new lecture 10 spr 09

8/14/2019 New Lecture 10 Spr 09

1/11

Spring 2009 NBA 5060

Lecture 10 Implementing Valuation

1. Implementing valuation

2. Short-cut valuation using residual income model


2/11

Implementing Valuation

In theory, value depends on payoffs over an infinite forecast horizon.

To simplify matters, however, the forecasting period is limited to a finitenumber of years, after which a simplifying assumption is used.

In particular, if we forecast until the firm reaches steady state, then aperpetuity, or a perpetuity with a constant growth rate can be used (this isthe familiar Gordon growth model):

g r

DividendsValueTerminal

e

T

=

Note: to use this formula, the terminal value estimate has to be a perpetuityor have a constant growth rate.

To get the present value, it needs to be discounted to today by a factor of (1+r e)-(T-1)


3/11

Implementing Valuation

With the steady-state assumption and the perpetuity with growth formula,equity value can be expressed as:

FCFE Valuation:

=+

++

=1

11)1)(()1(

T

t T

ee

T t

e

t

r g r FCFE

r FCFE Value Equity

Residual Income Valuation:

11

1

1

1

)1)(()1(

=

+

+

++= T

ee

T eT T

t t

e

t et 0

r g r

BVE r NI

r

BVE r - NI BVE Value Equity

Residual Income Valuation based on ROE:


4/11

What values do we assign to the parameters?

(1) Explicitly forecast FCFE, RI, and BVE using pro-forma financialstatements.

(2) Terminal Growth Rate (g) represent growth in abnormal earnings in perpetuity. Growth in GDP is a good assumption for g because it assumes that, insteady state, the companys growth keeps pace with growth in the economy. At amaximum, g cannot exceed the GDP growth rate or else the firm would subsumethe entire economy. Note that the forecasted financial statements in year T

should equal the projected accounts in year 10, growing at your projected terminal growth rate (g) see CBRL spreadsheet.

(3) Cost of Equity Capital (r e): This parameter is the source of ongoing debate inFinance. Alternatives include:

(a) DCF approach or implied cost of capital uses internal rate of return.

(b) Asset Pricing Approach e.g. Capital Asset Pricing Model.

Implementing the CAPM:

f m f e r r E r r += )(


5/11

e.g. CBRL Cost of Equity Capital:

Unadjusted: r e = 2.70%+ 1.80*(5.77%) = 13.09%

Adjusted: r e = 2.70%+ 1.53*(5.77%) = 11.55%

10-year T-Bond in Feb. 2009 Avg. equity premium, 1968-2007


6/11

Valuation Date Adjustments:

All forecasts using pro-formas are inherently treated as of the date of the previous fiscalyear end (i.e., the balance sheet date). Hence, adjustments need to be made to bringvalue current to todays date.

General Technique:

1. Estimate days outstanding from the valuation date and the last fiscal year end.

2. Adjust your final value to reflect the passage of time since the prior fiscal year end.

Current value = Estimated value*(1+r e)(months since last fiscal year end / 12)

or Current value = Estimated value*(1+r e)(days since last fiscal year end / 365)

For example, if you are 9 months into the year (i.e., September 30 for a calendar year company), have a 10% cost of capital, and derived a value of $30 as of the lastfiscal year end, your value today would be:

$30*(1.10) 9/12 = $32.22


7/11

Example of Final Valuation Parameters and Calculations

Valuation AssumptionsLong-run g rowth rate 4.10%

Beta (Adjusted) 1.53 Risk-free rate 2.70%Equity Risk Premium 5.77%Cost of Equity 11.55%Balance Sheet Date 7/31/2008Valuation Date 2/17/2009Days Since BS Date 201Valuation Date Adjustment 106.2%Shares Outstanding (MM) 22.39

FCFE I 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 TerminalNet Income 48.7 50.4 58.9 67.5 75.7 84.1 92.3 100.1 107.4 115.4 120.1Less: Increase in Equity 23.8 76.7 75.7 76.8 75.2 74.3 70.0 72.7 74.7 75.3 32.3FCFE 24.9 -26.3 -16.9 -9.3 0.5 9.8 22.2 27.4 32.7 40.0 87.8PV of FCFE - Finite $35.8PV of FCFE - Terminal $395.2Equity Value - BS Da te $431.0Valuation Date Adjustment 106.2%Equity Value - Current Date $457.75Shares Outstanding 22.39 Equity Value per Share $20.44

