The document discusses various valuation models and approaches including discounted cash flow valuation, relative valuation, and contingent claim valuation. It provides examples of calculating enterprise value and weighted average cost of capital. It also summarizes the steps to conduct a discounted cash flow valuation, including forecasting free cash flows, determining the terminal value, and validating assumptions.
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Valuation
1. VALUATION OF SHARES Siddharth Jaiswal Shruti Telang Chirag Mehta Kruti Shah Heer Shah
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3. CAPM P/E Ratio Gordon’s Model Dividend Growth Model Net Asset Value Liquidation Value Method DCF I need assistance EV
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15. REPLACEMENT COST METHOD …For Adjusted Book Value Debtors Valued at Face Value. Provide for bad debts if doubtful. Inventories R.M. at most recent cost of acquisition WIP at Cost of R.M + Cost of processing FG at Realizable S.P – (holding, transport & selling costs) Other C.A. Other C.A. like deposits, prepaid expenses and accruals valued at Book Value Fixed Assets (Land, P&M, Buildings valued at Market Price ) + (transportation, installation & selling expenses if any). Non-operating assets Financial securities, excess land & buildings valued at Fair Market Value
16. … Replacement Cost per share Total assets at replacement cost Total liabilities (excluding networth) No. of Outstanding shares
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18. … LIQUIDATION VALUE per share The value realized from liquidating all the assets of the firm. Less amount paid to all the creditors and preference share holders No. of outstanding shares
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27. Valuation Models DCF Model Relative Valuation Model Equity / Balance Sheet Valuation Models Book Value Liquidation Value Replacement Cost P/E Ratio Economic Profit Model Entity DCF Model Dividend Models Dividend Discount Constant Growth DDM
41. Reliance has a beta of 1.5. Assuming the treasury rate as 5%. The cost of equity can be calculated as follows: Cost of Equity = 5% + (1.5 * 8%) = 17% The market premium of 8% was based upon historical data and is the premium earned by stocks on an average over treasury bills. The cost of equity of 17% will be used to discount dividends and cashflows to equity and to obtain the value of Reliance. Capital Asset Pricing Model Example: Reliance
54. Discounted Cashflow Valuation where, – n = Life of the asset – CFt = Cashflow in period t – r = Discount rate reflecting the riskiness of the estimated cashflows
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56. Equity Valuation The value of equity is obtained by discounting expected cashflows to equity, i.e., the residual cashflows after meeting all expenses, tax obligations and interest and principal payments, at the cost of equity where, CF to Equity t = Expected Cashflow to Equity in period t ke = Cost of Equity Discounted Cashflow Valuation
57. Firm Valuation The value of the firm is obtained by discounting expected cashflows to the firm, i.e., the residual cashflows after meeting all operating expenses and taxes, but prior to debt payments, at the weighted average cost of capital, which is the cost of the different components of financing used by the firm, weighted by their market value proportions where, CF to Firm t = Expected Cashflow to Firm in period t WACC = Weighted Average Cost of Capital Discounted Cashflow Valuation
58. Assume that you are analyzing a company with the following cashflows for the next five years. Assume also that the cost of equity is 13.625% and the firm can borrow long term at 10%. (The tax rate for the firm is 50%.) The current market value of equity is $1,073 and the value of debt outstanding is $800. Discounted Cashflow Valuation Year CF to Equity CF to Firm 1 $ 50 $ 90 2 60 100 3 68 108 4 76.2 116.2 5 83.49 123.49 Terminal Value 1603.008 2363.008
59. Method 1: Discount CF to Equity at Cost of Equity to get value of equity Cost of Equity = 13.625% PV of Equity = 50/1.13625 + 60/1.13625 2 + 68/1.13625 3 + 76.2/1.13625 4 + (83.49+1603)/1.13625 5 = $1073 Method 2: Discount CF to Firm at Cost of Capital to get value of firm Cost of Debt = Pre-tax rate (1- tax rate) = 10% (1-.5) = 5% WACC = 13.625% (1073/1873) + 5% (800/1873) = 9.94% PV of Firm = 90/1.0994 + 100/1.0994 2 + 108/1.0994 3 + 116.2/1.0994 4 + (123.49+2363)/1.0994 5 = $1873 PV of Equity = PV of Firm - Market Value of Debt = $ 1873 - $ 800 = $1073
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61. Effects of Mismatching Error 1: Discount CF to Equity at Cost of Capital to get equity value PV of Equity = 50/1.0994 + 60/1.0994 2 + 68/1.0994 3 + 76.2/1.0994 4 + (83.49+1603)/1.0994 5 = $1248 Value of equity is overstated by $175. Error 2: Discount CF to Firm at Cost of Equity to get firm value PV of Firm = 90/1.13625 + 100/1.13625 2 + 108/1.13625 3 + 116.2/ 1.13625 4 + (123.49+2363)/1.13625 5 = $1613 PV of Equity = $1612.86 - $800 = $813 Value of Equity is understated by $ 260. Error 3: Discount CF to Firm at Cost of Equity, forget to subtract out debt, and get too high a value for equity Value of Equity = $ 1613 Value of Equity is overstated by $ 540 Discounted Cashflow Valuation
