...Chapter 7: Prospective Analysis: Valuation Theory and Concepts Copyright (c) 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Chapter 7: Prospective Analysis: Valuation Theory and Concepts Palepu & Healy Key Concepts in Chapter 7 • Forecasts (Ch. 6) are converted into estimates of value. • Discounted future dividends, cash flows, and abnormal earnings may be used to estimate value. • Price-based multiples may also be used as value estimates. • No method by itself dominates any of the others. Copyright (c) 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Chapter 7: Prospective Analysis: Valuation Theory and Concepts Palepu & Healy Discounted Dividends Valuation • The present value of future cash flows to shareholders is the basis of the discounted dividends method. • This method is the basis for most theoretical approaches to stock valuation, including the other methods discussed in this chapter. Where re is the cost of equity capital Copyright (c) 2008 Thomson South-Western, a part of the Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. Chapter 7: Prospective Analysis: Valuation Theory and Concepts Palepu & Healy Discounted Abnormal Earnings • Abnormal earnings are...
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...FINANCIAL INFORMATION ANALYSIS ACCOUNTING-BASED VALUATION TECHNIQUES Application Exercises Question 2 Construct a two-period numerical example to show that the accounting-based valuation of a firm is the same whether R&D is capitalized or expensed. ACCOUNTING-BASED VALUATION TECHNIQUES Application Exercises Question 2 Consider R&D Inc., a biotech start up. This firm: • Incurs expenditures in R&D of $50 in the first year of activity; • Has an opening book value of equity of $1,000; • Generates income (before R&D expenses) of $200 in year 1 and $220 in year 2, at the end of which it is liquidated; • Has a cost of equity capital of 10%; • Pays no dividends prior to liquidation; Show that the PVAE obtains regardless of whether R&D Inc. expenses R&D expenditure as incurred or capitalizes and amortizes R&D expenditure! ACCOUNTING-BASED VALUATION TECHNIQUES Application Exercises Question 2 Expensing R&D As Incurred Assume that the R&D expenditure is expensed at the end of year1: [pic] And Thus: PVAE = 1132.2 ACCOUNTING-BASED VALUATION TECHNIQUES Application Exercises Question 2 Capitalising And Amortising R&D (1) Assume that the R&D expenditure is capitalised and amortised linearly: • R&D expense recognised at end of year 1: 25; • R&D expense recognised at end of year 2: 25; [pic] And thus: PVAE = 1132.2 ACCOUNTING-BASED VALUATION TECHNIQUES Application Exercises Question 2 Capitalising And Amortising...
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...Equity Valuation and Negative Earnings: The Role of Book Value of Equity ABSTRACT: This study provides an explanation for the anomalous significantly negative price-earnings relation using the simple earnings capitalization model for firms that report losses. We hypothesize and find that including book value of equity in the valuation specification eliminates the negative relation. This suggests that the simple earnings capitalization model is misspecified and the negative coefficient on earnings for loss firms is a manifestation of that misspecification. Furthermore, we provide evidence on three competing explanations for the role that book value of equity plays in valuing loss firms. Specifically, we investigate whether the importance of book value in cross-sectional valuation models stems from its role as (1) a control for scale differences (Barth and Kallapur 1996), (2) a proxy for expected future normal earnings (Ohlson 1995; Penman 1992), or (3) a proxy for loss firms’ abandonment option (Berger et al. 1996; Barth et al. 1996; Burgstahler and Dichev 1997). Our results do not support the conjecture that the importance of book value in cross-sectional valuation stems primarily from its role as a control for scale differences. Rather, the results are consistent with book value serving as a value-relevant proxy for expected future normal earnings for loss firms in general, and as a proxy for abandonment option for loss firms most likely to cease operations and...
