principles of investing fin 330 chapter 7 valuation of the firm dr. david p echevarriaall rights...
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Principles of InvestingFIN 330
Chapter 7Valuation of the Firm
Dr. David P Echevarria
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Student Learning Objectives
A. Basic Valuation MethodsB. Evaluating Risk/Return relationshipsC. Sustainable GrowthD. EPS Forecasting Techniques
Dr. David P Echevarria
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Basic Valuation Concepts
A. Dividend Valuation Models: Gordon Growth (see Eq. 7-5)
B. Earnings Valuation (P/E ratio) – a measure of attractiveness to investors
C. Capital Asset Pricing Model (CAPM)1. Expected returns a function of risk free
rates, beta, and a risk premium (see Eq. 7-2)2. Beta (b) = a measure of risk relative to the
broad market3. Value = Cash Flow / E(r)
Dr. David P Echevarria
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Sustainable Growth Measures
A. Earnings growth is [partly] a function of profits reinvested in the firm (retention ratio)
B. Sustainable Growth rate = ROE * RRC. ROE = Return on Equity = Net
Income / Stockholder EquityD. Growth companies typically pay
small dividends and reinvest most of their earnings
Dr. David P Echevarria
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Forecasting Earnings
A. Least Squares (regression analysis): EPS over time
B. Income Statement method (see Table 7-9 for example of methodology)1. Forecast Revenues and Expenses2. Rev – Exp = Profits3. Profits / # shares outstanding = EPS4. EPS / Ke = Price per share
Dr. David P Echevarria
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Elements of Company Analysis
A. Description of business and properties
B. Historical Financial Performance data
C. Details about senior managementD. Competitive Position
1. Sales Revenue (growth)2. Profitability (trend)3. Product line (turnover, age)
Dr. David P Echevarria
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Elements of Company Analysis
E. Output rate of new products1. Product innovation strategies2. R&D budgets
F. Operating efficiency3. Output / Input ratio4. Position on cost curve
G Pricing Strategy5. Low price6. High quality - price
Dr. David P Echevarria
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Elements of Company Analysis
A. Patents and technologyB. Nature of Management
1. Organizational performancea. Effective application of company resourcesb. Efficient accomplishment of company goals
Dr. David P Echevarria
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Homework
A. Discussion Questions: 2, 3, 5, 11, 19B. Problems: 2, 5, 8, 15
Dr. David P Echevarria