Equity Valuation Models - PowerPoint by malj

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									          Equity Valuation Models
Valuation of Honda Motor using various models

  Model                                             Intrinsic value

  Two-stage dividend discount model                      $34.32

  DDM with earnings multiple terminal value               43.28

  Three-stage DDM                                         39.71

  Free cash flow to the firm                              36.28

  Free cash flow to equity                                37.75

  Market price of Honda Motor   (from Value Line)         32.10

                                                     Source: BKM page 601
Value Line Investment Survey Report on Honda
 Basic Information (as of August 31, 2007)
Recent price                         $32.10
Beta                                   0.90
Dividend per share (2008)             $0.77
Return on shareholder equity          12.5%
Dividend payout ratio                   26%
Risk free rate                         4.5%
Market risk premium                    8.0%
P/E ratio (2009)                          15
Tax rate                              38.5%
Earnings per share (2009)              $4.20
         Dividend Discount Model (DDM)
             D1      D2           D3              DN  PN
       V0                               ... 
            1  k (1  k ) 2
                               (1  k ) 3
                                                  (1  k ) N

• Constant-growth DDM
                         D0 (1  g )   D
                  V0                 1
                          kg         kg

• Market capitalization rate using CAPM

  k  rf  MRP    4.5%  (12 .5%  4.5%)  .90  11 .7%
 Two-Stage Dividend Discount Model (DDM)
• Two stage DDM
  – Near term: rapid growth
     • Dividend increase linearly from $.77 in 2008 to $1.10 in 2011
  – Long term: steady-state growth rate

     g  ROE  b  12.5%  (1  0.26)  9.25%
            D2012 D2011 (1  g ) 1.10  (1  9.25 %)
    P2011                                          $49 .05
            kg      kg          11 .7%  9.25 %

             D2008   D2009        D2010      D2011  P2011
   V2007                                
             1  k (1  k ) 2
                                (1  k ) 3
                                               (1  k ) 4
              .77     .88         .99       1.10  49 .05
                         2
                                      3
                                                     4
                                                            $34 .32
             1.117 1.117        1.117          1.117
Two-stage dividend valuation model
  Honda 2008
  beta                 0.9
  mkt_prem            0.08
  rf                 0.045
  k                 0.1170
  plowback            0.74
  roe                0.125
  growth            0.0925
  g_VL                0.09
  Div1                0.77   PVD1         0.689346
  Div2                0.88   PVD2         0.705304
  Div3                0.99   PVD3         0.710355
  Div4                 1.1   PVD4          0.70661

  Price4         49.0510 PVprice          31.50905

  Act Price                  Intrin Val   34.32067


  Price4_from_EPS
  EPS4                 4.2
  P/E_4                 15
  Price4:               63 PVprice4        40.4695
                           IntrinVal      43.28112


  Value Line,   31-Aug-07
          Two-Stage DDM with
     Earnings Multiple Terminal Value
• Earnings multiple terminal value


       P2011  ( P / E ) 2011  EPS 2011  15  $4.2  $63

             D2008   D2009       D2010     D2011  P2011
   V2007                              
             1  k (1  k ) (1  k )
                           2           3
                                             (1  k ) 4
              .77     .88        .99      1.10  63 .00
                         2
                                    3
                                                   4
                                                          $43 .28
             1.117 1.117       1.117         1.117
A Three Stage Growth Model for
            Honda
 Inputs                             Year           Dividend Div growth Term value Investor CF
 beta             0.9                      2008         0.77                              0.77
 mkt_prem        0.08                      2009         0.88                              0.88
 rf             0.045                      2010         0.99                              0.99
 k_equity       0.117                      2011         1.10                              1.10
 plowback        0.74                      2012         1.24    0.1262                    1.24
 roe            0.125                      2013         1.39    0.1229                    1.39
 term_gwth     0.0925                      2014         1.56    0.1195                    1.56
                                           2015         1.74    0.1161                    1.74
                                           2016         1.93    0.1127                    1.93
                                           2017         2.15    0.1094                    2.15
 Value line                                2018         2.37    0.1060                    2.37
 forecasts of                              2019         2.62    0.1026                    2.62
 annual dividends                          2020         2.88    0.0992                    2.88
                                           2021         3.15    0.0959                    3.15
                                           2022         3.44    0.0925                    3.44
 Transitional period                       2023         3.76    0.0925     167.77      171.53
 with slowing dividend
 growth                                                                                 39.71 = PV of CF
            Beginning of constant                 E17 * (1+ F17)/(B5 - F17)
            growth period                                                         NPV(B5,H2:H17)
        Free Cash Flow Valuation
• Free cash flow to the firm (FCFF)
   – FCFF=EBIT(1-tc)+Depreciation-Capital Expenditures-Increase in NWC
                   T
                             FCFFt          PT                   FCFFT 1
   Firm value                                   , where PT 
                  t 1   (1  WACC )t (1  WACC )T              WACC  g


