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Lecture 21: Valuation
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Key Concepts:
Terms in this set (18)
What is valuation
It measures willingness to pay, and is a great decision making tool
What is the value of a company
The expected present value of its future cash flows
Absolute valuation
Pricing an asset relative to its exposure to fundamental sources of risks in the broader economy
- EV or APV Method (DCF)
Relative valuation
What can we learn about an assets value tie the prices of some other assets - multiples based valuation using comparable firms
Absolute valuation steps
Forecast financial statements over some period
- estimate continuation value
- find appropriate discount rate
- discount cash flows to present
FCFE method
Only project the free cash flows to equity holders, discount by return on equity, add back debt to get value of firm
use when debt is fixed
EVM Method
Determine FCF over forecast period
- determine WACC
- discount cash flows by WACC to get present value
use when target debt to value ratio
APV Method
Determine FCF
- Determine level of interest tax shields over forecast period
- discount cash flows by unlevered return and interest shields by return of debt
use with changing levels of leverage
compute value of firm if it were unlevered, then add additional value effects from debt financing
FCFE Steps
determine FCF to equity
- determine return on equity
- discount cash flows by return on equity
- add value of debt for the whole firm
Relative Valuation
Multiples.
- Identify set if comparable firms (best if targets from previous mergers) then use multiples as a guide as to how much to pay for your own target
Multiple
Ratio of the market value of the entire firm to some consistent performance base
- Valuing equity then numerator should be the market value of equity and accounting base should be an equity related measure
- Net income, FCFE, common dividends, or book value of equity
- value entire firm then the numerator should be the market value of the firm and accounting base should be sales, NOPAT, EBIT, EBITDA, FCF (cap structure neutral)
Method
Choose comparable, performance base, compute mean, project performance base for the firm you want to value, multiply mean or median multiple of comparable firms with the projected performance base - result is value of equity or total enterprise value
- Use forward looking numbers
Multiples advantages
- easier than DCF
Disadvantages
Key value drivers not analyzed (growth, profitability, WACC)
- easy to get inappropriate comparable and bad valuation
Systematic over or under valuation of comparable firms will carry over to the valuation of the firm under consideration
DCF advantage
Forces analyst to evaluate the key value drivers of business and the firm's strategic advantages and disadvantages - should be better valuation
- Multiples can provide a check
Price to earnings
Same as total market cap / net income
P/E problems
earnings include non operating gains or losses - also can be contaminated by leverage and growth rate
EBITDA multiple
Comparable across companies with similar growth rates and returns.
- Sometimes can make adjustment in allowing growth rates to vary across firms (PEG)
-EBITDA multiples are most common
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