Document Sample
Definitions Powered By Docstoc
					Term                  Topic                Abbreviation   Definition

Accelerated                                               Allows companies to depreciate an asset by a
Depreciation          Accounting                          greater amount in the earlier part of its useful life;
Alt-A Mortgages

Altman Z-Score        Financial Analysis                  Aids in bankruptcy prediction

                                                          Any resource with the potential to either produce
Asset                 Financial Analysis                  future cash inflows or reduce future cash outflows;
Information           Economics
                                                          Ratio of the number/value of bids received to
Bid-to-Cover Ratio    Finance                             number of bids accepted;
Buono del Tesoro
Poliennale                                 BTP            Italian Government Bonds;
                                                          Capital Invested = Book value of equity + Book
Capital Invested   Financial Analysis                     value of debt - Cash
Chicago Mercantile
Exchange           Finance                 CME
                                                          Use geometric mean of the growth rate; Using
Compound Annual                                           EPS from period t to (t+n): [CAGR] = [ EPS_t /
Growth Rate           Financial Analysis   CAGR           EPS_(t+n) ]^[1/n] - 1;

Cost of Goods Sold Financial Analysis      COGS
Counterparty Credit
Risk                Finance                CCR
                                                          Public registrant filing due to a material corporate
                                                          event/change (triggering event) that are important
Current Report        Finance              Form 8-K       to share- or security-holders;
                                                          Used to reflect the decline in the value of long-
                                                          term / fixed assets as they decline in value over
                                                          time; Firms can use straight-line or accelerated
Depreciation          Accounting                          depreciation;
Depreiation &
Amortization          Finance

                                                          Diluted Shares = [Basic Shares Outstanding] +
                                                          [Restricted Shares] + [Net Share Equivalents from
Diluted Shares        Finance                             Options, Warrants, and Convertible Bonds];
                                                          Non-equity securities than enable holder to obtain
Dilutive Securities   Finance                             equity upon exercise/conversion;

Downside Risk         Financial Analysis                  DR = [ integral ( T - x )^2 f(x) dx ]^1/2;

E-mini S&P500
Futures               Trading              Ticker: ES     $50/contract; Expirations Mar., Jun., Sep., Dec.;

                                                          [ Earnings per Share ] = [ Net Income ] / [ Number
Earnings per Share Financial Analysis      EPS            of Shares Outstanding ];
Earnings before
interest, after taxes Financial Analysis   EBIAT          [ EBIAT ] = [ (EBIT) x ( 1-t ) ];
Earnings before                                       EBIT = Revenues - Operating Expenses + Non-
interest & taxes     Financial Analysis     EBIT      Operating Income
Earnings before
interest, taxes,
depreciation, &                                       EBITDA = Revenues - Operating Expenses + Non-
amortization         Financial Analysis     EBITDA    Operating Income + Depreciation & Amortization;
EBIT Margin          Financial Analysis               EBIT Margin = [ EBIT ] / [ Sales ];
EBITDA Margin        Financial Analysis               EBITDA Margin = [ EBITDA ] / [ Sales ];

                                                      5 ratios: T1 = [Working Cap] / [Total Assets], T2 =
                                                      Retained Earnings] / [Total Assets], T3 = EBIT /
Employee Cost                                         [Total Assets], T4 = [Market Value of Equity] /
Index                Economics              ECI       [Book Value], T5 = [Sales] / [Total Assets];

                                                      Underlying market into which a company sells its
End Market           Finance                          products or services;

                                                      A company's economic value, i.e. the minimum
                                                      amount to buy it outright; EV = Equity Value + Net
                                                      Debt + Noncontrolling Interest + Preferred Stock +
                                                      Capital Leases (Damodaran); Enterprise Value =
                                                      Equity Value + Total Debt + Preferred Stock + Non-
                                                      controlling Interests - Cash/Equivalents
Enterprise Value     Financial Analysis     EV        (Rosenbaum, Pearl);
                                                      [ Equity Reinvestment Rate ] = [ Capital
Equity                                                Expenditures - Depreciation + Change in NWC -
Reinvestment Rate Financial Analysis                  Change in Debt ] / [ Net Income ];
Equity Risk                                           Excess return over the risk-free rate demanded by
Premium           Financial Analysis        ERP       investors for average stock market returns;
                                                      Equity Value = Share Prive x Fully Diluted Shares
Equity Value         Financial Analysis               Outstanding;
                                                      U.S.-denominated time deposits kept outside of
                                                      the United States; Does not bear any relation to
EuroDollar           Finance                          the Euro or Euro-area;
                                                      Exchange-traded futures contract to borrow
EuroDollar Futures                                    $1,000,000 with a 3-month maturity at a specified
Contract             Financial Instrument             date;
                                                      On EBIT, Expected Growth = [Reinvestment Rate]
Expected Growth      Financial Analysis               * [Return on Capital];
Fiscal Multiplier    Economics

