Class Business Upcoming Debate

Valuation Assignment Free-Cash Flow Valuation of Target (TGT) Graded portions – Pro forma projections (Wednesday, 5/25) – Valuation and Investment recommendation (Tuesday, 5/31) – 7 minute presentation on valuations (Tuesday, 5/31)

Valuation Assignment Download Financial Data From SEC website Construct Forecasts of Financial Statements Use Forecasts of FS to construct forecasts of free- cash flows Construct Intrinsic Value based on free-cash flows Recommend Investment decision based on Valuation

Integration Economics/Strategy – Constructing reasonable forecasts Accounting – Constructing consistent forecasts Finance – Valuation

Intrinsic Value vs. Market Price Intrinsic Value (V 0 ) – The value you believe the security to be based on your analysis. Market Value (P) – The observed market price at which the security is traded.

Valuation Methods: Other Methods Book Value – The net worth of common equity according to a firm’s balance sheet. Liquidation Value – Net amount that can be realized by selling the assets of a firm and paying off the debt. Replacement Cost – Costs to replace a firm’s assets. Tobin’s q: Ratio of market value of a firm to replacement cost.

Discount Models: General Model V 0 = Value of Stock CF t = Cash flow at period ‘ t ’ k = required return

Dividend Discount Models V 0 = Value of Stock D t = Dividend at period ‘ t ’ k = required return

Expected Dividends How do we get the D’s? – Forecast total future dividends, D t (or actually earnings, E t ) above that which is needed to maintain productive capacity (earnings net of depreciation or NOD) Sound Economic Motivation – Accounts for Macroeconomic conditions – Accounts for Industry dynamics – Accounts for firm-specific economies Follows Accounting consistencies This approach falls under the general category of Fundamental Analysis

Fundamental Analysis Approach to Fundamental Analysis 1. Domestic and global economic analysis 2. Industry analysis 3. Company analysis Why use the top-down approach? Framework of Analysis

Performance in countries and regions is highly variable Political risk Exchange rate risk – Sales – Profits – Stock returns Global Economic Considerations

Gross domestic product Unemployment rates Interest rates & inflation Consumer sentiment Domestic Considerations

Fiscal Policy - government spending and taxing actions – Direct policy – Slowly implemented Monetary Policy - manipulation of the money supply to influence economic activity – Initial & feedback effects Tools of monetary policy – Open market operations – Discount rate – Reserve requirements Federal Government Policy

Demand shock - an event that affects demand for goods and services in the economy – Tax rate cut – Increases in government spending Supply shock - an event that influences production capacity or production costs – Commodity price changes – Educational level of economic participants Economy Shocks

Business Cycle – Peak – Trough Industry relationship to business cycles – Cyclical – Defensive Business Cycles

Leading Indicators - tend to rise and fall in advance of the economy – Avg. weekly hours of production workers – Stock Prices Coincident Indicators - indicators that tend to change directly with the economy – Industrial production – Manufacturing and trade sales Lagging Indicators - indicators that tend to follow the lag economic performance – Ratio of trade inventories to sales – Ratio of consumer installment credit outstanding to personal income NBER Cyclical Indicators:

Sensitivity to business cycles Factors affecting sensitivity of earnings to business cycles – Sensitivity of sales of the firm’s product to the business cycles – Operating leverage – Financial leverage Industry life cycles Industry Analysis