fmv slides review (topic 3, 5, 6)

7/30/2019 FMV Slides Review (Topic 3, 5, 6)

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University College Dublin

Michael Smurfit Graduate School of Business

MASTER OF BUSINESS ADMINISTRATION

2006/07

Financial Markets & Valuation

Review of Lecture Slides(Topic 3, 5 & 6)

Fall 2006


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FMV Slides Review

Table of Contents

1 FMV Exam Overview..........................................................................................................12 Cost of Capital & Capital Structure...................................................................................1

2.1 Definitions............................................................................................................................ 12.2 Acronyms............................................................................................................................. 12.3 Ordinary Shares................................................................................................................... 2

2.3.1 Dividend approach...............................................................................................................22.3.2 Risk/Return Approach......................................................................................................... .22.3.3 Capital Asset Pricing Model (CAPM)...................................................................................3

2.4 Loan Capital........................................................................................................................ 42.5 Preference Shares............................................................................................................... 5

2.6 Weighted Avg Cost of Capital (WACC)................................................................................52.7 Financial Gearing................................................................................................................. 5

2.7.1 Ratios...................................................................................................................................6

2.8 Breakeven Analysis............................................................................................................. 62.8.1 PBIT EPS Indifference Chart............................................................................................62.8.2 Calculate..............................................................................................................................6

2.9 Practical considerations in selecting source of finance........................................................72.10 Theories of Capital Structure.............................................................................................8

2.10.1 Traditional View.................................................................................................................82.10.2 Modigliani-Miller Approach...............................................................................................10

3 Working Capital Mgmt.....................................................................................................133.1 Mgmt of Stock....................................................................................................................13

3.1.1 Stock turnover....................................................................................................................143.1.2 Economic Order Quantity (EOQ) models...........................................................................14

3.2 Mgmt of Trade Debtors......................................................................................................153.2.1 Monitor Outstanding Debts................................................................................................16

3.3 Cash Mgmt........................................................................................................................ 173.4 Using Trade Creditors as a source of finance.................................................................... 17

3.4.1 Controlling Trade Creditors................................................................................................18

4 Mergers, Takeovers & Valuation of Shares....................................................................184.1 Why merger?..................................................................................................................... 184.2 The Three forms of Purchase Consideration.....................................................................19

4.2.1 Shares................................................................................................................................194.2.2 Loan Capital.......................................................................................................................204.2.3 Cash...................................................................................................................................20

4.3 Assessing Vulnerability to a Takeover...............................................................................204.4 Defense Strategies............................................................................................................21

4.5 Demerger...........................................................................................................................214.5.1 Divestment.........................................................................................................................214.5.2 Spin-off...............................................................................................................................22

4.6 Valuation of Shares...........................................................................................................224.6.1 Asset based methods........................................................................................................224.6.2 Stock Market Methods.......................................................................................................234.6.3 Cash Flow Methods...........................................................................................................23

Full Time MBA 06-07 Date: 03/12/2006


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1 FMV Exam Overview

3 out of 4 questions:1. Topic 3: Cost of Capital and Capital Structure

2. Topic 5: Working Capital Mgmt3. Topic 6: Mergers, takeovers and valuation of shares4. Descriptive: Based on two chapters:(Note: I wrote the scribbles below during class as he was speaking and have not read thechapters yet)

o Chp6

ord/pref shares

interest rates and int. rate risks

finance lease, Stroke Sales and lease back

Securization?

LT v ST borrowing (briefly in COK)o Chp7:

role and form of stock exchange (why do companies go on stockmarket; adv & limitations on stock mrkt;

Efficiency of stock market (share price reflect avail info of company orare companies over/undervalued; can u trust share price?);

Methods of share issue on stock markets (how u raise capital; stockexchange place etc.)

venture capital and business angels (nature, issues they look at in termsof assessing projects)

Tips:

Look at questions before reading case

2 Cost of Capital & Capital Structure

How do you determine the optimal source of capital (debt and/or equity) that will be thecheapest for firm?

