slaves seized and freed
When you quote from a source in your essay please be sure to
put the
quoted passage in quotation marks and cite the source.
Burgos 3
respectively. However, Lincoln ordered him to reverse the
policy and later demoted him from the
command position.

Nonetheless, many enslaved people were fleeing to the southern
states controlled by the
Union such as Virginia, where General Butler had declared them
as "contraband"; this
contravened the Fugitive Slave Law authorizing their return to
their holders (Adams). He argued
that setting the southern slaves free would support the Union's
victory notwithstanding the
importance of slave labor among the southern states. In 1862,
the congress approved the Militia
Act, which permitted the previously enslaved Africans to be
recruited in the military as laborers.
Also, the act authorized that slaves held in southern states
would be set free. Lincoln also aimed
to encourage the slaveholders to release their slaves by
promising them some compensation.
However, when other abolitionists condemned him for not
bringing forth a stronger liberation
policy, Lincoln replied that his main goal was to save the Union
and not the slaves' freedom.
However, conflicts began in 1861 when the confederate state's
forces attacked the Fort
Sumter by claiming that it belonged to them (Hummel). This
attack prompted the intervention of

the militia who aided in the suppression of the southern
rebellion. This move forced most of the
states, such as the Virginia, Arkansas, and Tennessee, to reverse
themselves and instead support
the secession. Actions in the battle were divided into the eastern
and northern theaters. The
eastern theaters consisted of the states, such as North Carolina,
Pennsylvania, and Maryland. The
northern theaters, on the other hand, comprised Florida and
Georgia. The first inland war began
when 3,000 Union volunteers attacked 800 confederates in
Virginia. Owing to their vast number,
the unionist won the battle, which contributed to the elevation
of General George's reputation.
However, in 1892, the war between the north and south
escalated and led to significant loss of
Do you mean 1862? The Civil War had ended before 1892.
Burgos 4
more human lives. Towards the end of 1892, more invasions
into the United States transpired
and enabled the Union to expand its territory. Still, in the
subsequent months, more battles fought

led to further destruction of the south and a significant victory
to the Union.
On September 1892, Lincoln made the proclamation, which
required the confederates to
join the Union before 1963 (Hummel). Lincoln had been advised
by his secretary that he had to
wait for the Union's victory before announcing the
emancipation. After making the
announcement, Lincoln signed the proclamation, which
comprised the gradual liberation,
slaveholders' compensation, and colonization. He justified the
freedom as a wartime measure and
was keen to use it in the confederate state that rebelled the
Union. Lincoln's proclamation was
targeting territories outside his governance. Considering that his
primary focus was on
preserving the Union, the emancipation did not cause many
effects on the slaves' freedom.
Essentially, Lincoln's decree led to the more states rejoining the
Union. However, it had a
tremendous symbolic power since it aided the liberation of
enslaved blacks, which was one of
the goals for the Northern state war. Besides, emancipation
proclamation had practical impacts

as evident in the states which had previously supported the
confederacy but backed off owing to
their unwavering opposition to slavery. Based on the provisions
of the slave act, African
Americans were required to serve in the military after being
freed. They were supposed to work
as laborers in the military for over four years before being
granted their freedom. Besides the
liberation, the proclamation fostered the complete abolition of
slavery in the U.S. Generally, the
success in the ban of slavery resulted from the Union's victory
in the Civil War.
When you quote from a source please be sure to put the quoted
passage
in quotation marks and cite the source.Please check these dates.
Burgos 5
Works Cited
Adams, Ephraim Douglass. Great Britain and the American
Civil War. Good Press, 2020.
Hummel, Jeffrey. Emancipating slaves, enslaving free men: a
history of the American civil war.
Open court, 2013.

Keegan, John. The American Civil War. Random House, 2011.
Corporate Valuation and Stock Valuation
CHAPTER 7
© 2020 Cengage Learning. All Rights Reserved. May not be
copied, scanned, or duplicated, in whole or in part, except for
use as permitted in a license distributed with a certain product
or service or otherwise on a password-protected website for
classroom use.
Topics in Chapter
Features of common stock
Valuing common stock
Dividend growth model
Free cash flow valuation model
Market multiples
Preferred stock
classroom use.
Corporate Valuation and Stock Valuation
classroom use.

Common Stock: Owners, Directors, and Managers
Represents ownership.
Ownership implies control.
Stockholders elect directors.
Directors hire management.
Since managers are “agents” of shareholders, their goal should
be: Maximize stock price.
classroom use.
Classified Stock
Classified stock has special provisions for each class, usually
involving voting rights and dividend rights.
Usually named Class A, Class B, etc.
New shares in IPO sometimes have voting restrictions but full
dividend rights.
Founders’ shares usually have voting rights but dividend
restrictions.
Standard & Poor’s no longer allows new additions to its indices
to have classified stock.
classroom use.
Tracking Stock
The dividends of tracking stock are tied to a particular division,
rather than the company as a whole.
Investors can separately value the divisions.

