Finance is about∨a|ue Discounted cashflow valuation Basis for Approach value of asset = CR 2 CE F4 CE (1+r)(1+r)2(1+r)3(1+r) (1+r) where CF is the expected cash flow in period t, r is the discount rate appropriate given the riskiness of the cash flow and n is the life of the asset Proposition 1: For an asset to have value, the ted cash fows have to be positive some time over the life of the asset. Proposition 2: Assets that generate cash flows early in their life will be worth more than assets that generate cash flows later; the latter may however have greater growth and higher cash flows to compensate
Finance is about Value!
Value of what DCF Choices: Equity Valuation versus Firm Valuation Firm Valuation: Value the entire business Assets Liabilities Existing Investment Fixed Claim on cash flows Generate cashflows toda Assets in Place Debt Little or No role in management Inchudes long lived (fixed) and Fixed matri short-lived(working Tax Deduct capital) assets Expected Value that will be Growth Assets Equity Residual Claim on cash flows reated l by 1 Significant Role in management Perpetual lives Equity valuation: Value just the equity claim in the business
Value of what?
Equity.owners capital) Equity Valuation Figure 5.5: Equiry Valuation Assets Liabilities Assets in Place Debt Cash flows considered are cashfilows firom assets after debt payments and after making reinvestments needed for future growth Discount rate reflects only the Growth Assets cost of raising equity financin Present value is value of just the equity claims on the firm
Equity…(owner’s capital)
The Firm including lt debt Firm∨ aluation Figure 5.6: Firm Valuation Assets Liabilities Assets in Place Det Cash flows considered are cashflows from assets prior to any debt payments Discount rate reflects the cost but after firm has of raising both debt and equity reinvested to create growth financing, in proportion to their assets Growth assets Present value is value of the entire firm, and reflects the value of all claims on the firm
The Firm including LT debt
Class assignment What is the firm value and equity value? Cash Flows and discount rates Assume that you are analyzing a company with the following cashflows for the next five years CF to Equity Interest Exp(l-tax rate) CF to firm $. 50 $40 $ $40 $100 $40 $108 $762 $40 $1162 $8349 $40 $12349 Terminal Value $.0 $2363008 Assume also that the cost of equity is 13.625%o and the firm can borrow long term at 10%. (The tax rate for the firm is 50%0. The current market value of equity is $1,073 and the value of debt outstanding is $800
Class Assignment; What is the Firm value and Equity value?