FIN 449 - Valuation

Spring 2013

Instructor: Daniel A. Rogers, PhD

CORPORATE FINANCE AND VALUATION

This is not a course in investment valuation…why do we care about valuation in corporate finance?

Several reasons:– M&A (large dollar investments): relevant to both

buyer and seller.

– Private companies: don’t know price.

– Reinforce/learn a lot of important principles of finance and economics in the process of valuation.

Why should I “really” care about working hard in this class (beyond getting a good grade)? I suspect that few (if any) of you will go into a career in

which you spend a lot of time valuing companies!– However, I hope that some of you will at least investigate the

possibility (and that this course will stoke your enthusiasm). Valuation of public companies reflects investor sentiment

about the relative level of “success” of business models.– What “drives” valuation?– As an employee, you should care about the answer to the prior

question…your career may depend on whether you know how to answer it.

If you work for a private company, you are likely an “owner” of the business (ESOP or profit sharing stock ownership plan)

FIN 449 COURSE OVERVIEW

Recall how to value cash flows Forecasting financial statements Free cash flow – a (better?) alternative to dividends Making growth assumptions in forecasting Calculation of a company’s cost of capital Industry analysis Relative valuation Presentations Course wrap-up

VALUING CASH FLOWS

Discount expected future cash flows at an appropriate rate of interest.

In valuing a company’s equity, what cash flows should we forecast AND how do we estimate an appropriate cost of capital?

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“TRADITIONAL” VALUATION

Ordinary dividends on common stock = only cash flow to shareholders.

Ability to pay dividends depends on earnings. Introduce forecast horizons and terminal value.

– Role of constant growth model

– Value of share of stock = PV of dividends expected during forecast horizon + PV of terminal price at end of forecast horizon.

FORECASTING FINANCIAL STATEMENTS

Income statements– Provides a forecast for future income

Balance sheets– Provides a forecast for future investment spending (and debt

requirements)

Financial ratios & the economic meaning of financial statement accounts– Financial ratios can provide us with clues as to what may be

“expected” in the future.

– Economic meaning of accounts helps with constructing forecast

FREE CASH FLOW to EQUITY (FCFE)

During the last 20 - 30 years, dividend payments by publicly traded firms have become a much less important portion of shareholder total returns.

At the same time, stock repurchases have increased dramatically.

Both represent cash flow to shareholders. Unfortunately, while dividends are highly predictable, repurchases are not.

Forecasting FCFE may provide a “smoothed” picture of future dividends and repurchases, therefore provide a better numerator in the valuation equation.

ASSUMPTION-MAKING

Anybody can construct a forecast! The trick is in preparing forecasts that have defendable assumptions.

We will discuss the practice of using historical growth rates in making future growth assumptions.

We will discuss the informational content of analyst forecasts.

We will discuss the fundamental predictors of growth and how we can incorporate these into forecasting.

We will discuss strategies for forecasting line items in financial statements.

INDUSTRY ANALYSIS

Valuing a company without understanding the industry environment in which it operates is like going out for fresh air on a smoggy day…POINTLESS!

We will discuss a general framework for understanding industry environments.

This knowledge should translate into added insights in the forecasting process.

COST OF CAPITAL

We will focus on practical issues and complications that arise in estimating cost of equity and cost of debt.

Review “normal” and alternative means of calculating “beta” (stock’s risk).

Discuss “market risk premium” in detail.Estimation of cost of debt from public data.Discussion of realism of cost of equity estimate.

RELATIVE VALUATION

Valuation pros often talk in terms of multiples…P/E, M/B, etc.

As a finance major, you should know what they are talking about.

Furthermore, you should know that we can tie these types of multiples back to fundamentals of discounted cash flow valuation.

EXAM!?!?#@!&#?!

Sorry, I have to make make sure you’re learning something!

PREP FOR PRESENTATIONS

Prior to our first group presentations, I will have a forum for questions regarding material and analysis/presentation format.

PRESENTATIONS

8th and 9th weeks of class2 or 3 groups per class sessionShould communicate crucial content of analysis

in preliminary fashionForum for feedback (from all, not just instructor!)Prepare approximately 30-minute presentation

(the additional time is filled with questions, comments, etc.)

COURSE WRAP-UP

Some final comments on valuationAdvice from a life-long finance major (me)Questions regarding final analysesGuest speaker: ???????

Company Project

Due date of final paper is Tuesday,6/11 (no later than Noon).

Many critical dates throughout quarterPLEASE familiarize yourself with project

assignment document!