1. 12-1 McGraw-Hill/Irwin © 2007 The McGraw-Hill Companies, Inc., All Rights Reserved. CHAPTER 12 Equity Valuation

2. 12-2 Fundamental of Stock Analysis: Models of Equity Valuation Basic Stock Valuation Models – Dividend Discount Models – Valuation multiples – Free Cash Flow model (covered in Fin 350)

3. 12-3 Intrinsic Value and Market Price Intrinsic Value (IV) – What the stock is worth (based on various estimation techniques) Market Price – Consensus value of all potential traders Trading Signal IV > MP Stock is ______________________________ IV < MP Stock is ______________________________ IV = MP Stock is Fairly Priced: ___________________

4. 12-4 Constant Growth Model V 0 = Value of Stock at t = 0 D 1 = Dividend in year 1 k = required return g = constant perpetual growth rate Vo D kg 1  

5. 12-5 5 Required rate of return: beta = 1.25, r f = 5%, and r M = 13%. k= r f +  (r M - r f ) = 5% + (1.25) (8%) = 15%. Use the CAPM to calculate k:

6. 12-6 Constant Growth Model: Example D 1 = $3.00 k = 15%g = 8% V 0 = 3.00 / (.15 -.08) = $42.86 Vo Dg kg o    ()1

7. 12-7 Estimating Dividend Growth Rates g = growth rate in dividends ROE = Return on Equity for the firm b = retention rate (dividend payout = 1 - b) gROEb 

8. 12-8 8 Nonconstant Growth Model A firm is expected to have high growth for n years, followed by constant growth at rate g c. Steps: 1.Calculate dividends to n+1. 2.Calculate the stock value at n using constant growth model and g C. 3.The stock value at t=0 (P 0 ) is the present value of D 1, to D n plus the present value of P n, discounted at the req ret (r s ).

9. 12-9 Price Earnings Ratios P/E Ratios are primarily a function of two factors – _________________________________________ – Expected _________________________________ Use: Relative valuation

10. 12-10 Estimating stock value using P/E Ratios To use P/E to estimate firm value, we can use – firm’s historical relationship between P and E (adjusted for changes in __________________ ___________________________ – average P/E for the industry (adjusted for differences in ___________________________

11. 12-11 Figure 12-6 P/E Ratios

12. 12-12 Other Valuation Ratios & Approaches Price-to-book Price-to-cash flow Price-to-sales Present Value of Free Cash Flow

13. 12-13 Figure 12-7 Market Valuation Statistics