1. VALUATION

2. Five Categories of Valuation Methods 1. Discounted cash-flow 2. Market-based 3. Mixed models 4. Asset-based methods 5. Option-based methods

3. Discounted Cash-Flow Approach Estimated future cash flows are discounted back to present value based on the investor’s required rate of return Discounted dividend valuation Discounted operating cash-flow models

4. Discounted Dividend Valuation Most straightforward approach Explicit cash flows received by equity investors Dividends Terminal value when shares are sold Firm is expected to have an infinite life

5. Discounted Dividend Valuation Theoretical Model No-growth, constant dividend Dividends are growing at rate g

6. Discounted Dividend Valuation Required rate of return (r) r is the rate of return demanded on a specific investment Based on investor’s assessment of risk CAPM

7. Discounted Operating Cash-Flow Models Most applicable in the event of a takeover Free cash flow (FCF) is operating cash flows less necessary investments in working capital and property, plant and equipment

8. FCFF or FCFE

9. Discount Rate FCFF Weighted Average Cost of Capital FCFE Cost of Equity (required rate of return)

10. Market-based Models Compare subject company to other similar companies for which market prices are available Simple computations but require a great deal of professional judgment P/E Model P/B Method P/S Model

11. P/E Model Assumes a company is worth a certain multiple of its current earnings Assumes each share is worth the same multiple of EPS Requires judgment regarding Peer firms and their prices Historical (average) data

12. P/E Model - Example Consensus analyst forecast EPS = $0.46 P/E of 23 is appropriate Value = 23*$0.46 = $10.58 If the current price is $10.22, there is limited upside to this investment

13. Asset-Based Models Used when a company is going to be liquidated Valuation is based on underlying assets Market value of balance sheet items Assets and liabilities Also called cost or adjusted book value approach

14. Options-Based Models Theoretically elegant but practical application is difficult Analyst must have information about opportunities (and their value) available to a firm Equity ownership is viewed as an option call on the firm Limited downside, unlimited upside

15. Selecting a Model Consider characteristics of the firm Dividend paying Growing Likely to be liquidated Consider data availability of data Publicly available or closely held