Valuation Part 1

Objectives Firm and equity fair valuation methods o Present value DCF methods o Approximate valuation methods Drivers of equity value The price / earnings rati 2

Value of Simple Corp 3 Net Operating Assets Invested Capital Capital Net Operating Assets Invested Capital Capital Book Value ofFair Value of

Constant FCF Growth In the case where FCF is assumed to grow at a constant rate, g FCF, a simple formula is found from series convergence 4 or

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 k=10% 5

Variable Growth Value H H+1 N g FCF Step 2 Step 3 Step 1

Homework 19 Find the value of LeanTech by discounting its expected free cash flow Use 10% for the cost of capital Expected free cash flow as follows o Year 6: $100,000 o Years 7 to 10: FCF grows by 80.0% per year o Years: 11 to 20: FCF grows by 15.0% per year o Years: 21 to 30: FCF grows by 7.5% per year o Years: 31 to 50: FCF grows by 2.0% per year Check o My year 50 free cash flow is about $14.360M What is the value of LeanTech (end of year 5 or beginning of year 6) ? Plot the FCFs, the discount factors, and the value (partial sums) at the end of each year beginning at year 6 ? 7

Variable Growth Value FCF Years H 8

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

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 = N DIV 1 10 DIV N

Equity Value Per Share 11