2.1 Definitions

Cost of funds rate of return the firm must earn on its projects for the market value of thefirm to remain unchanged (i.e. NPV = 0)Cost of capital usually a combination of debt and equity

Cost of loan - interest rate attached to loanIrredeemable pays interest only every year; never pays capital backGearing = borrowing; debt; leverageRights issue - existing SH have the option to keep the same control as beforeDebentures = long-term loans

2.2 Acronyms

CAPM capital asset pricing modelPBIT Profit Before Interest & Tax

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2.3 Ordinary Shares

2.3.1 Dividend approach

The current market value of the share is the present value at rate Ko of all future dividends forthe next n years:

Po = D1 + D2 + D3 + Dn

(1 +Ko)l

(1 + Ko)2

(1 + Ko)3

(1 + Ko)n

where:

Po = the current market value of the shareD = the expected future dividend in years 1 to nn = the number of years over which the business expected to issue dividendsKo = the cost of ordinary shares to the business (i.e. the required return for

investors)

Note: Po = P zero = time nowKo = K ordinary (as in ordinary share); also Ko is in decimal format (i.e. 0.18not 18%)

If dividends are constant (perpetuity):Po = Do

KoThis can be seen in a mature industry (not a software company).

If dividend grows at constant rateg(Gordon growth model)Po = Do .

Ko g

Example P3s7

2.3.2 Risk/Return Approach

Reduce risk by diversifying over many projects

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Figure 5.14 Reducing risk through diversification

2.3.3 Capital Asset Pricing Model (CAPM)

Ko = Krf + (Km - Krf)

where:

Ko = the required return for investors for a particular share

Krf = the risk-free rate on government securities

= beta of the particular shareKm = the expected returns to the market for the next period

(Km- Krf) =the expected market average risk premium for the next period

Diagram P3s10 on how to calc. this equation

Beta is a measure of risk. The more risk the more premium investors will expect. The marketas a whole has a Beta of 1. Aggressive stocks have a Beta > 1 (extreme changes with respectto the market) while defensive stocks have a Beta < 1.

The figure below shows the relationship between expected return and Beta (level of risk). The

line is referred to as the security market line. When Beta = 0 (no risk) the investors willrequire the risk-free rate.

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2.4 Loan Capital

Cost of loan = interest rate attached to loan; can also have traded loans traded like sharesbetween investors.Irredeemable pays interest only every year; never pays capital back

Pd = I .Kd

Where:Pd = the current market value of the loan capitalI = the annual rate of interest on the loan capitalKd = the cost of loan capital to the business

Note:

d stands for debt Kd < Ko (shares are more risky and cost more)

With taxes

Kd = I(1 - t)

Pd

where t is the rate of corporation tax payable.

or the real interest rate of the

company. (example P3s16,17-18)

4

Expected

Return (%) Slope of line

(Km- Krf)Km

0.5 1.0 1.5 2.0 2.5 3.0

Beta

The figure shows the relationship between the expected level of return and

the level of risk as measured by beta. The risk/return characteristics of aninvestment will lie at some point on the continuous line (which is referred to

as the security market line).Where there is no risk, the return required from

investors will be the risk-free rate. As the level of risk increases, investors

ill demand an increasingly large risk premium to compensate. The market

as a whole will have a beta of 1.

(cap asset pricing model = security market line)

(risk free rate)

(Beta tells u how sensitive shares movement is to movement in market as a whole)


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2.5 Preference Shares

Pref. shareholders (SH) get dividend before ordinary shareholders. Therefore ordinary SHexpect more return due to higher risk.

Irredeemable

Pp = DpKp

Pp =the current market price of the preference shares

Kp= the cost of preference shares to the businessDp= the annual dividend payments

Note: p = preference shares(e.g. P3s20, 21(note in this example there should be brackets around 5.0 and 55.0))

2.6 Weighted Avg Cost of Capital (WACC)

Weighted in proportion to overall contribution to the company.

Figure 8.5 Calculating WACCFigure 1 - Calculation WACC

(e.g. P3s22-26)Limitations to this approach:

1. Assumes same risk as existing projects (new project may be in new industry or havediff. risk profile)

2. Assumes cap. Structure will remain stable (new project may not be financed using thesame proportions)

2.7 Financial Gearing

Gearing = borrowing; debt; leverage

(Cogged wheel diagram P3s30)

Financial gearing ratio = Loan Capital + Pref. Shares (if any) x 100%

Total long-term Capital

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(e.g. P3s31-34,35-39)

Higher gearing means company is more sensitive to changes.

2.7.1 RatiosReturn of ordinary SH funds (ROSF) = Earnings avail. To ord. SH

Ord. shares + reserves

Earnings per share (EPS) = Earnings avail. To ord SH# of ord. shares

Note: can improve EPS by getting more debt which comes at a cost

Interest Cover Ratio = Profit before interest and taxInterest payable

Gearing (Debt) Ratio = Loan Capital . x 100%Ord. shares + reserves + loan cap.