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...Equity Valuation: A Response to Penman 2001 (CAR, Winter 2001)* RUSSELL J. LUNDHOLM, University of Michigan TERRENCE B. O’KEEFE, University of Oregon and University of Queensland In the Summer 2001 issue of Contemporary Accounting Research we published a paper arguing that, given a full set of forecasted financial statements, the value estimates from a residual income model and a discounted cash flow model should yield identical results. The reason prior empirical studies (Penman and Sougiannis 1998 and Francis, Olsson, and Oswald 2000) found differences between the models is because of subtle errors in the implementation of the models. Penman (2001) understandably takes issue with our paper, claiming that we are wrong on three points. We feel quite confident in our original paper and will rebut each of Penman’s claims. Penman repeatedly states that he is interested in practical issues surrounding valuation. We share this interest; in fact, we were motivated to write our paper because of the common question raised by students and faculty: “Why do I get a different answer from my discounted cash flow valuation than from my residual income valuation?” We still maintain that, if carefully done, there will be no difference in the valuations from these theoretically equivalent models. Our paper shows exactly how to do this and illustrates commonly made mistakes. Further, any practical attempt to value a firm begins with forecasting future financial statements — earnings and book values...
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...Financial Statement Analysis Session #1: Fundamental Analysis and Valuation March 2015 In-Mu Haw (许 仁茂) 1 Create value through acquisition to build brands (over 100) 2 Lenovo vs. HP Stock Price Lenovo created value through acquisitions Poor acquisition (overpaid: $8.8B) $18 million in 2013 3 Deloitte Report Chet Wood, Managing Partner of Deloitte LLP, Merger & Acquisition Services: • • About 70 percent of all health plan M&As fail to create meaningful shareholder value. CFOs and management can take a stronger role in M&A deal evaluation, especially on revenue growth. 4 Use of Financial Statements for Valuation “I am considering to buy a small packing company. They offered me RMB 15 million and gave me their last 2 years’ Income Statements and Balance Sheets. I think it’s overpriced. How much do you think I should pay?” How will you use I/S and B/S to assess the target firm’s fair value? 5 Warren Buffet Emphasized importance of looking at a firm’s Competitive advantage of products Long-term growth potential… for good investment 6 Sound Fundamental Analysis One does not buy a stock, one buys a business. When buying a business, know the business. Good firms can be bad buys (if overpriced). Price is what you pay, value is what you get. Value of firm = Value of Debt + Value of Equity TA = L + SE (BV) on B/S 7 TA – L = SE SE (BV) vs. Market value of equity 8 Stock Price What is intrinsic value? Is the price overvalued? P/E=41: What earnings growth...
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...PLEKHANOV RUSSIAN UNIVERSITY OF ECONOMICS INTERNATIONAL BUSINESS SCHOOL COURSE WORK « Business Valuation on the basis of Damodaran model » Corporate Finance Student: Pavel Terefera Supervisor: Irina Sokolnikova Moscow 2015 Contents Introduction _____________________________________________ 3 Chapter 1. Valuation______________________________________ 4 1.1 Valuation in portfolio management_________________________ 7 1.2 Valuation in acquisition__________________________________ 10 1.3 Valuation in corporate finance_____________________________ 10 Chapter 2. Approaches to Valuation___________________________ 11 2.1 Profitable Approach_____________________________________ 12 2.1.2 Income capitalization approach __________________________ 12 2.1.3Method of discounted cash flows__________________________ 14 2.1.4 Discounted Cash Flow Valuation on example of JSC NLMK____ 20 2.2 Relative Valuation Approach______________________________ 23 Conclusion _______________________________________________ 28 Bibliography ______________________________________________ 29 Introduction. Knowing the value of an asset may not be a guarantee for success for investor, but it does help us make more informed judgments. A postulate of sound investing is that an investor does not pay more for an asset than its worth. In conditions of market economy when all transactions are made "on fear and risk" their participants, both seller...
