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Valuation methods and equity value drivers
- 2. Objectives • Firm and equity fair valuation methods o Present value DCF method o Constant free cash flow and dividend growth methods • Drivers of equity value • The price / earnings ratio 2
- 3. Value of Simple Corp 3 Book Value Market or Fair Value V=D+E= FCFi (1+k)i i=1 N å k = kD ×(1 - t)× D V + kE × E V
- 4. Constant FCF Growth • In the case where FCF is assumed to grow at a constant rate, gFCF, a simple formula is found from series convergence V0 = FCF1 k-gFCF 4 V0 = FCFi (1+k)i i=1 N å V0 = FCF1 × (1+gFCF )i-1 (1+ k)i i=1 ¥ å V0 =FCF1 × 1 1+k + (1+gFCF ) (1+k)2 + (1+gFCF )2 (1+k)3 +...+ (1+gFCF )∞-1 (1+k)∞ é ë ê ù û ú FCF1=FCF0 ×(1+gFCF ) FCFi =FCFi-1 ×(1+gFCF ) V0 = FCF0 × 1+gFCF( ) k-gFCF or
- 5. Constant FCF Growth • As the spread between the rate cost and cash flow growth rate narrows, convergence slows considerably • As cash flow growth rate approaches the rate cost, the series does not converge 5
- 6. Variable Growth Value 1 2 3 4 5 6 7 8 9 10 11 12 13 14 FCF Years H V0 = FCFi (1+ k)i i=1 10 å é ë ê ù û ú+ FCF11 (k -gFCF ) × 1 (1+ k)10 é ë ê ù û ú 6
- 7. Variable Growth Value V0 = FCFi (1+k)i i=1 H å é ë ê ù û ú+ FCFH+1 (k-gFCF ) × 1 (1+k)H é ë ê ù û ú 7 0 1 H H+1 N gFCF Step 2 Step 3 Step 1
- 8. Dividend Discount Model • Method is most applicable to firms that have a high dividend payout ratio • Assume that last dividend is a total repurchase of the stock i = 0 1 2 3 4 5 N DIV1 8 DIVN
- 9. Equity Value Management • Explore the relationships between o Earnings growth o Dividend payouts o Cost of equity o Fair value of equity • Based on the Dividend Growth Model with constant dividend growth assumption 9
Editor's Notes
- Banks make collateralized loans, Short term debt on your balance sheet You want an equity investment Privet offering or public offering Secondary market Capital ? Claim on the company for which a return is expected Accounts buyable Loan Bond Equity
- Note gray line. OCE is needed to fund the cash cycle and is assume to earn no interest or dividends NOCE is excess cash and probably does earn interest or dividends Don’t need cash, buy back stock or bonds Sell off or cash out IS Captial need to support opearing assets IF T = 0, further simplity Fairway Corp has all cash in OCE (NOCE=0) Remember to include OCE in OCA
- Gordon Growth Model