Note: need to look at industry date to see if this ratio is too high or low.

2.8 Breakeven Analysis

2.8.1 PBIT EPS Indifference Chart

Figure 8.10 PBITEPS indifference chart for two financing optionsIntersection = indifference point = both options provide same return to SH

2.8.2 Calculate

To calculate use definition of EPS

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(X I1) (1 - t) = (X - 12) (1 - t)

El E2

where:

X = the profit before interest and taxation at which the two financing options

provide the same return to ordinary shareholders

I = the annual interest charges under each financing option

E = the number of ordinary shares in issue

(e.g. P3s43-44)

2.9 Practical considerations in selecting source of finance

1. Impact on existing financial struct. And financial risk of company2. operational gearing

o sensitivity of op. profits to changes in sales volume

o amount of fixed costs you have in income statement; greater chance of

bankruptcy the higher the fixed cost3. duration of investment

o matching long term projects should be matched with long term finances

4. business risko high risk businesses more suited to equity finance (i.e. software company)

5. prospects for investorso EPS, DPS and investors attitudes towards these

6. foreign currency risko financing payment should match currency of revenues generated

7. future prospects of businesso look at budgets and cashflow forecasts

8. avail. of financial sources at reasonable cost9. target capital structure of business

o min. overall cost to company

10. company have realisable assets to use as borrowing security?

11. will the company be able to borrow again in the future?o Shouldnt move to far away from optimal structure

12. movement in interest rateso i.e. if interest rates expected to fall use short-term financing

o speculative

o violates matching principle

o risky i.e. rate increases or banks might not want to roll over financing

13. legal restrictionso companys articles of assoc.

o loan covenants on existing debt

14. pecking ordero on average companies use:

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retained earnings

debt

equity (ord. shares)15. signalling managers signal based on financial structure

o i.e. taking on more debt signals future profit potential

16. Asymmetric info public disclosure of information may not be in the best interest ofthe company (i.e. competitors may get data)

2.10Theories of Capital Structure

2.10.1 Traditional View

Level of borrowing determined by risk how volatile earnings are

The figure assumes that at low levels of borrowing, ordinary (equity)

shareholders will not require a higher level of return to compensate for the

higher risk incurred. As loan finance is cheaper than equity finance, this will

lead to a fall in the overall cost of capital. However, this situation will

change as the level of borrowing increases. At some point, the increased

returns required by ordinary shareholders will begin to outweigh the benefitsof cheap loan capital and so the overall cost of capital will start to rise. The

implication is, therefore, that there is an optimum level of gearing for a

business.

8

Theories of capital structure

(1) traditional view

Figure 8.11 The traditional view of the relationship between levels of borrowingand expected returns

(no debt)

(required return going to goup as we request more debt)

50/50

(software company) (supermarket)(Volatile)


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Figure 8.12 Relationship between the level of borrowing, the cost of capital andbusiness value: the traditional view

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2.10.2 Modigliani-Miller Approach

The MM view assumes that the cost of capital will remain constant atdifferent levels of gearing. This is because the benefits of cheap loan capital

will be exactly offset by the increased returns required by equity

shareholders. Thus, there is no optimum level of gearing.

Figure 8.13 The MM view of the relationship between levels of borrowing andexpected returns

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The first graph shows that, according to MM, the cost of capital will remain

constant at different levels of borrowing. The second graph shows the

implication of this for the value of the business. As the cost of capital isconstant, the net present value of future cash flows from the business will

not be affected by the level of borrowing. Hence, the value of the business

will remain constant.

Figure 8.14 Relationship between the level of borrowing, the cost of capital andbusiness value: the MM view

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Assumptions

(I) perfect capital markets- no transaction costs

- personal borrowing rate = corporate borrowing rate

(2) no bankruptcy costs- no legal costs- assets realise market value

(3) risk- companies exist that have identical business risk

(4) no taxation

(personal lower)

(well relax this assumption and see what happens)

(cost assoc. with financial stress)

(assets that dont transfer well IP)


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The first graph displays the MM (including tax) view of the relationship

between the cost of capital and the level of borrowing. We can see that as

the level of borrowing increases, the overall cost of capital decreases. The

second graph shows the relationship between the value of the business and

the level of borrowing. A decrease in the overall cost of capital results in a

rise in the value of the business and so, as the level of borrowing increases,the value of the business increases.