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...Chapter 8 Valuation of Company Shares: Earnings Based Methods The objectives of this chapter are to present the earnings based methods of share valuation, to critically appraise the available empirical evidence, and to provide examples of the problems, issues and limitations of share valuation. Chapter Outline • Overview of the relationship between earnings and value. • Compounding versus Discounting • Long Event Windows and Discounted/Compounded Earnings. • Earnings Capitalisation and P/E Valuations. • Permanent versus Transitory Earnings and Financial Analysis. • Ohlson’s Theory of Value. • Example of Ohlson Style Valuation. Why focus on earnings for valuation? In chapter 7 we argued that cash flow and dividend based valuation models were conceptually and empirically inappropriate. Earnings based valuation methods, in particular Ohlson style valuation models, are shown in this chapter to be conceptually superior to dividend and cash flow valuation approaches. There is growing empirical evidence consistent with our arguments, some of which is reviewed in this chapter. Chapter 9 provides some detailed examples of the Ohlson style earnings valuation methodology and should be studied after digesting the current chapter. Why focus on earnings? The actions and statements of the professional investment community provide compelling anecdotal evidence that earnings are important in the...
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...Chapter 8 Valuation of Company Shares: Earnings Based Methods The objectives of this chapter are to present the earnings based methods of share valuation, to critically appraise the available empirical evidence, and to provide examples of the problems, issues and limitations of share valuation. Chapter Outline • Overview of the relationship between earnings and value. • Compounding versus Discounting • Long Event Windows and Discounted/Compounded Earnings. • Earnings Capitalisation and P/E Valuations. • Permanent versus Transitory Earnings and Financial Analysis. • Ohlson’s Theory of Value. • Example of Ohlson Style Valuation. Why focus on earnings for valuation? In chapter 7 we argued that cash flow and dividend based valuation models were conceptually and empirically inappropriate. Earnings based valuation methods, in particular Ohlson style valuation models, are shown in this chapter to be conceptually superior to dividend and cash flow valuation approaches. There is growing empirical evidence consistent with our arguments, some of which is reviewed in this chapter. Chapter 9 provides some detailed examples of the Ohlson style earnings valuation methodology and should be studied after digesting the current chapter. Why focus on earnings? The actions and statements of the professional investment community provide compelling anecdotal evidence that earnings are important in the...
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...[pic] Michael G. Foster School of Business Using a Valuation Model to Estimate a Firm’s Stock Price* In the ongoing search for bargains in the stock market, analysts and investors rely on models to estimate the intrinsic value of a firm’s equity. By comparing the valuation suggested by their model to the actual value in the marketplace, they form opinions as to whether a given stock is under or over valued. Valuation models are also used by investment bankers as an aid to pricing initial public offerings, and to inform parties involved in assorted private transactions such as selling a business or division, dividing property among owners, and settling estates. In this note, we introduce a relatively simple but powerful model of equity (stock) valuation.[1] 1. The basic idea behind valuation Valuation models in finance are typically based on discounted future cash flows or discounted future dividends. Keep in mind that, holding underlying assumptions constant, all valuation models should yield the same result. A model for valuing equity based on accounting data may be preferable in some cases, in that: o Benchmarks for performance are almost always given in earnings per share (EPS) – not cash flows or dividends. o Since real world dividend payout policies tend to be stable for long periods, valuation models based on dividends are less useful for modeling changes in value. o Earnings generally receive far more attention from the business...