• Free Cash flow to equity-holders (FCFE)
   – FCFE=FCFF - Interest expense x (1 - tc) + Increase in net debt

                            T
                             FCFE t            PT                      FCFET 1
   MV    of   equity                                 , where   PT 
                       t 1 (1  k E )     (1  k E )                   kE  g
                                       t              T
          Free Cash Flow Valuation
                 Continued
• Un-leveraged beta vs. leveraged beta
                  L
    U                         ;    L  U [1  ( D / E )(1  tc )]
         1  ( D / E )(1  tc )

• Market capitalization rate from CAPM
    ke  rf   L  MRP  rf   L  (rm  rf )
• Weighted average cost of capital (WACC)

   WACC  wd k d (1  tc )  we ke
               Free Cash Flow Valuation of Honda
                    2006      2007     2008     2009     2010     2011
A. Value Line data
P/E                12.70     13.16    13.62    14.08    14.54    15.00
Cap spending/shr              3.55     3.65     3.78     3.92     4.05
LT Debt                      16000    15000    13333    11667    10000
Shares                        1810     1800     1792     1783     1775
EPS                           2.95     3.20     3.53     3.87     4.20
Working Capital               8740     8755     8770     8785     8800

B. Cash flow calculations
Profits (after tax)         5355.0    5775.0   6345.0   6915.0   7485.0
Interest (after tax)         560.9     525.8    467.4    409.0    350.6    = r_debt x (1-tax) x LT Debt
Chg Working Cap                         15.0     15.0     15.0     15.0
Depreciation                          3575.0   3650.0   3725.0   3800.0
Cap Spending                          6570.0   6776.3   6982.5   7188.8
                                                                          Terminal value
FCFF                                  3290.8   3671.2   4051.5   4431.8    103528.9
FCFE                                  1765.0   1537.1   1975.8   2414.6     96092.5    assumes fixed debt ratio after 2011

C. Discount rate calculations
Current beta          0.9                                                               from Value Line
Unlevered beta     0.790                                                                current beta /[1 + (1-tax)*debt/equity)]
terminal growth      0.06
tax_rate           0.385                                                                from Value Line
r_debt             0.057                                                                YTM in 2007 on A rated LT debt
risk-free rate     0.045
market risk prem     0.08
MV equity                     70472   78656    89338    100544   112275                 Row 3 x Row 11
Debt/Value                     0.19    0.16     0.13      0.10     0.08                 Row 5 / (Row 5 + Row 28)
Levered beta                  0.900   0.882    0.862     0.846    0.833                 unlevered beta x [1 + (1-tax)*debt/equity]
k_equity                      0.117   0.116    0.114     0.113    0.112        0.112    from CAPM and levered beta
WACC                          0.102   0.103    0.104     0.105    0.105        0.105    (1-t)*r_debt*D/V + k_equity*(1-D/V)
PV factor for FCFF            1.000   0.907    0.822     0.744    0.673        0.673    Discount each year at WACC
PV factor for FCFE            1.000   0.896    0.805     0.723    0.651        0.651    Discount each year at k_equity

D. Present values                                                                       Intrinsic val Equity val Intrin/share
PV(FCFF)                               2984     3016     3014     2982        69667          81663        65663       36.28
PV(FCFE)                               1582     1237     1429     1571        62513          68332        68332       37.75

								
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