Figure 8.16 Relationship between the level of borrowing, the cost of capital andbusiness value: the MM view (including tax effects)

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The figure shows the revised MM view. As the level of borrowing increases.

the greater the tax benefits to ordinary (equity) shareholders. These tax

benefits will increase with the level of borrowing and so the overall cost of

capital (after tax) will be lowered as the level of borrowing increases. This

means that there is an optimum level of gearing and it is at the 100 per cent

level of gearing.

Figure 8.15 The MM view of the relationship between levels of borrowing andexpected returns (including tax effects)

(dec. due to tax deductibilityOf interest)


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(e.g. P3s55-57)

3 Working Capital MgmtWorking capital = current assets current liab.

= stock + debtors creditors

How do you maximize SH value?1. Stock 2. Debtors3. Cash4. Trade creditors5. Overdraft

3.1 Mgmt of Stock

Issues:

Conflict between Mgrs (sales would like lots of stock while production mgr wants to

min. cost of production)

Cost of low stock levels

o Lost sales

o Loss of goodwill

o Increased transport cost for replenishment

o Lost production

o

Inefficient production schedulingo Higher purchasing costs to replenish quickly

Holding costs:

o Storage

o Insurance

o Handling costs

o Financing

Control systems

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Region A small # of items but considerable valueRegion C large # of items but low value

Note: should concentrate on high value items (i.e. not paperclips)

3.1.1 Stock turnover

Avg. stock turnover period = Avg. stock held x 365 daysCost of sales

Note: avg. stock held = opening + closing

2

3.1.2 Economic Order Quantity (EOQ) models

Which order level minimizes order cost?

(formula for EOQ on P5s13 but Paul said we dont need to memorize; e.g. P5s14)

3.1.2.1 Saw tooth (simplest model)

Assumptions:

Stocks depleted evenly over time Stocks will be replenished just at the point when existing stock runs out

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3.1.2.2 Stockholding and stock order costs

The more frequently you order the more costly it will be i.e. to maintain low stock levels.In other words, the less orders you make the cheaper it will be BUT the holding cost willincrease the more stock you order. Balance = point E; total costs are minimized.

3.2 Mgmt of Trade Debtors

Issues:

Which customers do you give credit to? (the 5 Cs of credit:o Capital

What percentage of the consumer is owned by a bank?

The more geared up they are the less likely they are to default(???)o Capacity

Ability to repay

Look at cashflow or liquidity or do credit checko Collateral

What assets do they have?

To what extent can you get your money back?

o Conditions Economic conditions of industry

The more volatile the more likely to get into troubleo Character

Character of mgmt team

Reputations and track record in business

Managerial experience

Sources of Credit Information

o Trade references

o Bank references

o Accounts Liquidity

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Profitabilityo Site visit

o Credit agencies

Bond ratings (i.e. double A, triple C)o Other suppliers

How much credit do you offer and for how long? Look at:

o Credit terms within the industry

o Degree of competition

o Bargaining power of customers

o Risk of non payment

o Marketing strategy

o Capacity to offer credit

Cash discount

o i.e. 2/10 net 30 (2% discount if you pay in 10 days otherwise pay in 30 days)

Collection policies

o Develop customer relationships

Meet freq.

Good if seasonality in cash flows etc.o Publicize credit terms

You must let the customer know (i.e. on invoices)o Invoice promptly

o Clear procedures for disputed items

o Monitor outstanding debts (see next section)

How many days stock do you have outstanding?

(e.g. P5s16-18)

3.2.1 Monitor Outstanding Debts

Avg Settlement period (for debtors) = Trade debtors x 365 daysCredit sales

(e.g. P5s20)

Deal with slow players

Reduce the risk of non payment by

Getting customers to pay in advance

Setup offsetting arrangementso If you are buying and selling from same company offset (i.e. you buy $5 of

apples from them and they buy $8 of oranges from you, then they only oweyou $3)

Third party guarantee

o Someone else will pay if they cant

Legal title retention (???)

Insurance

o Factoring insurance will pay in case of default (see more examples of

factoring below)

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3.3 Cash Mgmt

Why hold cash?

Transactions

Precautionary (just in case)

Speculative; i.e.o For bank liquidity purposes

o Interest rate movements

How much cash should be held?

Depends on nature of business

Look at opportunity cost of holding and not using cash

Inflation

Avail. Of near liquid assets

o You dont need cash if you have something that you can convert to cash

quickly Look at cost and availability of borrowing

o Interest rate high?

