Lesson 4-2: Perpetuity Valuation

Learning Objectives:

• The formula for valuing a perpetuity with growing cash flows
• The sensitivity of the value of a perpetuity to slight changes in the discount and growth
• How to apply the perpetuity formula to analyze changes in value of S&P 500 Index

Recall

Perpetuity Formulas

Notes

• income approach to valuation
• Refer to 4-2.1 and 4-2.2 (Only applies if r>g) (LO#1)
• Small changes r and g, big effects on perpetuity value, particularly for assets with back-weighted payments. (LO#2)

Lesson 4-3: Market and Income Approaches

Recall

Market Approach

Key Assumption

Computing Comparables

When to use

Problems

Income Approach (Discounted Cash Flow or DCF)

Approaches:

Capital Cash Flow

Equity Cash Flow

Free Cash Flow (FCF)

Weighted Average Cost of Capital (WACC)

Notes

• Comparable companies should be valued similarly to your company along financial metrics

• Market value and financial/accounting data

• Comparable companies have future cash flow expectations and risks similar to the firm

• Start with sample firms similar to firm under valuations

• Assume financial ratios are similar

  • Stock Price/Earnings
  • Market/Book
  • Total Firm Market Value/Sales
  • Total Firm Market Value/EBT

• Total Firm Market Value = Debt + Equity

• Before IPO

• Can use even if already publicly traded

• sense if firm value is appropriate in current market (if subject to takeover bid).

• Market sentiment

• hard to find truly “comparable” firms

• no right answer for which ratio to use

• many comparable companies = different capital structures

• leverage affects some ratios

• add CF generated from asset to get asset’s value

• +: directly reflects actual benefits (investors view)

• -: projections (assumptions about short term cash flows)