Forward Contract     Financial Instrument             Over-the-counter product;
                                                      [Fully diluted shares outstanding] = [Basic shares
Fully Diluted Shares                                  outstanding]+ [In-the-money options] + [In-the-
Outstanding          Financial Analysis               money convertible securities];
General Collateral
Government Bond
Repo Rate            Finance                GC Rate
                                                   For a set of numbers x_1, x_2, .. , x_n, the
                                                   geometric mean G is: G = (x_1 * x_2 * .. *
Geometric Mean         Mathematics                 x_n)^(1/n);

                                                   The some of earnings for producing goods or
                                                   services within an economy; Two formulas: (1)
                                                   GDI = [ compensation of employees ] + [ gross
                                                   operating surplus ] + [ gross mixed income ] + [
                                                   taxes ] - [ subsidies on production and imports ], or
Gross Domestic                                     (2) GDI = [ rental income ] + [ interest income ] + [
Income                 Economics            GDI    profits ] + [ wages ] + [ statistical adjustments ];

Gross Domestic
Product                Economics            GDP
                                                   [Gross Margin] = [Sales Revenue] - [Cost of
Gross Margin           Financial Analysis          Goods Sold];
Gross Mixed
Income                 Economics
Gross Operating
Surplus                Economics

                                                   [ Gross Profit Marin ] = [ (Gross Profit) x (Sales -
Gross Profit Margin Financial Analysis             COGS) ] / [ Sales ];
Growth at a
Reasonable Price    Finance                 GARP
                                                   Assumes society maximizes profits derived from
                                                   exhaustible resources over time and that price
Hotelling Pricing      Economics                   grows exponentially;
                                                   First report published by an equity research
                                                   analyst, usually including a comprehensive
Initiating Coverage                                business description of the target company, sector
Report                 Finance                     analysis, and other commentary;

If-Converted                                       [ If-converted Incremental Shares ] = [ Amount
Method                 Financial Analysis          Outstanding ] / [ Conversion Price ];
Institute for Supply
Surveys                Economics
Interest Coverage      Financial Analysis          Interest Coverage = Interest Expense / EBIT
                                                       Consists of Mergers and Acquisitions, Sales and
                                                       Trading, Assets Management, and Proprietary
Investment Banking Finance                             Trading;

                                                       Interest rate at which banks can borrow unsecured
                                                       funds from other banks in London in the wholesale
                                                       market for 3-month periods; Compiled by the
London Interbank                                       British Banker's Association: surveys 16 banks,
Offered Rate         Finance              LIBOR        takes the average of the middle 8 rates;
                                                       Spread between LIBOR and the overnight indexed
LIBOR-OIS            Finance              .LOIS3:IND   swap rate;
                                                       Use of cunning or duplicity in politics or general
                                                       conduct; In psychology, it describes a generally
Machiavellianism     Philosophy                        deceptive or manipulative person;
                                                       If there are no bankruptcy or agency costs and no
Miller-Modigliani                                      tax advantages to carrying debt, the capital
Theorem              Finance              MM Theory    structure of a firm does not affect its value;

Monoline Insurance Finance                             Insurance covering a particular issue or loan;
National Income
and Product
Accounts           Economics              NIPAs

Net Income           Financial Analysis   NI
Net Income Margin Financial Analysis
Net Operating Profit
After Tax                                              [ NOPAT ] = [ Operating Income x ( 1 - t ) ];
                                                       How to calculate shares issued: [Shares Issues on
                                                       Conversion] = [Excess over par] / [Current Share
                                                       Price], where [Excess over Par] = [Total Value of
                                                       Convert] - [Par Value of Amount Converted],
                                                       where [Total Value of Convert] = [Incremental
                                                       Shares] x [Current Share Price], where
Net Share                                              [Incremental Shares] = [Amount Outstanding] /
Settlement Method    Financial Analysis                [Current Share Price];
Nominal Gross
Domestic Product     Economics            NGDP

