ValuationPart 1

Objectives • Firm and equity fair valuation methods

o Present value DCF methodo Constant free cash flow and dividend growth methods

• Drivers of equity value• The price / earnings ratio

2

Value of Simple Corp

3

Book Value Market or Fair Value

Constant FCF Growth• In the case where FCF is assumed to grow at a constant

rate, gFCF, a simple formula is found from series convergence

4

or

Constant FCF Growth• As the spread

between the rate cost and cash flow growth rate narrows, convergence slows considerably

• As cash flow growth rate approaches the rate cost, the series does not converge

5

Variable Growth Value

1 2 3 4 5 6 7 8 9 10 11 12 13 14

FCF

Years H

6

Variable Growth Value

7

0 1 H H+1 N

gFCF

Step 2Step 3

Step 1

Dividend Discount Model• Method is most applicable to firms that have a high

dividend payout ratio

• Assume that last dividend is a total repurchase of the stock

i = 0 1 2 3 4 5 N

DIV1

8

DIVN

Equity Value Management• Explore the relationships between

o Earnings growtho Dividend payoutso Cost of equity o Fair value of equity

• Based on the Dividend Growth Model with constant dividend growth assumption

9

10

Constant Growth Formulas

11

Constant Growth Formulas

12

Constant Growth Formulas

13

Constant Growth Formulas

14

Constant Growth Formulas