DISCOUNTED CASH FLOW MODEL, DIVIDEND DISCOUNT MODELS, & MULTIPLES Valuation MU Investment Club...
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Transcript of DISCOUNTED CASH FLOW MODEL, DIVIDEND DISCOUNT MODELS, & MULTIPLES Valuation MU Investment Club...
DISCOUNTED CASH FLOW MODEL, DIVIDEND DISCOUNT MODELS, & MULTIPLES
Valuation
MU Investment Club Spring 2013
4-Step Process
1)Project Free Cash Flow2)Discount Free Cash Flows3)Calculate Perpetuity Value4)Put it all together
MU Investment Club Spring 2013
Step 1: Project Free Cash Flows
Free Cash Flow = EBIT(1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital Expenditure
MU Investment Club Spring 2013
Step 2: Discount Free Cash Flows
Discount Rate is usually equal to or near the company’s WACC, but can be adjusted based on other risk factors
Discounted Free Cash Flow = Free Cash Flow /(1+discount rate or WACC)^# years
For example: If the discount rate is 10% and in the 3rd year the predicted free cash flow is $20,000, the discounted cash flow for that year will be:$20,000/(1.1)^3= $15,026.30
MU Investment Club Spring 2013
Step 3: Calculate Perpetuity Value
Most DCFs only project 5 or 10 years into the future and then use a perpetuity value to account for the rest of the time
Perpetuity values are usually between 1-3% Perpetuity Value = (final free cash flow * (1 +
perpetuity rate) / (discount rate – perpetuity rate)
For example: If the 10th year’s free cash flow was $300, with a discount rate of 8% and a perpetuity rate of 2%, then the perpetuity value would be: ($300*1.02) / (8%-2%) = $5,100
MU Investment Club Spring 2013
Step 4: Put it all together
1) Add together discounted cash flows2) Discount perpetuity value 3) Add discounted cash flows to discounted
perpetuity value4) Divide that sum by # shares outstanding to
find the per share value of the company
MU Investment Club Spring 2013
DCF Equations
Free Cash Flow = EBIT(1-Tax Rate) + Depreciation & Amortization - Change in Net Working Capital - Capital Expenditure
Discounted Free Cash Flow = Free Cash Flow / (1+discount rate)^# years
Perpetuity Value = (final free cash flow * (1 + perpetuity rate)) / (discount rate – perpetuity rate)
Discounted Perpetuity Value = Perpetuity Value / (1 + discount rate) ^ # year
MU Investment Club Spring 2013
Stable Dividend Discount
Two-Stage Model
Use for firms with long term stable growth
Use for firms going through a period of high growth and then expect long term stable growth
Dividend Discount Models
MU Investment Club Spring 2013
Stable Dividend Discount Model
DPS(1): Total Annual Dividends per Share expected one year forward
K: Discount Rate (or Required Rate of Return)
g: Dividend Growth RateValue of Stock = DPS(1) / (K – g)
For example, if DPS in one year is expected to be $1.20, the discount rate is 9%, and growth is 6%, the value of the stock = $1.20/ (9%-6%) = $40.00
MU Investment Club Spring 2013
Two-Stage Model
Like a DCF using DPS instead of Free Cash Flow
Stage 1: Project future dividends DPS * (1+high growth rate) Discount Projected Dividends
Stage 2: Find Perpetuity Value DPS(final) / (discount rate – long-term growth rate) Discount Perpetuity Value Add Discounted Projected Dividends and Discounted
Perpetuity Values together to arrive at the Value of the Stock
MU Investment Club Spring 2013
Two-Stage Model Example
DPS(0)= $1.00; Discount Rate = 12%; High-Growth Rate = 30%; Long-Term Growth Rate = 6%; High-Growth Period = 4 years
Stage 1:DPS(1) = $1.00 * 1.3= $1.30 / (1.12)^1 = $1.16DPS(2) = $1.00 * 1.3= $1.69 / (1.12)^2 = $1.35DPS(3) = $1.00 * 1.3= $2.20 / (1.12)^3 = $1.56DPS(4) = $1.00 * 1.3= $2.86 / (1.12)^4 = $1.82Sum of Projected Discounted Dividends = $5.89
MU Investment Club Spring 2013
Two-Stage Model Example
DPS(0)= $1.00; Discount Rate = 12%; High-Growth Rate = 30%; Long-Term Growth Rate = 6%; High-Growth Period = 4 years; DPS(4) = $2.86
Stage 2:DPS(4) = $2.86 / (12%-6%) = $47.67 Perpetuity ValueDiscounted = $47.67 / (1.12)^4 =$30.30
Value of Stock =$30.30 + $5.89 = $36.19MU Investment Club Spring 2013
Price to Earnings (P/E)
Price of a share of stock to the most recent annual earnings per share Historical P/E: based on an average of historical P/E Competitor P/E: based on a market cap weighted
average of competitor P/E Forward P/E: what some analyst thinks the P/E will be
in the future based on his stock price and earnings estimates
Generally used to predict the future price of the stock based off of projected earnings per share
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Price to Book
Price of a share of stock to book value per share of stock
Book value is the difference between the book value of assets and the book value of liabilities, so is heavily dependent on accounting practices
Commonly used when valuing financial institutions
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Example of How Multiples Work
To use a multiple, simply multiply the multiple by expected EPS, expected free cash flow per share, expected sales, book value per share, or whatever else the multiple is measuring
For example, if expected EPS is $1.15 and the P/E multiple that is most fitting is 9.57, the expected future value of the stock will be $1.15 * 9.57 = $11.01.
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Enterprise Value
Enterprise Value (EV) is the theoretical price a company could be acquired for by buying all the outstanding equity and paying off debts
EV = Equity Value + Net Debt + Noncontrolling (Minority) Interests + Preferred Stock + Capital Leases Equity Value: calculated as current stock price
multiplied by diluted shares outstanding Net Debt: total debt minus cash and cash equivalents
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EV/EBITDA
To use an EV/EBITDA multiple, you essentially reverse engineer the way the multiple is calculated. Determine appropriate model based on historical or
competitor averages Multiply EV/EBITDA multiple by the forecasted
EBITDA for desired year Subtract estimated values of capital leases, minority
interests, preferred stock, and net debt to arrive at a new Equity Value
Divide the new Equity Value by diluted shares outstanding to arrive at the price per share
MU Investment Club Spring 2013
For More Information:
DCF: http://news.morningstar.com/classroom2/course.asp?docId=145102&page=1&CN=COM
Dividend Discount: http://pages.stern.nyu.edu/~adamodar/New_Home_Page/articles/ddm.htm
Multiples: http://pages.stern.nyu.edu/~adamodar/pdfiles/damodaran2ed/ch8.pdf
EV/EBITDA: http://macabacus.com/valuation/enterprise-value
MU Investment Club Spring 2013