Operating Income     Finance

                                                       Lease with terms much shorter than the useful life
Operating Lease      Financial Analysis                of the assets; PV of the lease held on the books;
Operational                                            Typically referred to as Sales, General and
Expenses             Financial Analysis   OPEX         Administrative Expenses
Overnight Indexed
Swap                 Finance              OIS

Overnight Indexed                                      Standardized OIS contracts traded on the Chicago
Swap Futures         Financial Instrument OIS Future   Mercantile Exchange; Underlying Instrument:

Pari Passu           Quotes                            Latin: side by side, or on an equal footing; Adverb;
Expenditure Price
Index                Economics            PCEPI        Federal Reserve price indicator
                                                       inverse (downward sloping) relationship between
                                                       unemployment and inflation; i.e. that rising
                                                       unemployment increases labor market
                                                       competition, suppresses wages, and restrains
Phillips Curve       Economics                         inflation;
Compression          Trading                           Some sort of CDS consolidation;
Principal Agent
Problems             Economics
Probability of
Default              Financial Analysis   PD

                                                       Companies that issue public securities and are
                                                       therefore subject to SEC disclosure requirements;
                                                       Note this includes not just companies with publicly
                                                       traded equity securities, but privately held
Public Registrants   Finance                           companies with publicly issued debt;

                                                       [Reinvestment Rate] = ( [Capital Expenditure -
                                                       Depreciation + Change in Working Capital] ) / (
Reinvestment Rate Financial Analysis                   [EBIT * (1 - T)] );
Restricted Shares
Retained Earnings /
Total Assets        Financial Analysis    RE / TA

                                                       [ Retention Ratio ] = [ 1 - (Dividends / Net Income)
Retention Ratio      Financial Analysis                ];

                                                       ROC = [ (Operating Income)*(1 - T) ] / [ Book
Return on Capital    Financial Analysis   ROC          Value of Equity + Book Value of Debt - Cash ];
                                                       [ ROE ] = [ Net Income / Average Shareholders'
Return on Equity     Financial Analysis   ROE          Equity ] (from Pearl and Rosenbaum);
Return on Invested                                       ROIC = [ (Operating Income in t)*(1 - t) ] / [ Book
Capital              Financial Analysis   ROIC           Value of Capital in t-1 ];

                                                         Return on an asset with no risk of default; Risk-
                                                         free rate = Expected Inflation + Expected Real
                                                         Growth; No variance in returns, i.e. expected
Risk-Free Rate       Financial Analysis                  returns always equal actual returns;

                                                         S = [R - T] / DR; where R is realized returns, T is
Sortino Ratio        Financial Analysis                  target return, and DR is the downside risk;
Special Opening
Quotation            Trading              SOQ

                                                      Equation: [ short-term nominal target rate, i.e. Fed
                                                      Funds rate ] = [ GDP deflated inflation ] + [
                                                      equilibrium real interest rate ] + a_i*[ (GDP
                                                      deflated inflation) - (desired rate of inflation) ] +
                                                      a_y[ (logarithm of real GDP) - (logarithm of
                                                      potential output) ]; Term explanations: GDP
                                                      deflated inflation averaged over past 4 quarters;
                                                      equilibrium real interest rate set through discretion,
                                                      usually to 2%; desired rate of inflation set through
                                                      discretion, usually to 2%; a_y set through
                                                      discretion, usually to 1/2; [ (logarithm of real GDP)
                                                      - (logarithm of potential output) ] is the % deviation
                                                      of real GDP from its trend, and potential output
Taylor Rule          Economics                        growth usually assumed to be 2% annually;
                                                      Difference between the interest rate of interbank
                                                      loans (LIBOR) and the 3-month U.S. government
                                                      T-Bill; The abbreviation TED came from T-Bill and
                                          Ticker:     EuroDollar, since those were the original
TED Spread           Finance              .TEDSP:IND; components of the indicator;

                                                         Inputs: Current share price, number of common
                                                         shares outstanding, number of in-the-money (ITM)
                                                         options, and weighted average price of ITM
                                                         options; Method: [Fully Diluted Shares] = [number
                                                         of common shares outstanding] + [net new shares
                                                         from options], where [net new shares from options]
                                                         = [number of ITM options, i.e. number of shares
                                                         issued due to options] - [shares repurchased],
                                                         where [shares repurchased] = [options proceeds
                                                         to company, i.e. (number of options)*(weighted
Treasury Method      Finance                             average price)] / [current share price];
                                                         [ (Sell trades + Buy trades)/2 ] / [ Market value of
Turnover Ratio       Finance                             Portfolio ]