Its easier to compensate division managers with the tracking
stock.
But tracking stock usually has no voting rights, and the
financial disclosure for the division is not as regulated as for
the company.
Very few companies have tracking stock.
classroom use.
Different Approaches for Valuing Common Stock
Free cash flow model
Constant growth
Nonconstant growth
Dividend growth model
Constant growth
Nonconstant growth
Using the multiples of comparable firms
classroom use.
The Free Cash Flow Valuation Model: FCF and WACC
Free cash flow (FCF) is:
The cash flow available for distribution to all of a company’s
investors.
Generated by a company’s operations.
The weighted average cost of capital (WACC) is:
The overall rate of return required by all of the company’s
investors.

classroom use.
Value of Operations (Vop)
The PV of expected future FCF, discounted at the WACC, is the
value of a company’s operations (Vop):
classroom use.
Sources of Value
Value of operations
Nonoperating assets
Short-term investments and other marketable securities
Ownership of non-controlling interest in another company
Value of nonoperating assets usually is very close to figure that
is reported on balance sheets.
classroom use.
Claims on Corporate Value
Debtholders have first claim.
Preferred stockholders have the next claim.

Any remaining value belongs to stockholders.
classroom use.
Total Corporate Value: Sources and Claims
classroom use.
Value of operations= PV of FCF discounted
at WACC
Conceptually correct, but how do you find the present value of
an infinite stream?
classroom use.
Suppose FCFs are expected to grow at a constant rate, gL,
starting at t=1, and continue forever. What happens to FCF?
What is the value of operations if FCFs grow at a constant rate?
See next slide.

classroom use.
Value of operations in terms of FCF1 and gL:
We can multiply and divide by (1+gL), for a reason that will
soon be clear, as shown on the next slide.
classroom use.
Rewritten value of operations:
We can group , as shown on the next slide.
classroom use.
Value of operations with grouped terms:
We can group the terms, as shown on the next slide.

classroom use.
Value of operations if FCF grows
at a constant rate:
What happens toif t gets large? It depends on the size of gL
relative to WACC. See next slide.
classroom use.
What happens to as t gets large?
If gL < WACC: Then < 1.
If gL ≥ WACC: Then ≥ 1.
What happens to the value of operations if gL ≥ WACC? See
next slide.
classroom use.
What happens to the value of operations
if gL ≥ WACC?
Vop = (Big) + (Bigger) + (Even Bigger) + …+ (Really big!)
= Infinity! So g can’t be greater than or equal to WACC!

classroom use.
What happens to the value of operations
if gL ≤ WACC?
Vop = (Small) + (Smaller) + (Even smaller) + …+ FCF0
(Really small!) = ?
All the terms get smaller and smaller, but what happens to the
sum? See next slide
classroom use.
What is the sum of an infinite number of factors that get smaller
at a geometric rate?
Consider this example. The first row is t. The second row is a
number that is less than 1 that is compounded to the power of t.
The third row is the cumulative sum.t1234 . . .
∞(1/2)t1/21/41/81/161/∞ ≈ 0Σ(1/2)t1/23/47/815/16≈ 1
This sum converges to 1. Similarly, converges (although not to
1). See next slide.
classroom use.

Constant Growth Formula for Value of Operations: gL begins at
Time 1
If FCF are expected to grow at a constant rate of gL from Time
1 and afterwards, and gL<WACC:
This is the PV of all FCF from Time 1 through infinity, when
discounted at WACC.
classroom use.
Constant Growth Formula for Value of Operations: gL begins at
Time 0
If FCF are expected to grow at a constant rate of gL from Time
0 and afterwards, and gL<WACC:
This is still the PV of all FCF from Time 1 through infinity,
when discounted at WACC.
classroom use.
Data for FCF Valuation
FCF0 = $24 million
WACC = 11%
FCF is expected to grow at a constant rate of gL = 5%
Short-term investments = $100 million

Debt = $200 million
Preferred stock = $50 million
Number of shares =n = 10 million
classroom use.
Find Value of Operations
classroom use.
Total Value of Company (VTotal)
classroom use.
Estimated Intrinsic Value of Equity
(VEquity)Voperations$420.00+ ST
Inv.100.00VTotal$520.00−Debt200.00− Preferred
Stk.50.00VEquity$270.00

classroom use.
Estimated Intrinsic Stock Price per Share,
(1 of 2)Voperations`$420.00+ ST
Inv.100.00VTotal$520.00−Debt200.00− Preferred
classroom use.
Expansion Plan: Nonconstant Growth
Finance expansion financed by owners.
Projected free cash flows (FCF):
Year 1 FCF = −$10 million.
Year 2 FCF = $20 million.
Year 3 FCF = $35 million
FCF grows at constant rate of 5% after year 3.
No change in WACC, marketable securities, debt, preferred
stock, or number of shares of stock.
classroom use.
Estimating the Value of Operations
Free cash flows are forecast for three years in this example, so
the forecast horizon is three years.