64. Formula P o = Present Value of expected dividends = DPS / (k e – g) Where, P o = Price of stock today DPS = Expected dividends per share next year K e = Cost of equity g = growth rate in dividends A simple manipulation of this formula yields K e = ( DPS / p o ) + g Dividend Growth Model
65. In 1992, Southwestern Bell paid dividends per share of $ 2.82 and the stock traded at $66 in December 1992. The estimated growth rate in dividends was 5.5% and the firm is assumed to be in steady state. Expected dividends in 1993 = $ 2.82 * 1.055 = $ 2.98 Cost of Equity = $2.98 /$66 + 5.5% = 10% Dividend Growth Model Example: Southwestern Bell
67. Cost of Debt After tax cost of debt = Pre tax cost of debt (1 – tax rate) Siemens AG had 4.244 bn DM of debt outstanding in July 1993. Due to its low leverage and substantial cash balances, its default risk was minimal at it could borrow at 6.72%. The tax rate it faced was 38%. After tax cost of debt = 6.72%(1-0.38) = 4.17% WACC
68. Cost of Preferred Stock K ps = Preferred Dividend per share / Mkt price of preferred share At the end of 1992, GM had preferred stock which paid a dividend of $ 2.28 annually and traded at $ 27. Kps = $2.28/$27 = 8.44% WACC
69. WACC: Pepsi Example WACC = k e (E/[E+D+PS]) + K d (D/[E+D+PS]) + K ps (PS/[E+D+PS]) In Dec 1992, Pepsi Cola Corp had a cost of equity of 12.83% and after tax cost of debt of 5.28%. Equity = 76.94% Debt = 23.06% WACC = (12.83% * 0.7694) + (5.28% * 0.2306) = 11.09% WACC
83. Extraordinary growth rate g % each year 1 2 3 4 5 6….. Stable growth for ever PV of dividends during extraordinary growth period + PV of terminal price The Two Stage Dividend Discount Models
126. PBV Ratio - ROE Price/Book Value Multiples ROE – Required Return PBV Ratio High High Low Overvalued Low ROE – High PBV High ROE – High PBV Low ROE – Low PBV Undervalued High ROE – Low PBV
The most direct approach for approximating the fair market value of the assets on the balance sheet of a firm is to find out what they would fetch if the firm were liquidated immediately.
It measures how much you need to fork out to buy an entire public company.
EV to Sales. This ratio measures the total company value as compared to its annual sales. A high ratio means that the company's value is much more than its sales. To compute it, divide the EV by the net sales for the last four quarters. This ratio is especially useful when valuing companies that do not have earnings, or that are going through unusually rough times. For example, if a company is facing restructuring and it is currently losing money, then the P/E ratio would be irrelevant. However, by applying a EV to Sales ratio, you could compute what that company could trade for when it's restructuring is over and its earnings are back to normal.
EBITDA. EBITDA stands for earnings before interest, taxes, depreciation and amortization. It is one of the best measures of a company's cash flow and is used for valuing both public and private companies. To compute EBITDA, use a companies income statement, take the net income and then add back interest, taxes, depreciation, amortization and any other non-cash or one-time charges. This leaves you with a number that approximates how much cash the company is producing. EBITDA is a very popular figure because it can easily be compared across companies, even if all of the companies are not profitable. EV to EBITDA. This is perhaps one of the best measurements of whether or not a company is cheap or expensive. To compute, divide the EV by EBITDA (see above for calculations). The higher the number, the more expensive the company is. However, remember that more expensive companies are often valued higher because they are growing faster or because they are a higher quality company. With that said, the best way to use EV/EBITDA is to compare it to that of other similar companies
Most executives would say that adding a point of growth and gaining a point of operating-profit margin contribute about equally to shareholder value. Margin improvements hit the bottom line immediately, whereas growth compounds value over time. But the reality is that the two are rarely equivalent. Growth often is far more valuable than managers think. This article presents a new strategic metric, called the relative value of growth (RVG), which gives managers a clear picture of how growth projects and margin improvement initiatives affect shareholder value. Using basic balance sheet and income sheet data, managers can determine their companies' RVGs, as well as those of their competitors. Calculating RVGs gives managers insights into which corporate strategies are working to deliver value and whether their companies are pulling the most powerful value-creation levers. The author examines a number of well-known companies and explains what their RVG numbers say about their strategies. He reviews the unspoken assumption that growth and profits are incompatible over the long term and shows that a fair number of companies are effective at delivering both. Finally, he explains how managers can use the RVG framework to help them define strategies that balance growth and profitability at both the corporate and business unit levels.