                                                         "The greatest happiness of the greatest number is
                                                         the foundation of morals and legislation," Jeremy
Utilitarianism       Philosophy                          Bentham
                                                 WC = [Current Assets] - [Current Liabilities];
Working Capital     Financial Analysis   WC      measure of absolute liquidity;
Working Capital /
Total Assets        Financial Analysis   WC/TA   measure of liquidity;
Use                                           Notes/Problems                             Source

Reduces net income, reducing taxable          Often fairs poorly in measuring economic
income;                                       depreciation;

Equation not constant over all industries;
Data set used in original paper covers

Gauges interest during a securities
auction or offering;

                                              Must be adjusted for non-recurring items
                                              in order to have predictive capacity;

Account expense;

A risk metric that does not incorporate
up-side risk; It is a semi-deviation, since
it takes the square root of the lower
partial moment of degree 2;

Gives a portfolio exposure to the broader
market; Very liquid - can be used for
short-term momentume trades;
[Growth in Earnings Per Share] = [ 1 - (
Dividends / Net Income ) ] * [ Return on
Equity ];

Tax-effected EBIT;
Usually the same as reported operating
income, operating profit, or income from
operations, a company's EBITDA (may Includes non-cash D&A charges (reflects
differ due to income outside of               capital spending and amortization policy
company's usual scope);                       differences);
Proxy for operating cash flow; Provides
a useful comparison that does not
account for capital structure (i.e. interest,
tax benefits from debt);

Lagging indicator; Can be proxied per
company by dividing COGS by SG&A;
End markets may provide a basis to
determine whether companies are
comparable in their business
                                         Does not take into account capital
                                         structure (might be a positive if the deal
                                         will dramatically change the capital
                                         structure of the company); After a while,
                                         financial structure may affect the EV of a
                                         company: a highly levered company may
Indicative of price an acquiring company trade a discount to its peers due to
may pay; Similar companies should        increased financial risk and growth
have similar EV multiples;               constraints;
[ Equity Reinvestment Rate ] * [ Non-
cash Return on Equity ] = [ Growth in
Net Income ];

Hedging product for short-term interest
rate shifts; Uses LIBOR quoted rate for
its corresponding contract date;

                                           Forward contracts have a zero value upon
                                           inception (unlike stock options);
Applies only to positive number; Often
used in modeling data that is exponential
in nature; 'Geometrically,' it can be
thought of as a side of an n-dimensional
cube with the same volume as that of
the product of the numbers -- as an
example, when annual percentage
growth is given, the total growth over the
period would be computed by the
product and the geometric mean would
be appropriate; Will always be less than
the arithmetic mean;

                                             GDI and GDP should theoretically be
                                             equal, but rarely are, demonstrating the
                                             possibility of issues; Measurement issue:
                                             uses sample to predict income, but may
Measures value of output by adding up        encounter 'non-sampling issues' such as
all the incomes within the economy;          firms starting up and closing down
Tends to be highly correlated with           <
business cycle indicators and next-          683896/the-case-for-gdi-a-qa-with-jeremy-
quarter GDP;                                 nalewaik/>;
                                             Includes both market and non-market
                                             transactions, usually valued at market

Measures percentage of revenus
remaining after COGS; Driven by unit
costs, and depends largely on variable

Pricing model for exhaustible resources;
                                                                                            Pearl &
                                                                                            Banking," 2009, 20
Used to account for dilutive effects of in-
the-money convertible debt; Note if the
security is converted to equity, no cash
changes hand (unlike in the Treasury
Stock Method), so there are no proceeds Note: net income and foregone interest
received by either the company or           expenses must be adjusted upwards to
security holder;                            reflect the change in debt servicing;

Fixed income analysis,
Can use LIBOR spread between highest
and lowest rate as a measure of banking
sector risk;
Measure of the health of the banking

Serves to show why capital structure
matters when these costs become
factored, and how they may differ
depending on the type of business; Ex.
manufacturing companies have much
lower liquidation values, Ex. Raising tax
rate may encourage debt financing;

Produced by Bureau of Economic

Residual profit earned after all expenses
often viewed as the earnings available to
equity after all non-equity obligations for
the period are met; Also called earnings,
or bottom line;

Tax-effected EBIT; Common in
economic value added computations;

Assumes that the conversion option has
the company pay the face value in cash
and the difference between the current
stock pice and the conversion price is
settled with the issuance of additional
shares; Dilutes current equity value less
than If-Converted method;

