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Chapter 07

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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 those that differ from the expected return: NIt – re * BVE0
• The discounted dividends method can be modified to yield the following relationship:

Equity value = BVE0 + PV expected future abnormal earnings 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:

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