Growth in free cash flows is not constant during the forecast, so
we can’t use the constant growth formula to find the value of
operations at time 0.
classroom use.
Time Line of FCFYear012345…
tFCF−$10$20$35FCF3(1+gL)FCF4(1+gL)FCFt(1+gL)
Free cash flows are forecast for three years in this example, so
the forecast horizon is three years.
Growth in free cash flows is not constant during the forecast, so
we can’t use the constant growth formula to find the value of
operations at time 0.
classroom use.
Horizon ValueYear012345…
tFCFFCF3(1+gL)FCF4(1+gL)FCFt(1+gL)HV3← ↵ ← ↵ ← ↵
Horizon value is also called terminal value, or continuing value.
classroom use.

Horizon Value Application
(FCF3 = $35, WACC = 11%, gL = 5%)
This is the value of FCF from Year 4 and beyond discounted
back to Year 3.
classroom use.
Value of Operations at t=0: PV of FCF1 through FCF3 plus PV
of HV3Year012345… tFCFFCF1FCF2FCF3PV of FCF in
explicit forecast← ↵ ← ↵ ←
↵ FCF3(1+gL)FCF4(1+gL)FCFt(1+gL)+HV3← ↵ ← ↵ ← ↵ PV
of HV← ↵ ← ↵ ← ↵ = Value of operations Time 0
PV of HV is the PV of FCF beyond the explicit forecast. So PV
of HV plus PV of FCF in explicit forecast is the PV of all future
FCFs.
classroom use.
Application: Current Value of Operations (Nonconstant g in
FCF until after Year 3; gL = 5%; WACC = 11%)

classroom use.
Estimated Intrinsic Stock Price per Share,
(2 of 2) Voperations$480.67 + ST Inv. 100.00
VTotal$580.67 −Debt200.00− Preferred Stk.
50.00VEquity$330.67 ÷ n 10 $33.07
classroom use.
How much of the value of operations is based on cash flows
from Year 4 and beyond?
The horizon value is the value of all FCF from Year 4 and
beyond, discounted back to Year 3.
The present value of HV3 is the present value of all FCF from
Year 4 and beyond.
The PV of HV3 is the percent of total value due to long-term
cash flows.
classroom use.
Value of Operations and Present Value of Horizon Value
Value of operations: Vop = $480.67
Horizon value: HV3 = $612.5
PV of HV3 = $612.5/(1 + 0.11)3
= $447.855

classroom use.
Percent of Value Due to Long-Term Cash Flows
In this example, 93% of value is due to cash flows 4 or more
years into the future.
For the average company, this percentage is around 80%.
classroom use.
Long-term versus Short-term Focus
Why focus on quarterly earnings if most value is from longer-
term cash flows?
Changes in quarterly earnings can signal changes future in cash
flows. This would affect the current stock price.
Managers often have bonuses tied to quarterly earnings, so they
have incentive to manage earnings.
classroom use.
Forecasting Free Cash Flows: A Simple Approach
Forecast sales to grow at chosen growth rates.
Forecast net operating profit after taxes (NOPAT) and total net
operating capital (OpCap) as a percent of sales.

classroom use.
Current Situation (in millions)
Most recent data:
Sales of $2,000
Total net operating capital, OpCap = $1,120
Operating profitability ratio
OP = NOPAT/Sales = 4.5%
Capital requirement ratio
CR = OpCap/Sales = 56%.
The target weighted average cost of capital (WACC) is 9%.
classroom use.
Initial Operating Assumptions for the No Change Scenario
Operating ratios remain unchanged from values in most recent
year.
Sales will grow by 10%, 8%, 5%, and 5% for the next four
years.
The long-term growth rate in sales is 5%.
The target weighted average cost of capital (WACC) is 9%.
classroom use.