Pre-tax, pre-debt income earned by firm,
and thus both debt and equity investors;
Add non-operating revenue to get EBIT
Classified as an operating expense, but
better suited to a financing cost; Little
risk borne by the lessee;
                                              Can be allocated among divisions without
                                              necessarily corresponding directly to its
Measure of risk and liquidity in the
money market;


Short-term macro-economic analysis

Public registrants are required to file 10-
K (annual), 10-Q (quarterly), and 8-K
(current, usually event-driven) forms;

Proportion of after-tax operating income
invested in net capital expenditures;
Note that [ (Reinvestment Rate) *
(Return on Invested Capital) ] = [ Growth
in Operating Income ];

Measures the proportion of income
retained by the firm, which will be used
to invest in future earnings growth;

Used to determine if capital investments
within the firm have produced value
above the financing costs; Measures the
excess returns generated by new an
existing investments;
Measures the % return earned in period
t on capital invested in period t-1; Pre-
interest earnings in numerator,
Qualities (Damodaran Blog): i. should be
the return if investment forgone taken
and safe cash equivalents held
(opportunity cost), ii. reflects economic
expectations, iii. acts as a "safe-haven,"
yielding much lower returns during
depressed growth;
Risk-adjusted returns metric; Does not
penalize for upside risk as the Sharpe
Ratio does;

Used as a short-hand way to calculate
the appropriate interest adjustment by a
Central Bank in response to a change in
inflation, output, or other economic         Not forward looking (aside from output
variables; Handy for central banks with      gap), might be improved if inflation
a dual mandate of both price and             expectations included; equal weight given
economic growth targets;                     to inflation and output gaps;

Since T-Bills are viewed as risk free, the
spread between them and lending to
commercial banks gauges the degree of
credit risk in the economy;

Calculate net share equivalents of stock
options; Includes all in-the-money
options, whether vested or not;

                                                                                         Original creators:
                                                                                         Jeremy Bantham
                                                                                         and John Stuart Mill;
Working capital is needed to support a
business's operations, so as a business
grows, an increase in WC may be
viewed as an investment; Related to the
current and quick ratios;
Inflation Measurements


Trade Deficit
Technology: Software
Companies will usually have high fixed costs
(developers, product management) but low variable
costs (CD production,
Structured Finance Risks
Credit Risk

Includes both market (privately bought/sold) and non-market goods (e.g. government-
Market prices used, set by the dollar amount; Consequently, GDP reflects nominal, rather
than 'real,' changes in the economy;
Measure productivity, not sales; A product manufactured in Q1 add to inventories in that
period, and when sold in a subsequent period, the consumer expenditure is offset by a
deduction from the inventory amounts;

Operational Expenses
Sources   Related Terms
Method                                  Sub-method

Comparable Companies Analysis           Market Valuation Methodology
1) Find all possible comparable         a. Business Profile: Sector, Products/services,
companies                               Customers / End Markets;
                                        b. Financial Profile: Size, Growth/Return Rates,
                                        Profitability, Financial Structure, Credit Rating;

                                        c. Identify competitors: look at 10-Ks, relevant proxy
                                        statements (DEF14A), investor presentations,
                                        initiating coverage, proxy statements in recent M&A
                                        deals within sector (specifically fairness opinion);

                                        Sources: SEC Filings, Equity Research, Ratings
2) Locate financial information         Agencies, Bloomberg, etc.
                                        Datapoints: Sales, COGs,

3) Spread key statistics, ratios, and   a. Find dilutive effect of options and warrants using
trading multiples                       the Treasury Stock Method;

                                        b. Find dilutive effect of convertible securities by
                                        using either the If-Converted or Net Share
                                        Settlement method;
                                        c. Calculate size metrics: Sales, Gross profit ($,%),
                                        EBITDA, EBIT, Net Income;

                                        d. Calculate profitability metrics: gross profit margin
                                        (%), EBITDA, EBIT, and Net Income margins (%);
                                        e. Calculate growth metrics: CAGR,

                                        f. Calculate return on investment: Return on
                                        Invested Capital (ROIC), Return on Equity (ROE),
                                        Dividend Yield, and Return on Total Assets (ROA);
Dividend Discount Model (DDM)           For dividend paying stock, held ad infinitum