What are the current economic conditions?

Look at relationships with suppliers

(e.g. cashflow P5s22, 26-28)

Operating cash cycle = amount of time between payment made to supplier and cash receivedfrom customer

3.4 Using Trade Creditors as a source of finance

Advantages:

Relatively easy to obtain

o Automatically get credit when relationship established

Directly linked to financing of goods or services

Frees up bank lines of credit

May be free

o i.e. no interest

Disadvantages Suppliers may increase prices to recover cost (risk) of extended credit

Suppliers may charge interest

Lose out on discounts

Suppliers may be alienated if you take extended credit without authorization

To determine optimal use of trade credit financing take into account:

Cost of lost discounts

Cost of borrowing

Loss of suppliers goodwill

(e.g. P5s30)

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3.4.1 Controlling Trade Creditors

Avg. settlement period of creditors = Trade creditors x 365 daysCredit purchases

Factoring

Another company can offer:

Administration of your sales/accounting function

o i.e. undertake collection of trade debts for fee of 2%

Cash advances (a source of finance but you have to pay interest rate)

o i.e. theyll pay up to 80% of trade debtors

Insurance (in case of default)

(e.g. P5s32-33, 34-35, 36-39)

4 Mergers, Takeovers & Valuation of SharesMerger share per share exchangeTakeover generally overpay for the company

Horizontal peer companiesVertical companies that are up/down the value chain

4.1 Why merger?Synergy outcome is more than the sum of the individual contributions (2+2 = 5) Earnings

o Increase EPS

o Acquire less risky earnings (cash cow)

Tax considerations

o If company gen. losses there exists unused tax shield that can offset buyers

own tax liability (usually have to stay in same business and not just sell offassets)

Diversification

o

Spread risk over conglomerates (but SH can do that with their own stockportfolio dont need company to do it for them)o Stick to core competency?

Economies of scale

o Easier access to capital markets

o R&D

o Advertising

o Overheads

Marketing

o Increase/maintain Mkt share

o

Eliminate/hold off competition Barriers to entry

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o Can enter market at lower cost than if company were to develop own resources

(i.e. buy someone whos already doing it)

Complete product lines

Acquire mgmt

Increase purchasing leverage (raw materials & cap. Equip.)

o Power over suppliers

Improve assets

o Acquire company that has higher earnings relative to assets

o Buyer will improve its risk profile and liquidity

Cash

o Acquisition of cash rich company (i.e. they are not investing in enough

projects)

Utilize excess capacity

o i.e. if two companies operating at 50%; buy and close down other plant

Personal obj. of mgmt

o Bigger firm will have greater prestige, power, remuneration

Level out seasonality of business

o Offset highs and lows

Cheap acquisition

o Target firm may be undervalued

4.2 The Three forms of Purchase Consideration

4.2.1 Shares

Ordinary shares are more likely to be used following a period of strong stock mrkt

performance

Ord. shares are used to ensure combined business is treated as a merger

Companies with good growth prospects use shares

Evidence of poor subsequent performance for share-for-share acquisitions

o More restrictions on company if loans had been used

o Overestimated synergy?

Advantages:

Ordinary shares are more likely to be used following a period of strong stock mrkt

performance

Ord. shares are used to ensure combined business is treated as a merger

Companies with good growth prospects use shares

Offeree SH will not be immediately liable to capital gains tax

If offerors shares are trading at a premium (i.e. high P/E) it is normally in the buying

companys interest to make a share offer, thereby purchasing assets and earningsrelatively cheaply

Offeree SH will be happy if there is a synergy and share price increases are expected

Disadvantages:

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Control

o New issue of shares may upset the balance of control within the company

Dilution of EPS and net assets per share

o Should worry more about risk than maximizing EPS

May require a resolution of the company at a general meeting

o Company may have insufficient authorized but unissued shares

Offeree may require greater value due to higher risk of shares over cash

Dividend policy of offeror may affect offeree SH decision

o Clientele effect some SH attracted to certain company that have certain div.

policies

4.2.2 Loan Capital

Advantages:

Interest is tax deductible

No control impact (in terms of voting power)

Loan creditor likely o require a lower rate of return (less risk than SH)

Disadvantages

Loan creditor is likely to require security

Loan creditor may place constraints on company activities

o E.g. require board representation or restrictions on dividends

Over-gearing

Company may exceed borrowing limit outlined in articles of association

4.2.3 Cash

Advantages:

Useful where offeror and/or offeree have substantial cash

No control aspect

Usually price is cheaper and no risk to offeree SH

No dilution of EPS or net assets per share

Disadvantages:

Over-gearing?