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...CHAPTER 11 CORPORATE VALUATION AND VALUE-BASED MANAGEMENT (Difficulty: E = Easy, M = Medium, and T = Tough) True/False Easy: (11.1) Corporate valuation model Answer: b Diff: E 1 . The corporate valuation model cannot be used unless a company doesn’t pay dividends. a. True b. False (11.2) Free cash flows and valuation Answer: a Diff: E 2 . Free cash flows should be discounted at the firm’s weighted average cost of capital to find the value of its operations. a. True b. False (11.3) Value-based management Answer: b Diff: E 3 . Value-based management focuses on sales growth, profitability, capital requirements, the weighted average cost of capital, and the dividend growth rate. a. True b. False (11.5) Corporate governance Answer: b Diff: E 4 . Two important issues in corporate governance are (1) the rules that cover the board’s ability to fire the CEO and (2)the rules that cover the CEO’s ability to remove members of the board. a. True b. False Medium: (11.3) Return on invested capital and MVA Answer: b Diff: M 5 . If a company’s expected return on invested capital is less than its cost of equity, then the company must also have a negative market value added (MVA). a. True b. False Chapter 11: Valuation and Value-Based Management Page 1 (11.5) Corporate governance Answer: b 6 . A poison pill is also known as a corporate restructuring. a. True b. False Diff: M (11.5) Stock options Answer: b Diff: M 7 . The CEO of D’Amico Motors has been granted some stock...
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...Ch13 Tool Kit.xlsx Corporate Valuation 4/11/2010 Chapter 13. Tool Kit for Corporate Valuation, Value-Based Management and Corporate Governance This spreadsheet has two major components, one for Corporate Valuation and one for Value Based Management. Click on the tabs in the lower left of the screen to switch between sections. The value of a company is the sum of: (1) the value of its assets-in-place, including their associated growth opportunities, which is called the value of operations and (2) the value of its nonoperating assets, such as marketable securities and investments in non-controlled affiliates. The value of operations is the present value of the free cash flows produced by the assets-in-place and their associated growth opportunities. THE CORPORATE VALUATION MODEL (Section 13.2) You are given the current and projected financial statements of MagnaVision. Growth is expected to be 5% for each year after the projections. If the WACC is 10.84%, what is the value of operations? INPUT DATA SECTION: Current and Projected Data Used in the Analysis Table 13-1. MagnaVision, Inc.: Income Statements for Years Ending December 31 (in millions of dollars) Actual Projected 2010 2011 2012 2013 2014 $850.0 $1,000.0 $1,100.0 $1,155.0 Net Sales $700.0 Costs (except depreciation) $599.0 $734.0 $911.0 $935.0 $982.0 Depreciation 28.0 31.0 34.0 36.0 38.0 Total operating costs $627.0 $765.0 $945.0 $971.0 $1,020.0 Earning before int. & tax $73.0 $85.0 $55.0 $129.0 $135.0...
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...Pages UK is most likely in the late maturity / early decline stage while Yellow Book USA is still in the growth phase. Although financing the acquisition of Yellow Pages will be a challenge due to the illiquid and lacking European high-yield markets, the recent reversal of high-yield spread coupled with major issuances indicate that investors’ risk appetites are growing and fuelling the growth of this European asset class. As more and more funds/private equities venture into the Europe market, exiting Yellow Pages will be more than viable. Industry Analysis Bargaining power of buyers is fairly high. In the US, there are no switching costs for buyers and they have the option of switching brands or utilize various means to obtain directories listing. However, in the UK, Yellow Pages have other businesses in addition to its core directory business to capture customers who prefer online/phone. Threat of new entrants is very low in both UK and US. For instance, the position of incumbents in US is so strong that it is a common practice to offer advertisers a free year of advertisement which require an upfront sunk cost of $4million. Likewise in the UK, the barriers to entry are so high that the anti-competition bureau has to step in to enforce a second antitrust policy on Yellow Pages. Intensity of competitive rivalry is fairly low. Yellow Pages enjoy a high market share of 85% and Yellow Books is the market-leading independent publisher and this market for independents is estimated...