AssumptionsActualForecastInputs01234WACC9.0%Sales$2,000
OpCap$1,120Sales growth
rate10%8%5%5%NOPAT/Sales4.5%4.5%4.5%4.5%4.5%OpCAP
/Sales56.0%56.0%56.0%56.0%56.0%
classroom use.
Examples of Forecasting Items
Sales1 = $2,000(1+0.10) = $2,200
NOPAT1 = $2,200(0.045) = $99
OpCap1 = $2,200(0.56) = $1,232
FCFt = NOPATt − (OpCapt − OpCapt-1)
ROICt = NOPATt/OpCapt
classroom use.
Forecasted FCF: No changes in operating ratiosScenario:
No
ChangeActualForecast01234Sales$2,000$2,200$2,376$2,495$2,
620NOPAT$99$107$112$117.879OpCap$1,120$1,232$1,331$1,
397.088$1,466.942FCF −$13$8.36$45.738$48.025Growth in
FCF-164%447.1%5.0%ROIC8.0%8.0%8.0%8.0%8.0%
FCF is negative in Year 1.
ROIC of 8% is less than WACC of 9%--not good!
Note: There is no rounding in intermediate calculations.

classroom use.
Estimated Intrinsic Value (1 of 2)
classroom use.
Estimated Intrinsic Value (2 of 2)Scenario: No ChangeHorizon
Value:HV4 =$1,260.65Value of Operations:Present value of
HV$893.08+ Present value of FCF$64.45Value of operations
≈$958
classroom use.
The Value of Operations versus the Total Net Operating Capital
The ROIC (8%) is too low compared to the WACC (9%).
The capital is not earning enough to meet investors’ required
return, so:
Horizon value ($958) is less than the total net operating capital
at the horizon ($1,467).
Current value of operations ($958) is less than the current total
net operating capital ($1,120).
ROIC must be greater than WACC/(1+gL) for horizon value to
be greater than the total net operating capital at the horizon.

classroom use.
Value Drivers
The ROIC (8%) is too low compared to the WACC (9%).
The capital is not earning enough to meet investors’ required
return, so:
Horizon value ($958) is less than the total net operating capital
at the horizon ($1,467).
Current value of operations ($958) is less than the current total
net operating capital ($1,120).
ROIC must be greater than WACC/(1+gL) for horizon value to
be greater than the total net operating capital at the horizon.
classroom use.
Impact of Higher Growth RatesNo ChangeImprove
Growthg0,110%11%g1,28%9%g2,35%6%g3,45%6%gL5%6%OP
4.5%4.5%CR56.0%56.0%ROIC8.0%8.0%Vop,0$958$933WACC
9.00%9.00%
Higher growth causes Vop,0 to fall.
ROIC must be greater than WACC/(1+WACC) for growth to add
value.
WACC/(1+WACC) = 8.26%

classroom use.
Impact of Higher Operating ProfitabilityNo ChangeImprove
OPg0,110%10%g1,28%8%g2,35%5%g3,45%5%gL5%5%OP4.5
%5.5%CR56.0%56.0%ROIC8.0%9.8%Vop,0$958$1,523WACC9
.00%9.00%
Higher operating profitability increases the ROIC.
ROIC of 9.8% > 8.26%
The higher ROIC causes a big increase in Vop,0.
classroom use.
Impact of Lower Capital RequirementsNo ChangeImprove
CRg0,110%10%g1,28%8%g2,35%5%g3,45%5%gL5%5%OP4.5
%4.5%CR56.0%51.0%ROIC8.0%8.8%Vop,0$958$1,191WACC9
.00%9.00%
Lower capital requirements increases the ROIC.
ROIC of 8.8% > 8.26%
The higher ROIC causes an increase in Vop,0.
classroom use.
Impact of Simultaneous Improvements in OP and CRNo
ChangeImprove OP and
CRg0,110%10%g1,28%8%g2,35%5%g3,45%5%gL5%5%OP4.5
%5.5%CR56.0%51.0%ROIC8.0%10.8%Vop,0$958$1,756WACC
9.00%9.00%
The ROIC is much higher due to the improvements in

operations.
classroom use.
Impact of Simultaneous Improvements in Growth, OP, and
CRNo ChangeImprove
Allg0,110%11%g1,28%9%g2,35%6%g3,45%6%gL5%6%OP4.5
%5.5%CR56.0%51.0%ROIC8.0%10.8%Vop,0$958$2,008WACC
9.00%9.00%
operations.
With a higher ROIC, growth adds substantial value.
classroom use.
Summary: Value of operations for previous combinations of
ROIC and
gLROICROICROICROICROIC8.0%8.8%9.8%10.8%gL5%$958$
1,191$1,523$1,756gL6%$933$1,247$1,694$2,008
operations.
With a higher ROIC, growth adds substantial value.
classroom use.

Are volatile stock prices consistent with rational pricing?
The previous slide shows that small changes in ROIC and
growth cause large changes in value.
Similarly, small changes in the cost of capital (WACC), perhaps
due to changes in risk or interest rates, cause large changes in
value.
As new information arrives, investors continually update their
estimates of operating profitability, capital requirements,
growth, risk, and interest rates.
If stock prices aren’t volatile, then this means there isn’t a good
flow of information.
classroom use.
Value of dividend-paying stock = PV of dividends …

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