Document Sample

An overview on valuation methods ON VALUATION 1 Asset Valuation Model: can we find the true value of a project using DCF? Discounted Cash Flow methods Multiples: Price/earning Ratio, Market to book ratio valuation. Option pricing model Piece meal approach: evaluate firm part by part Sources of Uncertainty in Asset valuation: the asset being valued, and the valuation model itself and the analyst Hard to quantify managerial skill, human factors. 2 Discounted Cash Flow Valuation where n = Life of the asset CFt = Cash flow in period t r = Discount rate reflecting the riskiness of the estimated cash flows 3 2 steps of the DCF methods Estimating the expected cash flows for the firm discounting the cash flows at an interest rate that reflects the default risk Some projects are easier to evaluate than others: companies with substantial uncertainties are harder to evaluate but more rewarding. 4 Book Valuation versus DCF Valuation Calculate the Value of firm X at end of year 10 (required rate of return = 10 %) Balance sheet 31. Dec. 09 Fixed Assets 50,000 Equity 10,000 Current Assets 60,000 Liabilities 100,000 110,000 110,000 5 Determination of Free Cash Flows: Equity Value Revenues -operating expenses = Earnings before interest, taxes and depreciation (EBITDA) -depreciation = EBIT (= Earnings before interest and taxes) -Interest expenses = Earnings before taxes -Taxes = Net income + depreciation -preferred dividends -capital spending * -working capital needs* = Free Cash Flow to equity - 6 Determination of Free Cash Flows: the equity value In the table, the capital expenditures is : reinvestment: capital expenditures in high- growth phases exceed depreciation. Working capital needs is: the difference between its current assets and current liabilities. Increases in working capital needs are cash outflows. 7 I.Equity Valuation The value of equity is obtained by discounting expected cash flows to equity, i.e., the residual cash flows after meeting all expenses, tax obligations and interest and principal payments, at the cost of equity, i.e., the rate of return required by equity investors in the firm. where, CF to Equityt = Expected Cash flow to Equity in period t ke = Cost of Equity 8 II. Firm Valuation 1. Cost of capital approach: The value of the firm is obtained by discounting expected cash flows to the firm, i.e., the residual cash flows after meeting all operating expenses and taxes, but prior to debt payments, at the weighted average cost of capital. 9 Adjusted present value approach 2. APV approach: The value of the firm can also be written as the sum of the value of the unlevered firm and the effects of debt. Firm Value = Unlevered Firm Value + PV of tax benefits of debt - Expected Bankruptcy Cost 10 More on APV Model In the adjusted present value approach, the value of the firm is written as the sum of the value of the firm without debt (the unlevered firm) and the effect of debt on firm value The unlevered firm value can be estimated by discounting the free cash flows to the firm at the unlevered cost of equity The tax benefit of debt reflects the present value of the expected tax benefits. Tax Benefit = Tax rate × Debt (1+ rd ) The expected bankruptcy cost is a function of the probability of bankruptcy and the cost of bankruptcy (as a percent of firm value). 11 III. Using Multiples the underlying belief of the multiple method is : The value of any asset can be estimated by looking at how the market evaluates “similar” or ‘comparable” assets. Equity versus Firm Value 1. Equity multiples (Price per share or Market value of equity) e.g. 6 times Book value 2. Firm value multiplies 12 III. Valuation using Multiples The multiple method usees Earnings (EPS, Net Income, EBIT, EBITDA) e.g. 8 times EBITDA. Book value (Book value of equity, Book value of assets, Book value of capital) Revenues Sector specific variables Relative valuation is much more likely to reflect market perceptions and moods than discounted cash flow valuation. Relative valuation generally requires less information than discounted cash flow valuation 13 Estimate the Cost of Equity: Competing Models Model Expected Return Inputs Needed Riskfree Rate; Beta; CAPM E(R) = Rf + b (Rm- Rf) Market Risk Premium Riskfree Rate; # of Factors; APM E(R) = Rf + Sj=1..n bj (Rj- Rf) Betas; Factor risk premiums Riskfree Rate; Macro Multi-factor E(R) = Rf + Sj=1,,n bj (Rj- Rf) factors; Betas; Macro economic risk premiums 14 Estimating Beta The standard procedure for estimating betas is to regress stock returns (Rj ) against market returns (Rm ) : Rj = a + b Rm The slope of the regression b is the beta ( β ) of the stock, and measures the riskiness of the stock. This beta has three problems: 1. It has high standard error 2. It reflects the firm’s business mix over the period of the regression, not the current mix 3. It reflects the firm’s average financial leverage over the period rather than the current leverage. 