RIM I 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 TerminalNet Income 48.7 50.4 58.9 67.5 75.7 84.1 92.3 100.1 107.4 115.4 120.1

re 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5% 11.5%Beg. BVE 92.8 116.6 193.3 269.0 345.8 421.0 495.3 565.3 638.0 712.8 788.1Residual Income 38.0 36.9 36.6 36.4 35.7 35.5 35.1 34.8 33.8 33.1 29.1Beg. BVE $92.8PV of RI - Finite $207.3PV of RI - Terminal $131.0Equity Value - BS Da te $431.0Valuation Date Adjustment 106.2%Equity Value - Current Date $457.75Shares Outstanding 22.39 Equity Value per Share $20.44

Lecture 10 Page 7 of 11


8/11



9/11

Shortcut Valuation using the Residual Income Model

Basic concept uses analyst forecasts of earnings to derive a quick residualincome valuation that does not require forecasting pro-forma financial statements .

Basic Idea:

111 )1)(()1(

=

++

++= T T

ee

eT -1T

1t t t

e

et 0 BVE

r g r r - ROE BVE

r r - ROE BVE Value Equity

1. Use current book value and forecasts of future earnings, earnings growth rates, anddividend payout ratios (think of as 1 plowback rate) to compute future ROEs.

2. Use this stream of future ROEs to compute the finite period valuation

3. Use industry median ROE to get the terminal value ROE T

4. Compute an Equity Value.

Can use this to determine intrinsic value estimate, given the cost of capital andother parameters. Alternatively, this framework can be used to back out the cost


10/11

This Year(July 09)

Next Year(July 10)

Growthfor Years

3 to 5

Cracker Barrel $2.65 $2.84 11.03 %

Required Inputs to the shortcut valuation model:

EPS Forecasts get these from any commercial service collecting analyst forecasts.You need FY1, FY2, and Long-term growth forecasts.

Book value per share As of the last fiscal year end.

Discount rate cost of capital as computed elsewhere

Dividend Payout ratio the portion of earnings expected to be paid out as netdividends (including repurchases). This will impact the future book value, and hencethe abnormal ROE computation.

Current Fiscal Month the adjustment to get value as of today

Target ROE the long-run ROE of the firm. The industry average is a good startingpoint. A conservative approach is to set the target ROE to the cost of equity capital this implies no abnormal earnings beyond the terminal year.


11/11

Shortcut Residual Income Model for CBRL Based on Analysts Forecasts

Cracker Barrelas of Feb. 2009

PARAMETERS FY1 FY2 LtgEPS Forecasts 2.65 2.84 11.03% Model 1: 12-year forecasting horizon (T=12).Book value/share (last fye) 4.14 and a 5-year growth period.Discount Rate 11.55%Payout Ratio 60.0%Next Fsc Year end 2009Current Fsc Mth (1 to 12) 7Terminal Growth 4.1%Target ROE (industry avg.) 15.0%

Implied price (date adjusted) 23.25

Year 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020Long-term EPS Growth Rate (Ltg) 0.1103 0.1103 0.1103Forecasted EPS 2.65 2.84 3.15 3.50 3.89 4.13 4.29 4.33 4.24 4.00 3.61 3.06Beg. of year BV/Shr 4.14 5.20 6.34 7.60 9.00 10.56 12.21 13.92 15.66 17.35 18.95 20.40Implied ROE 0.640 0.546 0.497 0.461 0.432 0.392 0.351 0.311 0.271 0.231 0.190 0.150Abnormal ROE 0.524 0.430 0.382 0.345 0.316 0.276 0.236 0.196 0.155 0.115 0.075 0.035required rate (r) 0.115 0.115 0.115 0.115 0.115 0.115 0.115 0.115 0.115 0.115 0.115 0.115discount rate 1.115 1.244 1.388 1.548 1.727 1.926 2.149 2.397 2.674 2.983 3.327 3.711PV of future Residual Income 1.95 1.80 1.74 1.69 1.65 1.51 1.34 1.14 0.91 0.67 0.43

PV of Finite Residual Income 14.83PV of Terminal Value RI 2.84Beg. of year BV/Shr 4.14

Implied Price21.81


new lecture 10 spr 09

Documents