Lesson 6/7 - RSM332

Common shares (3)

- EQUITY ownership in a company

- get paid last (residual claimant). u get what is left over after all other obligations (like debts or preferred dividends) have been paid

- get ownership on UPSIDE (means they benefit from stock price going up!)

Preferred Shares (3)

- ownership in a fixed-income stream, similar to bonds

- get paid first (u get a set dividend payment, but no residual claim)

- u do NOT own the upside (dont benefit from stock price going up!)

stock valuation

expected/estimated value (TVM)

how is the INFINITE dividend growth rate estimated?

the company's dividend history is used to estimate future dividend growth rates

When is the STAGED growth model used?

Used when dividend growth is high initially and then slows down.

The two-stage model works by first applying a higher growth rate to the company's dividends for a certain period (the early high growth phase) and then switching to a lower, more sustainable growth rate (the mature growth phase).

How is Sustainable Growth Rate 'g' estimated?

using a company's ABILITY and WILLINGNESS TO GROW its dividends

What is the Retention Ratio and how does it affect ROE?

% of net income retained and reinvested into the business

What does Sustainable Growth Rate (g) represent?

rate at which a company can grow without increasing debt

What if a company does not pay dividends?

managers may reinvest earnings to fuel growth. This decision can create a Principal-Agent problem if management seeks power or compensation over shareholder wealth.

NPVGO

measures how valuable a firm's reinvestments are!

Net PV of Growth Opportunities

goal of DCF?

Find Enterprise Value (EV) by taking FCF and discounting them back to today using WACC

What is the formula for Estimating Equity Value?

Equity value is derived from enterprise value by subtracting debt and adding cash. The formula is: Equity Value = EV - Debt + Cash.

Weighted Average Cost of Capital (WACC)

Weighted average required return for a company, taking into account the market values of debt, common equity, and preferred equity

Can dividend GROWTH rates be higher then GDP?

YES. bc history only covers a finite period

FCF (Free Cash Flow) formula

CFO - Capex

Does CAPEX (Capital Expenditures) count as CFI?

Yes

FCF (Free Cash Flow)

the cash a company has left over after it pays for its required investments (CAPEX).

Negative FCF is associated with large CAPEX, meaning the firm is....

investing a lot (high CFI), with potential for future CF

Positive FCF is associated with low CAPEX, meaning the firm is....

might be a more mature business with fewer investment options

CAPEX

Capital Expenditures = money a firm spends on long-term assets (CFI)

2 types of FCF

- FCFF (Free Cash Flow TO THE FIRM)

- FCFE (Free Cash Flow TO EQUITY)

Free Cash Flow to the Firm (FCFF)

Here is all the free cash the business produced.

First we pay bondholders (debt holders), and whatever is left goes to shareholders (equityholders).

We use FCFF when finding...

Enterprise value (valuing the entire business)

What do u use as the discount rate when using FCFF?

WACC (Weighted Average Cost of Capital)

Free Cash Flow to Equity (FCFE)

Cash that is only available to equity holders (shareholders)

- Bondholders have already been paid interest and principal.

We use FCFE when finding...

the equity

what discount rate do u use when finding FCFE?

Cost of Equity

Enterprise Value =

ValueEquity + ValueDebt - Cash

*** its the PV of all future FCFF

Equity Value =

Enterprise Value - ValueDebt + Cash

Multiples

valuation ratios used to compare companies

ex) EV/EBITDA, P/E, EV/Sales etc

Comparables (Comps)

actual companies we compare our company against

How do "Comparables" with multiples work?

Multiples are calculated for your comparables, and then you use the median or mean to estimate your company's value.