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..."Which Valuation Metrics Work Best for Stock-Picking Within the Sector?" FIN630 Section 9044 Professor John Halstead October 30, 2011 Overview The article entitled “Which Valuation Metrics Work Best for Stock-Picking Within the Sector?” studies the effectiveness of several market valuation multiples in predicting outperformance of regulated utility stocks relative to the industry as well as the S&P 500 index from 1972 to 2010. The study that was conducted utilizes a database of financial information on publicly traded regulated utility stocks. “The initial source for the universe of firms was from FactSet, and consisted of all publicly traded stocks, that were classified as "Electric Utilities" under the Fact Set industry classification scheme.” FactSet is a company that provides computer-based financial data and analysis for financial professionals on global markets, public and private companies. The study started in 1972 with 80 publicly traded regulated utilities and ends in 2010 with 41 active regulated utilities. “This drop in the number of publicly traded regulated utilities over the last 40 years largely reflects the consolidation wave of the late 1990s and early 2000s, as well as the impact of deregulation during this period.” Black Book (2011). Methodology At the end of each month during the period of 1972-2010, we ranked the universe of regulated utility stocks were ranked on the basis of the following eight valuation metrics, and then sorted the...
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...Valuing IPOs Moonchul Kim , Jay R. Ritter * Department of Accounting, KyungHee University, C1 Hoegie-Dong, Dongdaemun-Ku, Seoul 130-701, South Korea Department of Finance, School of Business Administration, University of Florida, Gainesville, FL 32611-7168, USA Received 3 June 1997; received in revised form 18 August 1998 Abstract The use of accounting information in conjunction with comparable "rm multiples is widely recommended for valuing initial public o!erings (IPOs). We "nd that the price}earnings (P/E), market-to-book, and price-to-sales multiples of comparable "rms have only modest predictive ability without further adjustments. This is largely due to the wide variation of these ratios for young "rms within an industry. P/E multiples using forecasted earnings result in much more accurate valuations than multiples using trailing 1999 Elsevier Science S.A. All rights reserved. earnings. JEL classixcation: G24 Keywords: Initial public o!erings; Valuation; Comparable "rms * Corresponding author. Tel.: #1-352-846-2837; fax: #1-352-392-0301. E-mail addresses: kimc@nms.kyunghee.ac.kr (M. Kim), jritter@dale.cba.u#.edu (J.R. Ritter) This paper is based on Moonchul Kim's University of Illinois Ph.D. dissertation. We would like to thank seminar participants at Boston, Emory, Georgetown, Humboldt (Berlin), and Vanderbilt Universities, the Universities of Miami and Texas, the Stockholm School of Economics, the Chinese University of Hong Kong, the New York Federal Reserve, the National...
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...Valuing IPOs Moonchul Kim , Jay R. Ritter * Department of Accounting, KyungHee University, C1 Hoegie-Dong, Dongdaemun-Ku, Seoul 130-701, South Korea Department of Finance, School of Business Administration, University of Florida, Gainesville, FL 32611-7168, USA Received 3 June 1997; received in revised form 18 August 1998 Abstract The use of accounting information in conjunction with comparable "rm multiples is widely recommended for valuing initial public o!erings (IPOs). We "nd that the price}earnings (P/E), market-to-book, and price-to-sales multiples of comparable "rms have only modest predictive ability without further adjustments. This is largely due to the wide variation of these ratios for young "rms within an industry. P/E multiples using forecasted earnings result in much more accurate valuations than multiples using trailing 1999 Elsevier Science S.A. All rights reserved. earnings. JEL classixcation: G24 Keywords: Initial public o!erings; Valuation; Comparable "rms * Corresponding author. Tel.: #1-352-846-2837; fax: #1-352-392-0301. E-mail addresses: kimc@nms.kyunghee.ac.kr (M. Kim), jritter@dale.cba.u#.edu (J.R. Ritter) This paper is based on Moonchul Kim's University of Illinois Ph.D. dissertation. We would like to thank seminar participants at Boston, Emory, Georgetown, Humboldt (Berlin), and Vanderbilt Universities, the Universities of Miami and Texas, the Stockholm School of Economics, the Chinese University of Hong Kong, the New York Federal Reserve, the National...
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