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Approaches to Valuation
ValuationModels
AssetBased
Valuation
DiscountedCashflow
Models
RelativeValuation
Liquidation
Value
Equity
Stable
Current
ContingentClaim
Models
Sector
Twostage
Threestage
ornstage
EquityValuation
Models
Normalized
Sector
specific
Young
firms
Dividends
Costofcapital
approach
APV
approach
ExcessReturn
Models
Optionto
liquidate
Equityin
troubled
firm
Undeveloped
land
FirmValuation
Models
Patent
FreeCashflow
toFirm
Optionto
expand
Firm
Market
Replacement
Cost
Optionto
delay
Undeveloped
Reserves
Valuation
Equity shareholders
All stakeholders
Equity valuation
Firm valuation
(Potential Dividend)
Single Stage
Two Stage
Dogs of Dow
Dogs of Dow
Dogs of Dow
Buying the stocks with the highest dividend yield in the index
every year
CRISIL and GlaxoSmithKline have doubled their dividend
rate in three years while maintaining a payout of 70 % plus
Cost of Equity
Ke = D/P + g
Value of Share
Firm
All investors
Equity + Debt holders
Equity Shareholders
Equity Valuation
Models
Dividend
Discount Models
Single Stage
Firm Valuation
Models
FCFE Models
Two Stage
FCFF Models
Three stage or
Multi stage
Firm
Leverage is
constant
Yes
Equity valuation
model
yes
D/P ratio is
more than
75 %
Dividend Discount
Model
NO
Firm Valuation
model
NO
Equity valuation
model
Value of Equity
Po = FCFE1
Ke g
Po = Value of stock today
FCFE1 = Expected FCFE over the next year
Ke = cost of equity of the firm
g =growth rate
Calculation of FCFE
Earnings per share
xxxxxxx
xxxxxxx
xxxxxxx
xxxxxx
------------------------
ECOLAB SOLUTION
Growth rate = 15.5 %
G.R = 6 %
2012
2013
2014
2015
2016
2017
2018
Year
EPS
Capx
Dep
Change in WC
FCFE
Terminal price (Pn)
Net cash flows
2012
Revenue
WC
Change in WC
Change in WC per share
2013
2014
2015
2016
2017
Calculation of change in working capital
2018
2012
2013
2014
2015
2016
2017
2018
1000.00
50.00
1060.00
53.00
1123.60
56.18
1191.02
59.55
1262.48 1338.23
63.12
66.91
1391.75
69.5.00
Change in WC
3.00
3.18
3.37
3.57
3.79
2.67
0.05
0.05
0.05
0.06
0.06
0.042
2012
0
2.35
2.25
1.125
Year
EPS
Capx
Dep
Change in WC
FCFE
Terminal price (Pn)
Net cash flows
ECOLAB SOLUTION
Growth rate = 15.5 %
2013
2014
2015
2016
1
2
3
4
2.71
3.13
3.62
4.18
2.60
3.00
3.47
4.00
1.30
1.50
1.73
2.00
0.05
0.05
0.05
0.06
1.63
1.89
2.19
2.53
1.63
Year
1.89
2.19
2.53
G.R = 6 %
2017
2018
5
6
4.83
5.12
4.62
2.31
0.06
0.05
2.93
5.08
84.74
87.67
The model
The value of any stock is the present value
(PV) of the FCFE of each year for the
extraordinary growth period plus the PV of the
terminal price
PV of FCFE
PV of terminal price
Stable growth rate
Particulars
Years
C.Y
2013
2014
2015
2016
2017
xxxxxx
2018
Ecolab
STAGES OF GROWTH
Declining growth
VALUING A FIRM
Cashflow to Firm
EBIT (1-t)
- (Cap Ex - Depr)
- Change in WC
= FCFF
Cost of Equity
Riskfree Rate :
- No default risk
- No reinvestment risk
- In same currency and
in same terms (real or
nominal as cash flows
Expected Growth
Reinvestment Rate
* Return on Capital
Cost of Debt
(Riskfree Rate
+ Default Spread) (1-t)
Beta
- Measures market risk
Type of
Business
Operating
Leverage
Weights
Based on Market Value
Risk Premium
- Premium for average
risk investment
Financial
Leverage
Base Equity
Premium
Country Risk
Premium