4.3 Assessing Vulnerability to a TakeoverTypical cases when company:

Has a low share return in preceding 4 years

o Underperforming

Has a higher growth-to-resource mismatch

o Not developing company

Low avg. sales growth (not growing)

High avg. liquidity (not reinvesting)

Low avg. gearing (conservative)o Growing too big too fast (rel. to capital)

High avg. sales growth (growing fast) Low avg. liquidity (investing a lot)

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High avg. gearing (conservative)

Is a small companies

o Tend to be taken over more

Is in an industry that was not acquisitive in previous years

o Deregulation?

4.4 Defense Strategies

Convert to private company

Employee share options

Circulating SH (tell them offer is too low)

Making the company unattractive

o Poison pill

Sell the crown jewelso

Golden parachute Mgr compensation schemes (i.e. bonuses) in event of takeover

Takes money out of companyo Dividend distribution

Convince SH to stay with existing company

Pac-man defense

o Counter-offer for their company

White-knight

o Friendly bidder

White-squire

o Someone who acquires strategic interest (thwarts overtures of unwelcomebidder) but doesnt take over

4.5 Demerger

De-couple or split the company into a number of indep. Units.Demerger may take place if:

Business is unprofitable

Parts of business do not fit with the strategic plan

It is higher risk than the remainder of the group companies

Two types of Demerger: Divestment

Spin-off

4.5.1 Divestment

Selling off part of the business to another company.Reasons include:

To ensure survival

Concentrate on core activities

Reduce the size of the business because it is difficult to control

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4.5.2 Spin-off

Existing company creates a new company.

New company is allocated assets from existing company

Ownership of new company remains with existing SH of existing company

Shares of new company usually distributed to SH in proportion to holdings in existingcompany

Reasons include:

Defense against takeover

o Protect the crown jewels

Improve performance

o Give mgmt more autonomy

o Focus on key activities

Market reaction

o Existing shares are undervalued; nature and value of various operating

divisions may be more appreciated after spin-off

Attract potential investors

o Merge

o Be acquired

o Floated on stock market

SH investment

o Some parts of business more attractive to SH than others

o SH adjust his/her investment

4.6 Valuation of Shares

(e.g. P6s16)

Goodwill

o Intangible assets

o Synergy

o Company is worth more than just its assets

4.6.1 Asset based methods

Assets: Seller will want to use replacement value while buyer will want to use resale

value.

4.6.1.1 Net Book Value Method

Po = tot. assets at bal. sheetvalues tot. liab.# of ord. shares issued

(e.g. P6s20)

4.6.1.2 Liquidation Value Method

Po = tot. assets at net realizable values tot. liab.# of ord. shares issued

(e.g. P6s20)

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4.6.1.3 Replacement Cost Method

Po = tot. assets at replacement cost tot. liab.# of ord. shares issued

Note: replacement cost includes goodwill.(e.g. P6s21)

4.6.2 Stock Market Methods

4.6.2.1 P/E Ratio

P/E ratio = Mkt value per shareEPS

Po = (P/E ratio of similar listed company) x (EPS of unlisted company)

Limitation: Variance of company selected as comparable

(e.g. P6s22)

4.6.2.2 Dividend Yield Method

DY = Gross div. per share x 100Mkt value per share (Po)

ThereforePo = Gross div. per share x 100

DY of comparable company

Note: Gross div. per share = DPS / (1 std. rate of tax)

(e.g. P6s23)

4.6.3 Cash Flow Methods

4.6.3.1 Discounted Dividend Method

Po = Do (as seen in cost of capital section above)Ko

Limitation:

Presupposes its a mature company with stable dividend (steady state)

Have to calculate cost of capital

(e.g. P6s24)

4.6.3.2 Future Cash Flow (FCF) Method

Po = PV long-term loans at current market value*

# of ord. shares

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Advantages:

Best method if you have the data

o Interested in what you will get out of assets

Limitations:

More complicated (forecast cashflow and work out cost of capital but thats what

mgrs and paid to do)

(e.g. P6s25)Note: example on P6s26-31 but he did not do it in class (ran out of time)

fmv slides review (topic 3, 5, 6)

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