15 Two stage DCF Valuation: Model DISCOUNTED CASHFLOW VALUATION Expe cte d Growth Cash flows Firm: Growth in Firm: Pre-debt cash Operating Earnings flow Equity: Growth in Equity: After debt Net Income/EPS Firm is in stable growth: cash flows Grows at con stant rate forever Terminal Value CF1 CF2 CF3 CF4 CF5 CFn Value ......... Firm: Value of Firm Fore ver Equity: Value of Equity Le ngth of Pe riod of High Growth Disc ount Rate Firm:Cost of Capital Equity: Cost of Equity 16 Stage 2: Stable Growth and Terminal Value When a firm’s cash flows grow at a “constant” rate forever, the present value of those cash flows can be written as: Value = Expected Cash Flow Next Period / (r - g) where, r = Discount rate (Cost of Equity or Cost of Capital) g = Expected growth rate 17 DDM: dividend discount model Case study: ABN Amro: As a financial service institution, estimating FCF to equity or FCFF is very difficult. The expected growth rate based upon the current return on equity of 15.56% and a retention ratio of 62.5% is 15.56%× .625 =9.73%. This is higher than what would be a stable growth rate (roughly 5% in Euros) Find more detail at: http://pages.stern.nyu.edu/~adamodar/pdfiles/e qnotes/ddm.pdf 18 Market Inputs Long Term Riskfree Rate (in Euros) = 5.02% Risk Premium = 4% (U.S. premium : Netherlands is AAA rated) Current Earnings Per Share = 1.60 €; Current DPS = 0.60 € 19 ABN Amro: Valuation 20 21 Multinational Capital Budgeting Cross border mergers and acquisitions Advantages of M&A Improve economies of scale Cost reduction Get rid of your competitor Less risky than green-field ventures Improved financial power 22 M&As – Reasons for failures Overoptimistic appraisal of market potential Overestimation of synergies (bad valuation methods) Overlooking problems Overbidding Poor post-acquisition integration 23 CSR and firm value Is there such a thing as Corporate Social Responsibility? How does it contribute to firm value? 24 Important chapters for exam Exchange rate: the basic equations: chapter 4, and 5. Theories of exchange rate movement: chapter 7 Economic exposure, transaction exposure, and translation exposure : chapter 8 Hedging technique, and management of exposures: chapter 10, 11,12,13, 15 FDI and international trade theory: chapter 20 Capital budgeting models, NPV, APV, EVA,: Chapter 22, 23, 24. Test bank 4 on the book. Page 513. 25 From our experience, the first essential trait of leadership is positive energy – the capacity to go-go-go with healthy vigor and an upbeat attitude through good times and bad. The second is the ability to energize others, releasing their positive energy, to take any hill. The third trait is edge – the ability to make tough calls, to say yes or no, not maybe. The fourth trait is the talent to execute – very simply, get things done. Fifth and finally, leaders have passion. They care deeply. They sweat; they believe. 26

DOCUMENT INFO

Shared By:

Categories:

Tags:

Stats:

views: | 16 |

posted: | 10/2/2012 |

language: | English |

pages: | 26 |

OTHER DOCS BY fjzhangxiaoquan

How are you planning on using Docstoc?
BUSINESS
PERSONAL

By registering with docstoc.com you agree to our
privacy policy and
terms of service, and to receive content and offer notifications.

Docstoc is the premier online destination to start and grow small businesses. It hosts the best quality and widest selection of professional documents (over 20 million) and resources including expert videos, articles and productivity tools to make every small business better.

Search or Browse for any specific document or resource you need for your business. Or explore our curated resources for Starting a Business, Growing a Business or for Professional Development.

Feel free to Contact Us with any questions you might have.