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Valuation and Methodologies
Valuation and Methodologies
Valuation and Methodologies
VALUATION
CHAPTER 4 OF VALUATION CEONCEPTS
AND METHODOLOGIES
DIVIDEND IRRELEVANCE
THEORY
TWO THEORIES
CONSIDERED IN
INCOME BASED
VALUATION BIRD-IN-HAND
THEORY/DIVIDEND
RELEVANCE THEORY
• WACC = (Ke x We) + (Kd x Wd) WACC
• Ke = cost of equity
• We = weight of the equity financing USED TO DETERMINE
THE COST OF C APITAL
• Kd = cost of debt after tax = Rf + DM (1-T) BY WEIGHING THE
• Rf = risk free rate PORTION OF THE
ASSET FUNDED BY
• DM = Debt margin EQUITY AND DEBT
• T = is the firm’s marginal tax rate.
• Wd = weight of the debt financing
CAPM
• Ke = Rf + B (Rm – Rf)
A MODEL B ASED ON
• Rp = risk free rate THE
PROPOSITION THAT
• B = beta ANY
STOCK’S REQUIRED
• Rm = market return RATE OF
RETURN IS EQUAL TO
THE RISK-FREE RATE
OF RETURN PLUS A
RISK PREMIUM THAT
REFLECTS ONLY THE
RISK REMAINING AFTER
DIVERSIFIC ATION.
ILLUSTRATION
INCOME BASED
CAPITL EARNINGS
VALUATION
APPROACHES APPROACH
DISCOUNTED CASH
FLOW APPROACH
EVA = Earnings - Cost of Capital EVA
INCOME BASED
CAPITL EARNINGS
VALUATION
APPROACHES APPROACH
DISCOUNTED CASH
FLOW APPROACH
C APITALIZATION
OF EARNINGS
METHOD
Future Earnings
Equity Value = Required Return
IN C APITALIZED
In the capitalization of earnings method, if EARNINGS METHOD,
earnings are fixed in the future, the THE VALUE OF THE
capitalization rate will be applied directly to ASSET OR THE
INVESTMENT IS
the projected fixed earnings. For example, DETERMINED USING
Mobile Inc. expects to earn Php450,000 per THE ANTICIPATED
year expecting a return at 12%. EARNINGS OF THE
COMPANY DIVIDED BY
THE C APITALIZATION
RATE (I.E. COST OF
Equity Value = P450,000/12% = P3,750,000 C APITAL).
C APITALIZATION
OF EARNINGS
METHOD
IF THE FUTURE
EARNINGS ARE NOT
CONSTANT AND YEAR,
THE SUGGESTED
APPROACH IS TO
DETERMINE AVERAGE
OF EARNINGS OF ALL
Equity Value = Php610,000 /12% THE ANTICIPATED
Equity Value = Php5,083,333 C ASH FLOWS.
C APITALIZATION
Following through the information of Mobile OF EARNINGS
Inc. with the calculated equity value of METHOD
Php5,083,333, assume that there is an idle
asset amounting to Php1,350.000.
This value should be included in the equity
value but on top of the capitalized earnings.
IN C ASE THERE ARE
Hence, the adjusted equity value is Php IDLE ASSETS, THIS WILL
6,433,333 computed as follows: BE AN ADDITION TO
THE C ALCULATED
C APITALIZED
Php 5,083,333 + Php 1,350,000 = Php EARNINGS,
6,433,333
DISCOUNTED
NEXT CHAPTER… C ASH FLOW
METHOD
THE DISCOUNTED
C ASH FLOWS OR DCF
THANK YOU. MODEL C ALCULATES
THE EQUITY VALUE BY
DETERMINING THE
PRESENT VALUE OF THE
PROJECTED NET C ASH
FLOWS OF THE FIRM.
THE NET C ASH FLOWS
MAY ALSO ASSUME A
TERMINAL VALUE THAT
WOULD SERVE AS A
REPRESENTATIVE VALUE
FOR THE C ASH FLOWS
BEYOND THE
PROJECTION.
DISCOUNTED
NEXT CHAPTER… C ASH FLOW
METHOD
THE DISCOUNTED
C ASH FLOWS OR DCF
THANK YOU. MODEL C ALCULATES
THE EQUITY VALUE BY
DETERMINING THE
PRESENT VALUE OF THE
PROJECTED NET C ASH
FLOWS OF THE FIRM.
THE NET C ASH FLOWS
MAY ALSO ASSUME A
TERMINAL VALUE THAT
WOULD SERVE AS A
REPRESENTATIVE VALUE
FOR THE C ASH FLOWS
BEYOND THE
PROJECTION.
1. HBB Company for the last to last ten years, QUIZ 1
has earned and had cash flows of about Php
500,000 every year. As per the predictions of
the company's earnings, the same cash flow
would continue for the foreseeable future.
The expenses for the business every year is
about Php 100,000 only. Based on the
available public information a Php 4 million
Treasury bond has a prevailing return of Php
400,000 annually. Using Capitalization of
Earnings approach, what is the value of HBB
Company?