Free Cash Flow to Equity                Conversion from Net Income

Marginal Return on Capital              Short-cut method used in place of ROC
1) Compute change in Capital            a. Capital Invested = Book value of equity + Book
Invested                                value of debt - Cash
                                        b. Calculate change in Capital Invested during
                                        period (net increase/decrease);
2) Compute change Operating             Calculate change in operating income during
Income                                  period;
3) Compute marginal return on           Divide change in Operating Income by change in
Capital Invested;                       Capital Invested for the period;
Credit Risk Issues
Normalizing Earnings                  Using FCFE
1) Find substitute for 'normalized'   a. Compute average return on equity (ROE) over
earnings in current period, i.e.      prior period (5-8 yrs) to get substitute return on
"Normalized EPS"                      equity;
                                      b. Multiply average return on equity by the book
                                      value of equity to get earnings per share in next

                                      a. Find a growth rate for the company in future
2) Value equity per share             periods;

                                      b. Find an average for net capital expenditures per

                                      c. Find a cost of equity;
                                      a. Find future cash flow to equity (FCFE) in next
                                      period; [FCFE in next period] = [Earnings per Share
                                      of next period] - [ Net capital expenditures next
3) Derive value of equity per share   period]
                                      b. Find value of equity per share; [VoE/Share] =
                                      [FCFE in next period] / [Cost of Equity - Growth

Normalizing Earnings                  Using FCFF
1) Derive normalized Earnings         a. Estimate return on capital (ROC) for company by
before Interest/Taxes                 pre-tax return on capital at comparable firms;
                                      b. Multiply ROC with book value of capital to get
                                      normalized EBIT;
                                      a. Determine a reasonable long-term growth rate for
2) Determine Assumptions              revenues;
                                      b. Determine net capital expenditures (CapEx -
                                      Depreciation) needed to sustain growth rate;
                                      c. Determine the level of working capital the firm will
                                      d. Determine an effective tax rate to apply;

3) Calculate Free Cash Flow to Firm a. EBIT (1-t)
                                    b. - ( Capital Expenditure - Depreciation)
                                    c. Change in Working Capital, to the next period
                                    which can be calculated using
                                    (Revenues)*(Working Capital as % of Revenue)*(1
                                    + Growth rate of Revenue);
                                    d. Determine an effective tax rate to apply;
4) Compute Weighted Average Cost Calculated as [Cost of Equity]*[Equity / (Equity+
of Capital                          Debt)] + [Cost of Debt]*[Debt / (Equity+Debt)];
                                    a. [Cash flow to firm in next period] / [Cost of Capital
5) Derive equity value              - Growth Rate]
                                    b. Net out market value of debt;

                                      c. May want to consider subtracting out other non-
                                      equity claims that may dilute shareholder value;
Options Valuation
1) Determine Basic values   a. Is option in-the-money or out-of-the-money;

Pearl & Rosenbaum, "Investment Banking," 2009

Accounts for business/operational risk;

Accounts for financial risk;

Looks for earnings, expenses and balance sheet
information through SEC filings; Look for share price
data and credit ratings through financial information
services or ratings agencies;

In-the-money options that are exercised will add to the
number of shares outstanding;
In-the-money convertibles become additional shares
using either the if-converted method or net share
settlement; Out-of-the-money convertibles remain
treated as debt;

Mayes, Timothy, "Common Stock Valuation"

Damodaran, Musing on Markets post, 10/27/11
Damodaran: Dark Side of Valuation, "Can
be Valued?" March 2000

Assumes that current period ROE is a mistake; uses
past performance to see what it should have been;

Assumes that the book value is a reasonable estimate
for equity value;

This provides a baseline for all future cash flows to

Damodaran: Dark Side of Valuation, "Can
be Valued?" March 2000

This will serve as a baseline for cash flow to the firm in
the next period;

Gives after tax earnings - must now calculate the amount
retained by the firm;

The cash flows to the firm will be discounted back at the
cost of capital;

This yields the firm value;
This yields the equity value;

Assumes that all ITM options will actually be exercised, and that all
proceeds received by the company due to options conversions will
be used to repurchase shares;
The ability of the firm to generate ROE in prior periods may have

Assumes that the company will average a certain return in the
future; Due to the front-weighting of present value discounting, it is
important the company can quickly rebound to this growth rate;
This should be determined in comparison to growth experienced in
the past, and reasonable given the projected future growth rate
estimated in the previous step;
Historical rate may understate COE in the future: since the company
now has negative earnings, investors may demand a higher return;
May use comparable firms;

If there were errors in finding either EPS or CapEx in the next
period, they carry through to this stage;

Shared By: