FCFE Valuation versus Dividend Discount Model Valuation

The discounted cash flow model that uses FCFE can be viewed as an alternative to the dividend discount model. Since the two approaches sometimes provide different estimates of value, it is worth examining when they provide similar estimates of value, when they provide different estimates of value and what the difference tells us about the firm. There are two conditions under which the value from using the FCFE in discounted cashflow valuation will be the same as the value obtained from using...

Valuation and Portfolio Management

The role that valuation plays in portfolio management is determined in large part by the investment philosophy of the investor. Valuation plays a minimal role in portfolio management for a passive investor, whereas it plays a larger role for an active investor. Even among active investors, the nature and the role of valuation is different for different types of active investment. Market timers use valuation much less than investors who pick stocks, and the focus is on market valuation rather...

APV and Financial Leverage

In the adjusted present value (APV) approach, we begin with the value of the firm without debt. As we add debt to the firm, we consider the net effect on value by considering both the benefits and the costs of borrowing. The value of the levered firm can Change in stock price - 0.23 per share then be estimated at different levels of the debt and the debt level that maximizes firm value is the optimal debt ratio. Steps in the Adjusted Present Value approach The unlevered firm value is not a...

Gross Debt versus Net Debt

Gross debt refers to all debt outstanding in a firm. Net debt is the difference between gross debt and the cash balance of the firm. For instance, a firm with 1.25 billion in interest bearing debt outstanding and a cash balance of 1 billion has a net debt balance of 250 million. The practice of netting cash against debt is common in both Latin America and Europe and the debt ratios are usually estimated using net debt. It is generally safer to value a firm based upon gross debt outstanding and...

Ke gn

P0 Value of equity per share today DPS1 Expected dividends per share next year gn Growth rate in dividends (forever) Substituting in for DPS1 (EPS1)(Payout ratio), the value of the equity can be written as Defining the return on equity (ROE) _EPS'_, the value of equity can be Rewriting in terms of the PBV ratio, If we define return on equity using contemporaneous earnings, ROE _EPS _, the price to book ratio can be written as The PBV ratio is an increasing function of the return on equity, the...

Net Debt versus Gross Debt

In valuing Embrarer, we used net debt where cash was netted out against debt. In all of the earlier valuations, we used gross debt. What is the difference between the two approaches and will the valuations from the two approaches agree A comparison of the Embraer and the earlier valuations reveals the differences in the way we approach the calculation of key inputs to the valuation. We summarize these. Unlevered beta is levered using gross debt to market equity ratio. Unlevered beta is levered...

Leverage FCFE and Equity Value

Embedded in the FCFE computation seems to be the makings of a free lunch. Increasing the debt ratio increases free cash flow to equity because more of a firm's reinvestment needs will come from borrowing and less is needed from equity investors. The released cash can be paid out as additional dividends or used for stock buybacks. In the case for Singapore Airlines, for instance, the free cash flow to equity is shown as a function of the debt to capital ratio in Figure 14.3 Figure 14.3 FCFE and...

Extensions of Option Pricing

All the option pricing models we have described so far - the Binomial, the Black-Scholes and the jump process models - are designed to value options, with clearly defined exercise prices and maturities, on underlying assets that are traded. The options we encounter in investment analysis or valuation are often on real assets rather than financial assets, thus leading to them to be categorized as real options, can take much more complicated forms. In this section, we will consider some of these...

Conclusion

The question of whether markets are efficient will always be a provocative one, given the implications that efficient markets have for investment management and research. If an efficient market is defined as one where the market price is an unbiased estimate of the true value, it is quite clear that some markets will always be more efficient than others and that markets will always be more efficient to some investors than to others. The capacity of a market to correct inefficiencies quickly...