2. Heinz, Inc. expects to generate QUIZ 1
earnings over the next five years
Php50,000.00; Php60,000.00;
Php65,000.00; Php70,000.00 and
Php75,000.00. Using the Capitalization
of Earnings Method, what is the
estimated value of the firm using
10.00% required rate of return
3. Using Capital Asset Pricing Method QUIZ 1
(CAPM), compute for the cost of capital
(equity) with risk-free rate of 5%,
market return of 12% and Beta of 1.3.
3. Using Capital Asset Pricing Method QUIZ 1
(CAPM), compute for the cost of capital
(equity) with risk-free rate of 5%,
market return of 12% and Beta of 1.3.
4. With risk-free rate of 5%, Beta of 1.5, QUIZ 1
market return of 8%, prevailing
credit spread of 3%, tax rate of 30% and
Equity ratio of 30%, compute for the
weighted average cost of capital.
5. Ernesto, Inc. has projected average QUIZ 1
earnings every year of Php 100 Million.
Debt to Equity Ratio is 3:1. After tax
cost of debt is cost of debt is 5% while
cost of equity is 10%. The Board of
Directors of the company decided to
sell the company for P1 Billion.
Compute for the Economic Value
Added (EVA).
DISCOUNTED CASH
FLOWS METHOD
CHAPTER 5 OF VALUATION CEONCEPTS
AND METHODOLOGIES
DISCOUNTED
The Net Cash Flows refer to the amount C ASH FLOW
of cash available for distribution to both debt METHOD
and equity claims of the business or asset.
This is calculated from the net cash THE DISCOUNTED
C ASH FLOWS OR DCF
generated from operations and for MODEL C ALCULATES
investment over time. THE EQUITY VALUE BY
DETERMINING THE
For GCBO, the net cash flows generated will PRESENT VALUE OF THE
PROJECTED NET C ASH
be based on the cash flows from operating FLOWS OF THE FIRM.
and investing activities, since this represents THE NET C ASH FLOWS
MAY ALSO ASSUME A
already the amount earned or will be earned TERMINAL VALUE THAT
from the business and the amount that is WOULD SERVE AS A
required to be infused in the operations to REPRESENTATIVE VALUE
FOR THE C ASH FLOWS
generate more profit. BEYOND THE
PROJECTION.
SOURCE OF FINANCING
FOR NEEDED
IN VALUATION,
INVESTMENTS
ANALYSTS FIND
ANALYZING CASH
FLOWS AND ITS
SOURCES HELPFUL RELIANCE ON DEBT
FINANCING
IN
UNDERSTANDING
THE FOLLOWING
QUALITY OF EARNINGS
NET CASH FLOWS TO
THE FIRM
TWO LEVELS OF
NET CASH FLOWS
TERMINAL
VALUE TV = Terminal Value
CF n+1 = Farthest net cash flows
r = cost of capital
g = growth rate
ILLUSTRATION
ILLUSTRATION
ILLUSTRATION
NCFo = net cash flows at the beginning
NCFn = latest net cash flows
n = latest time
ILLUSTRATION
NCFo = net cash flows at the beginning
NCFn = latest net cash flows
n = latest time
g = 10%
ILLUSTRATION
Dos Corp. reported the following information:
Revenue 95,000
Operating Expenses of 16,250
A. WACC?
B. Net Present Value of Cash Flows
Diaanne Inc. purchased an investment and expected to
earn:
Year NCF
1 100
2 200
3 300
Terminal Value 1200
A. WACC?
B. Net Present Value of Cash Flows
MKT Company has projected to generate revenues, cash
operating expenses, and the corresponding tax payments for the
next five years and is operating on a going concern assumption.
Cash Operating WC Adjustments
Year Revenue Expenses Taxes (Additional Investments)
1 100 50 10 5
2 150 60 20 10
3 200 70 30 15
4 250 80 40 20
5 300 90 50 25
A The Company sold an old fixed asset for Php 50 on year 3
QUIZ and purchased a new one on the same year for 80.
PROBLEM 4 B The Company also issued 50 worth of proffered stocks on
Year 0 with 8% annual dividend rate.
C Assume the growth rate is 5% with 10% required rate of
return.
Find:
A. Net Investment in Fixed Capital
B. Terminal Value
C. Annual Dividends on Preference Shares
D. Undiscounted Net Cash Flows to the Firm
E. Discounted Equity Value or Net Cash Flows to Equity
Anahaw Inc. projected invented shoes that makes its user jump
twice as high as a normal person. Upon studying the market, the
volume of shoes to be sold in Year 1 is 100 pairs which will all be
sold to NBA players, assuming a 10% growth every year, and the
estimated required return of 15%. The shoes are sold at Php
50,000 per pair with a cash net income margin of 20%. Anahaw
Inc.’s mahika can produce the shoes as long as the chemist is alive.
It was noted that the company has outstanding debt of
Php500,000.
QUIZ
PROBLEM 5 Find the following, assuming the Company will operate until Year
3.
A. Enterpise Value
B. Equity Value