1. Prepare to explain the implications of case Exhibit 1 (Paige Simon’s first task). Based on that exhibit, is terminal value (TV) a material component of firm values? From the exhibit, we can find the PV of five years’ dividends is small part of the market price of the stock. In my opinion, we buy a stock then get dividend periodically, which like buy a bond. The coupon payment is dividend and the face value is terminal value. The bond value is determined by the terminal value mostly. So the stock price is also determined by terminal value. The concept of going concern can explain that Terminal value is often higher than the present value of near term cash flows, which means that a company’s long-term cash-flow capacity is more important.
2. Drawing on case Exhibit 4 and your own general knowledge, where would the various estimators be appropriate? Where would they be inappropriate? Simon’s second task)
|Approach |appropriate |inappropriate |
|Book value |Depreciation (accounting) |When the book value is quite different from fair | || |value | |Liquidation value |Bankrupt company (capital budgeting, cases like |Liquidation value will inappropriate for a company | | |machines, plants, natural resources projects, which |which is doing well, because it ignores “going | | |have definite lives) |concern” value. | |firms in weird market conditions | | |Replacement Value |Fixed asset (like PP) | | |Multiples, earnings |P/E: Comparable benchmark companies in the same |P/E the country have not stock market | |capitalization |industry when valuing a stock. |value/EBIT: if working capital is growing, the CFO | |P/E |value/EBIT is useful for valuing capital-intensive |will be overstated which lead this method inaccurate. |value/EBIT |businesses with high depreciation. |P/B will inappropriate for high-tech company because | |P/B |P/B: Finance institutions, P/B more fit for value |they have little tangible asset. | | |companies composed chiefly of liquid assets. | | |Discounted Cash Flow |Private equity valuation, leveraged buyout issue, |when FCF is negative | | |generally there are there situations 1. the firm does|When the capital structure is volatile | | |not pay dividends. 2. he firm pays dividends, but | | | |the dividends do not reflect the company’s long-run | | | |profitability. 3. when taking a control perspective | | | |(minority interest perspective). | |
3. Regarding the case flow forecasts in case Exhibit 5, at what point in the future would you set the forecast horizon for the three invesmtents? Why? More generally, what should determine when you stop forecasting annual cash flows and estimate terminal value?
We calculate the growth rate is equal to 2% from the year list follow: |Movie studio |27th year | |Bottling plant |13th year | |Toll road |3rd year | A key point of judgment in valuation analysis is to set the forecast horizon at that point where stability or stable growth begins. Before the figures we listed above, the growth rate is extremely high which it is possible to sustain in the future. There is no easy answer to the question of how far we should project the free cash flows of a firm and stop to estimate a terminal value. Theoretically, we would prefer to forecast the individual components of revenue, expenses and investments until we have saturated market and revenue growth tracks the growth rate of the overall economy.
In practice, however, few businesses survive that long without experiencing some shock due to contextual changes or competition, so long-lived cash flow projections may be unrealistic. So once we reach the limits of ability to make credible estimates of revenues, expenses and investments (the terminal year), it is time to stop making discrete forecasts of annual free cash flows and instead lump all cash flows beyond the final year into a single “terminal value” that can be added to the final year’s operating cash flow. 4. Estimate other terminal values based on alternative estimation approaches. From these various estimates please make a single composite estimate of terminal value for each of Sierra Capital and Arcadian’s forecasts.
What is the resulting present value (PV) of cash flows under Sierra Capital and Arcadian’s outlook? How significant was TV in creating the difference between the two present value estimates? Chu used the constant growth valuation model to value the firm’s assets. We can also use market multiples method to analyze the value of the firm. |
|P/E |P/B | |Arcadina |15-20 |8. 5 | The book value of Arcadina is 3. 5 million. So the total value is 29. 75 million (3. 5*8. 5). The value range is probably from 29. 5 million to 68 million from the point view of Arcadina management. But the value range from the Sierra is 23 million to 46 million. As the article mentioned, the main difference between the assumptions is about the size of cash flows to be realized over next 10 years. Arcadian’s management believes that they can grow at 7% to infinity, which cause the result of free cash flow is different. So the adjusted free cash flow, terminal value and total present value are different. The PV result of two companies has significant different according their assumptions. Generally, the result of Arcadian’s view is 1. 46 times bigger than Sierra capital’s. 5.
As a general matter in valuation work, how much attention should terminal value garner? What short list of questions about TV could you keep on hand in case a client asked you to opine on a valuation of that company? Terminal value is important in valuing a company we should pay attention to the elements which used to calculate the terminal value. According to the characteristic of the company we valued, we select an appropriate model to handle it. In absolute valuation models, there are DDM, DCF and residual income approach. In relative valuation model, we can use price multiples approach Briefly, the most important we should collect are balance sheet, income statement and cash flow statement.
- In the accounting statement, we should control the quality of earnings, such as follows, accelerating or premature recognition of income, reclassify gains and nonoperating income, expense recognition and losses, amortization depreciation and discount rates, off balance sheet issues
- Based on going concern or non-going concern.
- The role of ownership perspectives in valuation, premiums for control discounts for lack of marketability, discounts for lack of liquidity. Equity valuation considers both quantitative factors (e. g. , growth in earnings, expenses, and margins) and qualitative factors (e. g., the acumen and integrity of management, and transparency and quality of the firm’s accounting practices.)